consumers confused with VAT
tax (VAT) system is finally here and there is still a lot of confusion
over its impact on the cost of living. Obviously, the government
campaign to explain matters to the public has not been effective
enough, despite the energetic efforts of the articulate Deputy Finance
Minister Bandula Gunawardene, the United National Front regime's
point man on all things economic. Gunawardene has been trying strenuously
to show that the VAT exemptions granted to a wide range of essential
consumer items, from rice and bread to kerosene and pharmaceuticals,
would inevitably result in lower prices and a reduction in the cost
stated objectives of the VAT - namely to avoid the cascading effect
of the previous system and to simplify the system - are laudable.
But there are
genuine concerns about its effect on the cost of living. Opposition
parties have not helped by making all sorts of wild claims about
the effects of VAT and deliberately muddying the waters. At last
week's news conference at the finance ministry, where the authorities
had assembled key figures of associations representing traders of
vegetables, fruit, rice, fish and motor vehicles and bicycles -
items of widespread use among the people - Gunawardene tried to
make out that any increase in living costs that occur now would
not be as a result of VAT. Rather, he pointed out, not without some
truth, that external and seasonal factors such as a depreciating
rupee and rain and drought could affect prices, especially those
of perishable commodities such as fruits and vegetables.
The lack of
storage, transport, and marketing facilities also impact on the
availability of goods and their prices.
But the public
is not convinced. They have the legitimate fear that given the government's
stated objective of increasing revenue through the VAT, price hikes
are inevitable and that it is they who would be called upon to bear
the burden of such increases.
They also fear,
again with some justification, that the country's traders and businessmen
would be naturally inclined to make a quick buck by exploiting the
confusion that comes with the introduction of the new tax system.
says that the increased revenue will come from widening the tax
net and by ensuring better compliance. Previous governments too
have made similar promises so it remains to be seen how successful
this one would be.
is used to seeing the business community in general and traders
in particular not hesitating to use such situations to increase
They know that
the alacrity with which traders and the business community respond
to increases in taxes and other costs by jacking up retail prices
is not matched by a similar desire to lower prices when taxes and
costs do come down.
Nor do they
have much confidence in the ability of the government machinery
to ensure fairplay and prevent exploitative pricing tactics. The
best example is that of private buses. Every time private bus operators
jack up fares we are told that this would be accompanied by a better
service. But this never happens. How many times have we been told
that private bus operators would be compelled to issue tickets?
How many private buses do issue tickets? Likewise, in the case of
auto-rickshaws or 'three-wheelers' the use of meters long went out
of fashion and drivers seem free to charge exorbitant fares as seen
from the widely different rates they quote for the same distance.
These issues concern not only the travelling public and but also
are matters that have an effect on revenue collection and of business
which is such an ardent fan of economic liberalisation and of giving
pride of place to the private sector, cannot expect to generate
public support for its pro-business economic policies if the people
see themselves being ripped off by a set of rapacious businessmen
and traders. The government's claim of having introduced the VAT
after much careful thought and consideration is not borne out by
the frequent changes that have been made to the VAT, especially
the numerous exemptions that have been announced in response to
complaints from the business community and the public.
what matters is the government's will and ability to ensure effective
regulation of the market to prevent consumers being exploited. As
we have said before, the business community itself has a responsibility
to ensure, perhaps through their chambers and associations, of more
responsible behaviour on the part of retail traders in passing on
the benefits of cost reductions resulting from a lower VAT or a
issue is reform, not aid - IMF
a Staff Reporter
From his office in the Central Bank high rise overlooking
the Indian Ocean, Dr. Nadeem Ul Haq speaks passionately about economic
reform. He has been a vocal advocate of liberalising the economy
and of reforming its institutions during his three-year stint here
as the senior resident representative of the International Monetary
Fund (IMF). The Pakistani-born economist, who will be leaving in
September for an assignment in Egypt, points to the empty sea and
asks why an island nation such as Sri Lanka is not making more use
of the ocean. The economy is too heavily regulated and needs urgent
reform if it is to grow, he says in this interview.
you consider your most difficult challenges and main achievements
during your term here?
The most difficult
challenge has been to truly generate an understanding of reforms
in this country. I've watched this economy grow in my first year
in 2000 at a moderate pace of about six percent a year and then
it started declining and went into negative growth last year.
But I see a
huge potential in Sri Lanka and unfortunately that potential is
not being realised partly because people are still stuck in the
earlier notion of looking for large governments and large government
protection. Unfortunately, the debate on reforms is not conducted
in an informed manner. There are too many misgivings and misunderstandings
I keep making
this statement that every reform that any good economist would suggest
to you will be in the interest of the poor. This is my challenge
to everybody. That there is no reform that a good economist would
recommend that is not in the interest of the poor. Yet people persist
in making the accusation that the reforms that have been recommended
are not in the interest of the poor.
In terms of
achievements, I would highlight a number of things that seem to
be beginning to happen - I will not say that they have happened.
For example, in terms of institutional reform we have begun the
Central Bank reforms. Still, a lot of work needs to be done to complete
We have begun
to talk about modernising the Inland Revenue and customs authorities.
So people have begun to understand that we need modern institutions.
At the idea level I hope I've been able to contribute to the debate
in Sri Lanka.
I helped arrange
the three conferences - the deregulation conference, the financial
markets conference and the education conference and I think they
were very successful because people are talking about them and beginning
to think about these issues.
an open debate about deregulation and reform because of these highly
important initiatives and that's very good. More importantly what
is of great interest to me is - people sometimes come up to me in
the streets and say 'Hey, I understood what you were trying to say'.
They seem to
appreciate reform thinking. Contrary to popular belief in upper
circles, the ordinary Sri Lankan likes modern ideas and more thinking.
That is very gratifying and very complimentary to Sri Lankan society.
It is very important to carry the message to the people. I tried
that in my own way because of my Pakistani origins because I have
always wanted my country to grow and do well and it is with exactly
that desire that I tried to work for Sri Lanka.
the current status of the talks between the government and the IMF
on obtaining further financial aid? Could you describe the nature
of the Poverty Reduction Growth Facility (PRGF) that is expected
We're ready to do a PRGF and the government has prepared a reform
programme and a poverty reduction strategy paper. If you will go
ahead with the economic reforms we'll do a PRGF. It is too early
to say how much money is involved.
But the issue
in Sri Lanka is not aid. You've got enough money waiting in the
pipeline. Donors have contributed enough. You've got enough unutilised
money. You don't use enough of your aid. So the issue is not money
The issue is
truly accepting economic reform and truly accepting the challenges
of globalisation and dressing up your economy to face globalisation.
We can give you more money, the world can give you more money. What
is important is what you are doing with the money. You've got an
economy where the size of the government is too large, you're running
large deficits and accumulating debt.
an economy where we cannot seem to move the privatisation process
ahead so that the size of the government will shrink. You've got
an economy where the government is employing too many people. You've
got an economy that remains highly regulated, where you closed down
your main sectors.
You're an island
economy but you've closed down the sea - the sea should be open
for business. So unless you do allow your economy to be more open
and friendly to investment to both local and foreign investment
your economy is not going to grow.
what matters is production - on the sea, in the air, on the ground.
The stock market should be moving, the banking sector should be
moving, you shouldn't have state-owned banks. They are not doing
too well and are a drag on the whole sector.
n How does
the IMF view the government's recent decision to reduce fuel prices?
How will it affect the agreement with the IMF? Will it affect government
We don't want
to get into the nitty-gritty of telling you little things like what
to do with fuel prices. We want the whole reform programme to move.
The true cost to the people is the drag on the economy placed by
the lack of reform. The fuel price decision will affect government
revenue and it should take other measures to raise the revenue.
always have choices and they should make them responsibly. Of course
we're concerned about the budget deficit being manageable. Ultimately
the way out of your problems is economic growth because your debt
burden and fiscal burden is only in relation to Gross Domestic Product
If you can
make GDP grow faster your debt burden and fiscal burden will be
reduced. When governments are managing crises, they have to play
around with prices and taxes. However, care should be taken that
long-term economic growth is not sacrificed.
In my tenure
here I've implemented the newer IMF approach of focusing on long-term
growth issues and hence have focused sharply on economic reform.
That's why we are doing the PRGF with you. We want to reduce poverty
through growth for the long term.
n But isn't
the IMF concerned that the government is tinkering with the agreement
owing to political expediency?
Let me put
it back to you. Why is the media focused on getting a headline from
a government-IMF debate or difference of view? As an analyst it
seems to me that what the government does with economic reforms
affects ordinary people far more than our differences.
I urge media
in Sri Lanka to focus more on reform and all its manifestations.
To write more about your institutions and how they can be modernised.
To worry more about your role in a globalised world and the global
opportunities that are offered to you. Are you taking up those opportunities
or not? Are your institutions ready for such opportunities? Now
on these issues, you should dialogue with us as well as all stakeholders
of your society.
arrangement was for stabilising the economy and now we are ready
to move towards a PRGF. The PRGF is for addressing the long-term
structural reform issues. And for the build-up to the PRGF we need
to have debate and dialogue on reform.
We have found
that if there is no debate and dialogue on reform the commitments
don't matter much. Ultimately the greater the understanding of reform
in society, the more easy it is for governments to make the reforms.
I argue that no democratic government will lead reform. The government
will follow society's thinking on reform. Because in a democratic
set up the government is always looking for votes. If they find
there are enough votes backing reform they will make the reforms.
So you can
see the media has a critical role in educating people on reform
and creating a constituency on reform. No amount of our pushing
will make the reform unless the people are ready.
been a vocal advocate of economic reforms and of liberalisation.
Is it fair to ask a poor, vulnerable, Third World country like Sri
Lanka to open up, eliminate tariff barriers to allow unrestricted
entry of foreign goods to the domestic market and be exposed to
the forces of globalisation and foreign competition when even the
USA, Japan, and the EU spend billions on subsidies to protect their
farmers and domestic industries?
I think that question is very misunderstood in poor countries.
When you think of farmers in America or Japan, look at the size
of the agricultural sectors in the GDP of those countries. It is
very, very small. And do not forget they are rich countries and
have the resources.
in poor countries there is often too much protection matched by
too few resources. This leads to a large fiscal burden which places
a drag on the economy.
Still, I should
mention that the IMF has consistently asked the rich countries to
open their markets fully to poor country exports.
But I must
correct misapprehension. We're not asking you only to liberalise
and open up - that is not our central message to you. Our central
message to you is - fix your institutions for economic growth.
If you can
fix them without liberalising, by all means do it. But ultimately
you must have institutions that are functioning well, that will
facilitate quick adjustment because this world in the 21st century
requires quick adjustment. You can't wait years to develop financial
or labour markets.
Where are the
markets? What are the institutions that are regulating markets?
What are the legal systems? How is the governance structure as a
whole performing? Our central message to you is - build institutions
of government that perform in a clear, transparent and efficient
So you don't
mind a certain degree of protection for domestic industry?
I don't mind any policy provided you have understood what it
means and you have analysed it fully. Unfortunately, protectionism
is a word that is misused very frequently.
Let us analyse
the case of food. Say you offer protection to farmers. But we forget
that consumers are paying for that protection. This is because when
you protect wheat or rice you do so by keeping the price above the
your home population, including the poor, is paying for these commodities
more than the rest of the world level. So as much as you protected
it, you hurt the poor. There's no easy answer. Sure, if you remove
the protection, farmers could go out of business. But at the same
time people would have cheaper bread and wheat.
The price of
food would go down. All of us would benefit. I find that farmers
are entrepreneurial and do not need protection. Without protection,
we will find that they will become more entrepreneurial and create
growth. It is these farmers that are migrating to the Middle East
and Australia. They are taking boats and smuggling themselves. They
are responding to economic incentives. They earn money abroad and
to put up a house here. They are innovative people. Give them the
opportunity to find fresh ways of doing things. Look at the way
you grew tea. Why can't we have another burst of such innovation?
been calls for reforming the international financial system itself
and the IMF. Hasn't the IMF displayed a remarkable degree of incompetence
in managing the international financial system given the way it
failed to tackle the South East Asian economic crisis and the one
There is some truth to what you are saying but probably you
are putting it a little more harshly than I would. In most crisis
countries, recoveries have been relatively fast. And I think that
does suggest that on the whole we are not doing too bad a job. The
IMF is not totally infallible. However, with regard to these crises
we have managed things reasonably well. This is not to say that
we know everything. No crisis is the same as the one before. There's
so much uncertainty in the world. And we are not in control of these
things. We try and do the best we can. But I do maintain we are
very good at what we do and do learn very fast.
One of the
main criticisms against the IMF is that it is not mindful of the
economic and social disruption caused by its policies, particularly
that its structural adjustment policies have not really worked and
actually made things worse? That the IMF really acts in the interests
of Western industrialised countries and their multinational corporations?
This is popular criticism. It is also a little too harsh. The
IMF is also undergoing a lot of changes. We're not the same institution
we were even five years ago or 10 years ago. E.g. 30 years ago we
were not doing any poverty work. Now we're doing poverty work, we're
concerned about social issues. I don't think it is right to say
we cause social disruption. We have learnt a lot about the political
economy of these countries.
But a lot of
problems arise in the politics of the situation. Governments have
choices - of making deep structural reforms. E.g. governments over
built themselves in the 1960s and 1970s - large governments were
created and accumulated large debts. That obviously has to change.
Governments also have to come down in size. The public expects more
reforms are very difficult to conduct. Every government wants to
postpone it for the next one because democratic governments have
short tenures. You have this inefficient sector acting as a dead
weight on the economy. And to cover up - in short-term crisis management
- the government has to increase taxation or prices. And that dilemma
of short-term crisis management versus the need for longer-term
growth, which means deep structural reforms, continues while the
economy continues to suffer.
need to address that. Now the moment you do so some people will
be discomforted. We can try and compensate that in some ways. But
there's going to be some adjustment cost. That is the key issue
that we try and face in every country.
But the political
set up will not allow us the freedom to do that in a reasonable
manner. Also, I think the education sector, key civil society institutions
are not ready to support such reforms.
has been pressing for a reduction in the government's role in the
economy and for giving more emphasis to the private sector. There
have been many criticisms that Sri Lanka's private sector is not
dynamic enough, and that we are still largely a trading economy
and that our industrial expertise is confined to merely assembling
garments under a protected quota system. In this context, is the
private sector really capable of being the engine of growth?
The private sector will never be ready until you allow them
a playing field to play on. If you are only going to restrict them
to garments then obviously they are always going to say they are
not ready. That's why I say deregulate the economy - let them do
all kinds of things. E.g. give them the sea, air and land.
When you have
different industries then you get a dynamic private sector. Maybe
it won't be the same people. Maybe it will be the migrants who will
come back and set up something. It has happened in many countries.
I don't accept
the fact that there isn't a dynamic private sector in any country.
Because I see it existing overseas when it is not allowed domestically,
because the economy is over-regulated and you have given licences
or space only for two or three activities.
Also, the private
sector is not the engine of growth. That is a misperception. It
is the market that is the engine of growth. The private sector is
but one player in the market. So is the government. The private
sector can be just as greedy and corrupt as governments.
That is why
I keep saying, build markets. If you want to play cricket you must
have a cricket field and competition. Unfortunately, the way the
private sector has been built in these countries is to build a cricket
team without a field or competition.
team obviously is handicapped and obviously that's what everybody
complains about. Then you say cricket is not a good game because
we don't have a good team.
the areas where more reforms are required?
For example, the last three years we've been talking about privatising
Sri Lanka Telecom. Its value has gone down dramatically and it has
not been privatised. In the last 3-4 years there's been very little
privatisation. We need to eventually privatise the state banks -
if you want a vibrant financial sector the state has to move out
If the umpire
is the only guy playing on the field, it's not cricket is it? So
you must have the umpire move out of the field and let the teams
play. Here the umpire is playing insurance, the umpire is playing
banks. That won't do. Everywhere in the world the one lesson we've
learnt is that state banks do not make money. Then the labour market
reforms. Markets means people must be able to transact without the
umpire controlling the whole transaction. You need to build up quality
education. You need to develop space for investment, to open out
all kinds of sectors for investment. At least let the Sri Lankans
invest. Let the overseas Sri Lankans invest. You must ask this question
in your paper "Where is your investment space?" That raises
issues like land acquisition, titling. If I want to put up a hotel
I need to buy land and get permission quickly.
You gave the
example of using the sea for business. What do you mean by that?
The sea is
used for business all over the world. Why don't hotels have jetties
from which they can take boats and people into the sea for fishing,
scuba diving, cruises, transport, whatever.