Traders, consumers confused with VAT
The value-added 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 of living.

Certainly the 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.

The government 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.

The public is used to seeing the business community in general and traders in particular not hesitating to use such situations to increase their profits.

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 ethics.

This government, 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.

Ultimately, 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 tax exemption.

The issue is reform, not aid - IMF
By 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.

What would 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 about reform.

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 it.

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.

There's been 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.

What is 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 by September?
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 at all.

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.

You've got 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.

Ultimately 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 revenue?

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.

Governments 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 (GDP).

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.

The standby 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.

For example, 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.

You have 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.

Unfortunately, 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 manner.

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 world level.

That means 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?

There have 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 in Argentina?
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 efficient government.

These structural 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.

Somehow we 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.

The IMF 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.

That cricket 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.

What are 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 of it.

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.

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