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The resolution of the widespread protests, political and constitutional issues and ensuring law and order are essential for the country’s economic stability and economic recovery.

The expeditious resolution of the political crises is vital for solving the country’s severe economic problems. The salient issue is whether there would be political stability and conditions to resolve the economic crisis.

Economy

The economy is in dire straits. Humanitarian aid from several countries, World Bank assistance of around US$ 400 million for subsidies, and an extension of the Indian assistance, have been indispensable. Further assistance is being sought from India, China, Japan and other countries and multilateral organisations to tide over the severe shortages in the country.

However, these are only essential palliatives to tide over the severe difficulties faced by the people.A programme to stabilise the economy and begin a process of economic recovery is vital.

IMF assistance

The only means of resolving the debt and balance of payments problems are through an International Monetary Fund (IMF) programme of assistance. The government has at last sought the assistance of the IMF to resolve the severe economic crisis that has gripped the country for more than a year.

The IMF programme is expected to lessen the immediate balance of payments crisis, assist in restructuring the impending debt and improve the external finances of the country. Present indications are that IMF assistance will take time and that there are preconditions to be fulfilled.

Conditions

The Achilles heel of an IMF programme is the painful conditions that the government has to agree on to obtain IMF assistance. Although these are essential financial and economic reforms for economic stabilisation and recovery, people have to incur many hardships and will be politically unpopular.

Misinformation

The opposition to seeking IMF assistance is due to ignorance, misinformation, ideological prejudices, and the political unpopularity of the reform agenda and the hardships of the policies on people. Nevertheless, there is no other alternative policy prescription to resolve the problems facing the country.

Hardships

The IMFs exchange rate policies and fiscal and monetary reforms would bring about hardships owing to further increases in prices. This underscores the need for policies to relieve the lower-income groups through effective safety nets. This is recognised by the IMF and other international organisations.

Policies

Policies must be devised to enable lower-income households to withstand these difficulties. For instance, while fuel prices are increased, public transport should not be costly. There should be methods of subsidising diesel and ensuring that rail transport for ordinary daily travel remains at earlier prices. The pricing structure of rail transport would have to be readjusted to increase higher class and luxury travel to more than reflect the increased costs.

IMF Conditions

The IMF assistance comes with conditions to improve government finances by a process of fiscal consolidation that requires the fiscal deficit to be progressively reduced. Complementary to this is a programme of structural adjustment to enable the reduction of the fiscal deficit. This includes the reform of a large number of loss-making state owned enterprises (SOEs).

Fiscal deficit

In 2021 the fiscal deficit peaked to 12.6 of GDP. It is likely to exceed this in 2022.This has to be reduced to about 8 percent initially and progressively reduced to about five percent of GDP. Fiscal consolidation has to be achieved by a two-pronged strategy of increasing government revenue and reducing government expenditure.

Pruning expenditure

The pruning of government expenditure is difficult owing to a high proportion of government expenditure being on salaries, pensions and interest payments that are mandatory.

Possibilities

However, there are government expenditures that could be curtailed. These include infrastructure projects that do not enhance output in the short term, such as road construction, urban beautification projects, jogging tracks and similar expenditures. Defence expenditure that has been increased must be curtailed, especially by not spending on military hardware.

Expenditure

The pruning of government expenditure has to be achieved by a stringent curtailment of public expenditure. This must begin from parliament itself. Ministers and members of parliament should be stripped of all their perks and instead given a higher salary than at present and only that. This would ensure a much more rational and lower expenditure.

Loss-making enterprises

The reform and divesture of state-owned enterprises that are a huge burden on the public purse would decrease government expenditure and increase government revenue. The government must have the political courage to divest some, reform others and enter into private-public partnerships to reduce public expenditure.

Increase revenue

Much of the reduction in the fiscal deficit would have to be from increased revenue collection. It should be possible to increase current tax receipts to much over the low 8 percent of GDP, which is perhaps the lowest revenue to GDP ratio in the world.

Tax the rich!

Taxes that fall on the rich, such as property taxes and consumer items of the rich should be subject to high taxation. There should be much higher taxes on “conspicuous spending”. For example, road license fees should be increased steeply.

Revenue licences

The current motor car license fees are grossly inadequate. The annual licence for a 1300 CC vehicle is only Rs. 2300: less than Rs. 200 per month. This is grossly inadequate. While this fee should be increased significantly to about Rs 6000, the road licenses of vehicles above this capacity should be increased by a higher proportion.

Justification

The justification for such an increase in indirect taxation is manifold. It is a means of ensuring progressive taxation. The conventional wisdom is that direct taxation fall on the affluent and indirect taxation, especially of food, falls on the poor is faulty. Since Sri Lanka’s tax system obtains only about 30 percent or less from direct taxation, while indirect taxation accounts for 60-70 percent, it is suggested that direct taxation should be increased to ensure a more progressive tax system.

Direct vs indirect taxation

In Sri Lanka’s context this conventional dichotomy is invalid. It is well known that tax avoidance and tax evasion is widespread in the country. The rich pay little taxes. This is due to an inefficient and corrupt administration whose incapacity to tax the rich and powerful are strengthened by political influence and interference. It would be interesting to know how many of the 225 MPs pay taxes and how much. Similarly, high earning professionals avoid taxes. Therefore, the realistic option is to tax the rich through indirect taxes that fall on affluent and conspicuous consumption.

Summing up

The financial and commodity assistance from international organisations, foreign governments and NGOs is invaluable to overcome the severe scarcities of essential food, fuel, fertiliser, medicines and raw materials for industry. Nevertheless, they are palliatives. There has to be a restructuring of debt obligations and reforms to stabilise the economy with the assistance of the IMF.

The foreign currency, fiscal, monetary and structural reforms will heap burdens especially on low-income households. There should be safety nets to relieve the poorer households. Fiscal consolidation should be achieved by curtailing public expenditure and progressive taxation.

Many of the necessary reforms, are politically unpopular and a strong political will and courage is needed to implement them. If however such reforms are not implemented, the island’s economy will remain in crisis.