Columns - The Sunday Times Economic Analysis

Central Bank indicates conditions for better economic performance

By the Economist

The Central Bank is quite optimistic about the prospects for the economy this year. Based on the performance of the economy after the end of the war, it predicts “greater prosperity” and “long term sustainable development”. In the summary of the Annual Report for 2009 it states: “The end to the prolonged internal conflict and the restoration of peace provide a greater optimism for economic prosperity and a strong basis for long-term sustainable development, supported by appropriate policies.

The opportunities created by the restoration of peace, will be complemented by the ongoing global economic recovery. The low inflation and interest rate regime that prevails also provides a conducive environment to fuel economic activities.”

This is a general expectation that must be realized through appropriate policy measures. The Central Bank has specified several conditions that must be established to achieve a higher growth in the economy. In the words of the Central Bank, “To harness these opportunities, the existing bottlenecks that hinder a faster growth need to be addressed urgently. Infrastructure projects, already commenced and planned, need to be accelerated to expand the productive capacity of the economy and to improve the efficiency and productivity of economic activities.

At the same time, special attention needs to be paid to implement much needed structural and institutional improvements, including the enhancement of the profitability and productivity of public enterprises that are a significant drain on public finances.

The fiscal consolidation process also needs to be strengthened. The contribution of the private sector to overall economic development needs to be increased. The regulatory framework has to be further strengthened. Establishment of a strong development planning and monitoring process would be helpful to prioritize projects, avoid delays and ensure the optimal allocation of resources. In the short to medium-term, moving to a high growth trajectory, while maintaining price stability remains a key policy challenge.”

Quite rightly the Central Bank has stressed the need for policy initiatives to strengthen the economy and usher in the rapid economic growth and prosperity that the country seeks. Although the end of the war brought about the resuscitation of the economy, the achievement was below potential.

The elections and its aftermath distracted the country from the urgent tasks that lay ahead for development. Now that the elections are over and no national elections are expected for another five to six years, the political stability so essential for economic policy formulation and implementation of policies has been established. What are the critical policy initiatives that are needed for rapid growth?

The Central Bank has stated these in a nutshell and these require to be spelled out in some detail. First and foremost: “The fiscal consolidation process also needs to be strengthened.” Fiscal consolidation means the reduction of the fiscal deficit to manageable proportions by increasing revenue, on the one hand and reducing expenditure on the other hand. The importance of this has to be stressed and stated more forcefully than the Central Bank has indicated. Without fiscal consolidation there is no way that the economy could be stabilized.

And stabilization is vital for the development of an economic environment conducive for development. Without this the economy will generate inflationary pressures that would destabilize economic activity. Inflation would affect the competitiveness of the country’s exports, increase the trade deficit, strain the balance of payments and require the depreciation of the rupee. In short, it would be a serious obstacle to economic growth, employment generation and poverty reduction.

The fact is that the government has failed to contain the fiscal deficit to a reasonable proportion of the GDP. It was particularly bad last year when the deficit reached 9.8 percent of GDP. The Central Bank explains the reasons for this: “The high deficit was a combined outcome of a shortfall in revenue, overrun in recurrent expenditure and increased expenditure on infrastructure projects. The government revenue was significantly below the targeted level. The total revenue as a percentage of GDP declined to 14.6 per cent in 2009 compared to 14.9 per cent in 2008 and 16.3 per cent in 2006. Meanwhile, total expenditure and net lending increased to 24.9 per cent of GDP, compared to that of 22.6 per cent in 2008 and 24.3 per cent in 2006. Recurrent expenditure increased significantly, as a percentage of GDP to 18.2 per cent from 16.9 per cent in 2008. Public investment increased to an encouraging level of 6.8 per cent of GDP in 2009 compared to 6.0 per cent in the previous year.”

It is vital that the government brings down the deficit to around 7 percent of GDP by pruning down government expenditure and increasing revenue. Cutting down defence expenditure, reducing waste and at least reducing losses in public enterprises are three vital areas for expenditure reduction.
A second factor the Central Bank identifies is infrastructure development that is recognized as a reason for the country’s modest economic performance.

However this is an area in which there has been significant progress despite financial constraints. “To harness these opportunities, the existing bottlenecks that hinder a faster growth need to be addressed urgently. Infrastructure projects, already commenced and planned, need to be accelerated to expand the productive capacity of the economy and to improve the efficiency and productivity of economic activities.” Since the country is faced with a resource constraint, it is important that infrastructure development that is very expensive is undertaken on the basis of priorities related to their contributions to the economy.

A very important need emphasized by the Central Bank is “to implement much needed structural and institutional improvements, including the enhancement of the profitability and productivity of public enterprises that are a significant drain on public finances.” This is an area of hardly any progress in recent years. Political factors have deterred governments taking the necessary measures. Trade union actions that are counter to the national economic interests have been a stumbling block to reforms. The new government must now have the resolve to implement these much needed reforms that would improve the efficiency of public enterprises and save much money due to losses of government enterprises.

Another very important area is effective implementation. This has been a serious and fundamental weakness that has vitiated economic performance. The Central Bank has urged the need for the ‘Establishment of a strong development planning and monitoring process which would be helpful to prioritize projects, avoid delays and ensure the optimal allocation of resources.’ The importance of this is well recognized and this must be a priority of the government in order to improve the economic efficiency of public investment.

The end of the war and terrorism, the establishment of a stable government and the expectations of global economic conditions provide an environment conducive to a faster rate of economic growth. Yet as the Central Bank has pointed out, there are serious constraints and bottlenecks that must be overcome. A serious resolution of these problems identified by the Central Bank would stimulate economic growth in the next five years.

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