Columns - The Sunday Times Economic Analysis

Another year of lost opportunities: Is there hope ahead?

By the Economist

The end of the war brought new hope to the country’s economy. The much awaited peace dividend was to be harvested, foreign investment was expected to flow in, reconstruction and rebuilding of the North was to boost southern enterprises, business confidence restored and the economy expected to begin a new trajectory of high growth.

Foreign investment was expected to flow in at unprecedented levels; tourists were to boost the ailing hospitality trade and several sectors dependent on tourism. Agricultural and fisheries output was to increase and a new wave of prosperity was expected to be round the corner. It would be difficult to suggest that much of this has happened. Only a trickle of economic gains is seen and there is much in the economy that has been a setback as well. The optimistic expectation after the war has turned to dust. In fact the initial confidence in the economy has been eroded and a new wave of confidence would have to be established soon.

Undoubtedly the end of the war brought some gains to the economy. Tourist arrivals increased significantly but perhaps still by less than it may have been had the elections and its associated violence not been there. There were increases in fish production and agricultural produce from the North arrived at markets in Colombo. Banking and financial institutions opened branches in the North and were poised to service these areas. Some new economic enterprises have also been established. These gains have been marginal and not anywhere near the expectations.

Despite these gains the business community viewed 2009 as a year when the expected economic recovery was not realised. One of the most important local business leaders described 2009 as the most turbulent year. The nature of this horrible year for business was captured by the Chairman of the Singer Group in several of the annual reports of the Singer Group of companies. In the Annual Report of the Singer Group, Mr Hemaka Amarasuriya said “As we report to you on the year that ended (2009) let me confirm that without doubt this was the most turbulent year in our 132 year old history. Never before have consumer markets fallen in this untoward manner…”

The Presidential election and then the chaos afterward followed by the general elections were a setback to the economy. The country’s focus was on the elections and the political unrest rather than the economy. And as is usual at times of elections, government’s economic decisions were based on short term political gains rather than the long term interests of the economy. Even the steps towards national reconciliation were postponed and the country has been virtually in limbo. Now the country awaits the end of the elections and a new beginning with the ushering in of a government soon after the ushering in of the National New Year.

The elections at the end of the war meant a complete diversion and distraction from the compelling needs of economic and national reconstruction. As it always happens, election time is a time of promises and instant relief through government spending. There is no better statistic that summarises the result of these decisions as the deterioration in the fiscal deficit. The fact that last year’s fiscal deficit reached nearly 10 percent of GDP captures this worsening in the economy.

The fiscal deficit that had reached 7.7 percent in 2008 was expected to be brought down to 7 percent in 2009. The government even gave an undertaking to the International Monetary Fund when it obtained the stand-by facility of US$ 2.6 million that it would bring down the deficit to 7 percent of GDP in 2009.

High government expenditure, lowering of tariffs and loss of revenues ensured that the deficit would rise to 9.7 percent of GDP. This is not only well above the agreed condition with the IMF but high by any standards of fiscal prudence. Instead of lowering the deficit the government succeeded in increasing it. The result was that the IMF suspended giving the third tranche of the loan.

The government must recognise that the fundamentals of the economy are weak. The public debt has reached around 90 percent of GDP and debt servicing costs are absorbing nearly the entirety of government revenue.

The high foreign exchange reserves are mostly borrowed funds and foreign debt is a high proportion of GDP and its servicing costs could strain the balance of payments. The trade deficit is high and there is every danger that it may increase this year owing to both higher prices of imports and the declining trend in the country’s industrial exports. Inflationary pressures are increasing and the forecast is for a higher rate of inflation this year.

The bright spot in the economy is the high and increasing inflows of remittances that wipe out the trade deficit and results in a balance of payments surplus. We must not ride this good fortune and neglect the correction of the fundamentals of the economy.

What steps the government would take post election is to be seen. One of the fundamental corrections that must be made is to align government expenditure more in line with government revenue. Moves in the direction of fiscal consolidation would be a key factor in developing business confidence, taming inflationary pressures, stabilising the economy and attracting foreign investment. What happens to the delayed IMF third tranche would have an enormous impact on the economic course in the next few years.

This is not because of the amount of the remaining loan, but the fact that the country’s credit assessment and foreign investment and foreign borrowing will depend on the IMFs confidence in the economy by continuing the stand-by loan facility. The earnest hope is that after the general election, whoever may form the government would take the management of the economy seriously and follow sound economic principles.

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