The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Is the economy about to take a plunge?
There are two questions uppermost in the minds of a large section of the population. Will the peace process go forward or are we at the brink of a period of terrorist activities by the LTTE? Will the economic policies of the new government destabilise the economy through its fiscal policies and reverse the market-friendly policies pursued since 1977? Both these questions are interrelated and uppermost in the minds of many people, as the policies of the government remain unclear at present. The answer to the first question would have an overriding impact on the economy and have a momentous bearing on the prosperity of the country.

There is serious concern about the peace process owing to pre-election pronouncements of the coalition and the lack of concrete proposals of a strategy to commence talks towards a settlement. On the one hand the stance of the LTTE and their boycott of the elections that resulted in the debarment of the Tamil people of the North to vote raises serious concerns about their intent to come to a settlement. The attitude of the LTTE to the new government and the peace process may be a little clearer after the likely Prabhakaran pronouncement today. The expectations of any positive response towards a solution are however bleak.

An atmosphere of peace is vital for the economy to grow. If we return to the pre-Cease Fire Agreement conditions of widespread terrorist actions on the part of the LTTE, especially in Colombo and the South, then several significant sectors of the economy would be adversely affected, among them tourism being the most vulnerable. Such set backs would have repercussions in the financial and corporate sectors and on several other economic activities with which tourism has backward linkages. Further, foreign investment in particular would not be forthcoming. In fact there has been tardiness in foreign direct investment flows in recent years owing to political uncertainty.

This trickling of investment flows may tend towards a complete drying up of such investment, if the country returns to a state of terrorism or war. President Rajapakse's swearing in speech was reconciliatory and moderate. Whether the actions of the government would follow such a path remains to be seen. Unfortunately the stance of the coalition partners leads to a scepticism about the intentions of the government. The president must move away from unrealistic positions and the policies of some of his coalition partners if the country is to move in the direction of a durable peace. There is an urgent need for policies that would reverse the present gloom regarding the prospects for peace.

He has to accommodate more moderate views and convince the international community that a viable political and constitutional settlement is possible. Without this the international community would, despite their avowed interest in eliminating terrorism, turn a blind eye to terrorist activities here. The government must be mindful of the trap that the LTTE has set in trying to provoke the government to display a Sinhala chauvinist path. Without a movement to peace the economy would perform far below its potential and economic enterprises seriously vitiated from the current levels of performance.

The President's announcement of presenting a new budget does not lend much hope for restrained and realistic fiscal policies. The budget presented in parliament on November 10, just before the election, was dubbed an election budget, as it had a number of costly proposals. The budget deficit was calculated to be a high 8.5 per cent, though the outturn was likely to be higher. If the revised budget that is expected to follow the principles of the Mahinda Chintanaya confers another set of subsidies, this would destabilise the economy.

The result would invariably be higher inflation, increase in the public debt, non- competitiveness of exports, depreciation of the currency and further inflationary pressures owing to these developments. It must be further mentioned that the reasons for this is not merely the magnitude of the budget deficit but the quality of the spending. The increases in public expenditure is on subsidies and welfare expenditure that are inflationary. If the additional public expenditure were to be for development of infrastructure, then after a time lag the increase in goods and services that results would be beneficial to the economy and result in the abatement of inflation. The kind of expenditure envisaged by the new proposals are mainly subsidies that will have hardly any impact on economic growth.

There is a lack of appreciation of fundamental economic principles or those deciding on policy are willing to go against their own understanding for immediate political gain. Ignoring economic principles would create serious problems for the government. To make things worse the UNP opposition is setting an economic trap in urging the President to implement the election promises. Unfortunately democratically elected leaders are myopic and fail to take decisions in the interest of long-term economic development.

With friends like the JVP promoting subsidies and advocating protectionist economic policies and a opposition cunningly promoting welfare policies that would ruin the economy, the President may find himself in severe economic difficulties sooner than he thinks. He has to choose between immediate political popularity and being an unpopular President by the end of his first term of office or much before. We hope the new budget would not put the government into pitfalls from which it would be difficult to extricate itself.

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