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Sri Lanka urged to cut tax breaksOct 23, 2009 (LBO) Sri Lanka should cut down on tax incentives to attract ForeignDirect Investments (FDI) and concentrate on improving the business climate to maximizethe benefits of peace, a senior economist said.
"Policy makers must bear in mind that investment decisions by local and foreign players
do not exclusively depend on fiscal incentives but also on a range on non-tax aspects,"Saman Kelegama, executive director at the think tank, Institute of Policy Studies, said.
"An improved investment climate is foremost of these; a streamlined tax system, lowercorporate tax rates, fasted granting of approvals related to setting up businesses and soon."
Kelegama's comments came during a speech at the 14th tax oration seminar onanomalies of the tax system in Sri Lanka, organized by the Institute of Chartered
Accountants of Sri Lanka.
Sri Lanka's investment climate has improved after government forces defeated TamilTiger separatists in May, ending a 30-year war that had forced the island to givegenerous tax breaks to attract investors.
Kelegama said according to the World Bank's 'Doing Business Report 2009', out of the171 countries featured, Sri Lanka way behind others in many business indicators.
Sri Lanka has one of the highest corporate tax structures in the region with a high of 35percent, when competing regional economies such as China, India, Malaysia, HongKong and Vietnam charge just 25 percent as corporate tax.
Only Pakistan and Philippines charge the same rate of corporate tax from its
businesses, Kelegama said.
Despite vast concessions offered to investors Sri Lanka could only muster 900 milliondollars in FDI in 2008. Most direct investments came as upgrades in the celco sector,while FDI to the real economy still remains low.
The Board of Investment (BOI) investment promotion agency estimates a one percentreduction in corporate taxes increases FDI's by two percent.
"FDI flows to the Sri Lankan economy amount to just 1.5 percent of Gross DomesticProduct (GDP) while revenues losses due to BOI tax exemptions cost as much as onepercent of GDP," Kelegama said.
"So while it certainly has promoted greater investment and more export orientation theBOI tax incentive regime has resulted in an erosion of tax revenue as it has granted, andcontinues to grant, broad tax incentives."
In paying taxes, Sri Lankan businesses must go through 62 payments that take 256hours, Kelegama said.
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In Singapore, one of the most efficient economies in the world, company's are taxed at28 percent. The tax process can be completed in five payments that take 84 hours tocomplete, Kelegama said.
"Malaysia, Indonesia, Thailand, Vietnam and even Bangladesh rank higher than SriLanka," Kelegama said.
"All these impose severe costs on businesses and are factors strongly considered byinvestors when looking to set up in a country, not just fiscal incentives."
A few days before President Mahinda Rajapaksa presents the 2011 national
budget (takes place tomorrow), Dr. Saman Kelegama, Executive Director,
Institute of Policy Studies of Sri Lanka and Member of the Presidential Taxation
Commission, spoke to the Business Times on the serious issues that confront tax
reform in the country.
Today, approximately 80% of tax revenue comes from indirect taxes and only
20% comes from direct taxation. In other words, the bulk of the taxation has
fallen on the less well-off people. Pic shows a small outlet in Galle
Q: What are the key recommendations of the Presidential Taxation
Commission?
The final report of the Commission was submitted to the President on October
26. The Commissioners consider the contents as confidential until the report
becomes a public document. Thus, I am not in a position to speak about the
specific recommendations but I can speak on the overall perspective and raise
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issues that are of interest in the context of tax policy.
Q: What is the most fundamental problem in regard to the taxation system
in Sri Lanka?
The tax system is not delivering the potential revenue in Sri Lanka. As income
increases in a country, the revenue also increases although the rate of increase
will decline after some time. This is not happening in Sri Lanka. Sri Lankas per
capita income has increased from US$ 720 in 1995 to US$ 2053 in 2009 but our
tax revenue has declined from 20.4 % GDP to 14.6 % GDP during this period.
Almost 90% of revenue comes from taxes (10% is accounted by non-tax
sources). Tax elasticity measures the extent to which the tax system generates
revenue in response to increase in income without change in the tax rates. This
is less than unity or one and not a healthy sign.
The key reason for this is that the tax base has not broadened in line with the
increase in income or economic activities. The reason for the weak tax base is
the multitude of tax exemptions, tax evasion, many discretionary tax measures in
operation, and weak tax administration.
Q: Are there any other outstanding specific problems in the Sri Lankan
taxation system?
The weak tax revenue over the years has led successive governments to impose
ad hoc taxes from time to time, so much so there are about 25 taxes in operation
in the Sri Lankan economic system. This is a large number of taxes compared to
other developing countries and has made the tax system very complicated. With
8 to 10 taxes in the system, some developing countries have managed to collect
a larger per cent of revenue per GDP than Sri Lanka.
Secondly, successive governments have heavily depended on indirect taxes for
tax revenue instead of working out a reasonable balance between indirect and
direct taxation. Today, approximately 80% of tax revenue comes from indirect
taxes and only 20% come from direct taxation. In other words, the bulk of the
taxation has fallen on the less well-off people. A better balance would be 60:40.
The contribution from direct taxes to total tax revenue is low largely because the
tax base has remained narrow.
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Q: Any statistics with regard to the direct tax base?
At present, the number of direct tax payers (corporates, non-corporates and
PAYE scheme employees) is just under 600,000. Around 25,775 corporate
entities contributed Rs 46 billion in 2008, while 219,166 non-corporate tax payers(individuals, partnerships, bodies of persons) contributed Rs 47 billion and
351,726 PAYE tax payers (employees) paid Rs 14.3 billion.
Individual (non-PAYE) income tax has the potential to be a valuable revenue
source, but has remained slim for years. The low value placed on getting caught
and the disincentives to fully declare income for fear of being harassed by the
authorities are just two of many reasons for not being able to attract new tax
payers, and the limited revenue collected from existing ones. The Sri Lankan
economy generated income taxes (personal, corporate and withholdings)
amounting to 2.4% of GDP on average per year in the past five years, whereas inmuch of the Asia-Pacific region, this figure was close to 5.4% of GDP.
Q: Can you elaborate on tax exemptions and tax evasion?
First on tax exemptions, (a) take the 1.2 million labour force in the public sector
do they pay taxes? No. In 1979 public servants were exempted from taxation
because the government could not afford to grant a salary increase to public
servants in line with the private sector. Ever since then, this has become a rigid
policy and Sri Lanka may be the only country in the world where public servantsdo not pay taxes; (b) BOI tax exemptions and tax holidays have led to
approximately 1% of GDP revenue losses per annum, and (c) various
exemptions on VAT and import duty from time to time have also contributed to
eroding the revenue.
Second, tax evasion happens in many ways: (a) some professionals (doctors,
lawyers, accountants, etc.) do not disclose their true income and pay less taxes
or completely evade paying taxes, (b) successive governments implementing tax
amnesties have also led to tax avoidance, (c) under-invoicing of imports is also
an evasion of paying correct taxes, (d) over-stating of expenses and transfer
pricing, and (e) illegal flows of imports to the country has contributed to losses
close to Rs. 300 million a day. These areas have to be seriously examined if we
are to strengthen the revenue flows to the government and these areas have
been closely examined by the Presidential Taxation Commission (PTC).
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Q: There is a lot of discussion on the future of BOI incentives what is
happening?
The rationale of incentives offered by BOI were: (a) offset the investment risks
generated by the North/East war related uncertainties, (b) offset the negativeimpact of problems of doing business in Sri Lanka. As is well known, Sri Lanka
ranks low in many of the Doing Business indicators produced by the World
Bank. To offset these problems, the generous tax incentives were offered, and
(c) to keep up with Sri Lankas competitors such as Bangladesh, Vietnam,
Indonesia, Mauritius, etc., in attracting FDI. The BOI incentives came under
scrutiny during the IMF Stand By Arrangement (SBA) of 2001 but nothing was
done to streamline BOI incentives with the Inland Revenue Department as was
suggested in the SBA. The BOI incentives came under scrutiny again under the
new IMF package of 2009 but before that, the PTC had identified this area for fullexamination and it was an item in the PTC terms of reference.
Let us examine the real situation. The country loses 1% GDP of revenue per year
as stated earlier to attract about 1.5% GDP worth of FDI every year (BOI
contribution to promoting large domestic investment is another matter). This year
we will not be able to achieve 1.5% GDP level FDI. Recent international literature
has found that the most important factors for attracting FDI are consistency and
predictability of policies, stable economic and political environment, and an easy
doing business environment. Incentives matter but they do not rank in the topamong large multinational investors. Moreover, many countries today are shifting
towards non-tax incentives for FDI, like offering investment relief, accelerated
depreciation allowances, etc. It is in this context that we have to have a fresh
look at BOI incentives.
First, should we use BOI incentives to offset the negative aspects doing
business environment? If there are problems in getting land or terminating
employment, should we use tax incentives to offset their negative side or address
these problems head-on and sort them out once and for all? The latter should be
the correct way forward. Second, the war is over and there is no war related
uncertainty in the investment regime for incentives to offset. Third, the fact that
competitors are offering tax holidays should not bother us too much. As stated
earlier, consistency and predictability of policy, ease of doing business, etc., are
more important for business decisions than tax incentives. Thus, the logic for BOI
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incentives has to be looked at again to see where changes need to take place.
The existing BOI incentive commitment should continue and should not be
changed. However, it is high time for the BOI to consider a new incentive system
that would be more cost-effective than the existing one for all new investmentprojects.
Q: What are the issues in regard to VAT?
VAT still does not bring the same revenue as the former BTT (Business Turnover
Tax) and GST (Goods and Services Tax) did when they were in operation. VAT
brings in 33% of tax revenue which amounts to 5.5% of GDP. The BTT brought
an average 6.5 % of GDP revenue and GST brought an average 6% of GDP
revenue. VAT is yet to achieve this after eight years of operation. Sri Lanka is stillon a learning curve in regard to VAT. This can be seen from the fact that eight
amendments were made to the VAT Act over the last eight years and a major
VAT fraud costing about Rs. 4 billion took place in 2004. Training personnel,
adequate public education, and institutional frameworks were not put in place
before VAT came into operation. VAT threshold is a hotly debated topic and VAT
refunds are also an issue there are computational problems and identification
issues. The application of VAT to the financial sector is also an issue.
These are by no means arguments for abolition of VAT. VAT is an internationallyaccepted non-cascading tax system and operates in more than 100 countries in
the world. We have to do more groundwork to firmly establish the VAT in the Sri
Lankan economy and gradually extend VAT to the wholesale and retail sectors.
Q: What are the issues in regard to import duty?
I highlighted some of them in my address at the AGM of the Import Section of the
Ceylon Chamber of Commerce in August this year. Basically, our import duty
structure has got complicated by various add on taxes over and above tariffs
and VAT (and Excise where applicable). These add on taxes are revenue
generators to the Treasury and additional protection for some domestic
manufacturers but they are basically nuisance taxes for import traders and
importers of manufacturing inputs.
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To meet certain development expenditures, the following taxes were imposed
and they are applicable at the border: (a) Nation Building Tax, (b) Port and
Airport Development Levy, (C) Regional Infrastructure Development Levy, and
(d) Social Responsibility Levy. To develop certain commodities the following
taxes were imposed: (1) Commodity Export Subsidy Scheme (CESS), and (2)Special Commodity Levy. In 2009, import tariff revenue was close to 2% of GDP
but the customs border revenue was 8% of GDP, thus nearly 6% GDP revenue
has come from these additional taxes.
All these minor taxes are an irritant to the importer although they fulfill some
revenue and protection objectives. These taxes have made the tax structure
more complicated and less transparent. And above all, these taxes operate
under different tax bases. One reason for illegal imports and undervaluation of
imports is due to these taxes. What Sri Lanka should aim at is a less complicatedborder tariff structure which gives reasonable protection and revenue.
Q: What about further decentralization of taxation to the provinces?
When the Provincial Council (PC) system came into operation after the 13th
Amendment to the Constitution in 1987, turnover tax at the wholesale and retail
levels was devolved to the PCs. Turnover tax is the highest revenue earner to
PCs accounting for 44% of revenue. This is followed by stamp duty 28%,
licensing fees from motor vehicles and excise -13%, and others -15%. In SriLanka, tax sources devolved to the PCs account for only 4% of the central
government revenue (0.6% of GDP). In comparison, province/state revenue is
above 50% of central government revenue in India and Australia, and above 15%
in Malaysia and Thailand. Apart from limited fiscal decentralization, the provinces
lack adequate tax administration capacity and specialized technical skills that the
Inland Revenue Department enjoys. There is a lack of motivation among PC
revenue collectors in seeking new and innovative sources of revenue. This
situation was partly due to the dependence on an annual grant received from the
Centre which almost/always ensures PCs that recurrent expenditure needs will
be met.
Any increase in PC powers to collect more taxes (i.e., additional fiscal
decentralization) should go with a reduction in the allocation of Central
government grants (particularly the Block Grant) and improvement of the tax
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collection capacity of the PCs.
Q: Does the government plan to increase revenue to 20% of GDP during the
next 4 to 5 years?
Yes, this should be the final aim. China, India, Korea, Vietnam, and others all
have revenue levels at 20% of GDP or more. Such revenue will facilitate Sri
Lanka to maintain current expenditure at around 18% of GDP and capital
expenditure at 6% of GDP ad keep a budget deficit of about 4% GDP. This is the
type of budgetary balance we should aim at in the future.
In the PTC report we have recommended a strategy to broaden the tax base,
lower the tax rates and make the tax system less complicated. We have argued
the case for a business and people-friendly taxation system. Yet, restores private-public employee tax equity and helps expand the tax base
Sri Lanka began to impose taxes on income in 1932, and witnessed several
amendments to these regulations over the years. Among these, one of the more
prominent changes was in 1979 when public servants were made exempt from
paying any income tax on their official salary emoluments. Over three decades
have passed since this was introduced, and the issue emerged strongly in the
national debate last year in the context of a new post-war budget, the severe
strains on government finances, the fiscal tightening required under the IMF
package, and the appointment of a Presidential Commission on Taxation to lookat ways of increasing tax revenue and expanding the tax base. It became a key
moot point in the context of the Government needing to broaden the tax base to
bolster revenue, bridge the continuously high budget deficits of the recent past,
and provide more elbow room for the post-war reconstruction and recovery
efforts.
The announcement in the Budget 2011 presented in November, to extend the
income tax net to include public servants, is a decisive move towards
broadening the base and re-introducing tax equity between public sector and
private sector workers. This article takes a brief look at the historical context of
the initial exemption, how the exemption affects government revenue, and makes
a preliminary assessment of what the extension could do towards improving the
countrys fiscal position.
A Thirty Year Exemption
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(click image to view full size)
As per previous tax regulations (pre-budget), the tax-free annual allowance of an
employee was Rs.300,000, and thus, all employees whose monthly taxable
income (after making relevant adjustments to earned income based on Inland
Revenue guides) exceeded Rs.25,000 became liable to tax. The public
employees tax contribution was waived by the tax exemption, where a rough
estimation according to Labour Force Survey 2006 indicates that tax contribution
has been made only by the semi-government and private sector employees who
have accounted for around 74% of all employees earning over Rs.25,000
monthly salary (Table 1).
(click image to view full size)
With the new tax reforms, the government employees falling into the tax liable
category, currently accounting for 26% of the labour force and thus far been
excluded from income taxation, will become liable.
Impact of the Change Preliminary Assessment**
The impact of including public servants in income tax on revenue generation and
the number of newly tax liable employees can be examined using the data in the
latest available Household Income and Expenditure Survey (HIES) 2006/07 and
analysed using the statistical software STATA.
For the purpose of our analysis, we can look at three scenarios, using the datafrom the HIES 2006/07.
Scenario A: What was the PAYE tax situation (number of persons and revenue
generated) under the previous tax policy which exempts public servants from
PAYE tax?
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Scenario B: What is the change in the PAYE tax situation by extending PAYE
tax to cover public servants (as per Budget 2011 announcement) with
the existing taxable income thresholds?
Scenario C: What is the change in the PAYE tax situation by extending PAYE
tax to cover public servants along with the new taxable income thresholds (as perBudget 2011 announcement)?
Accordingly, an initial assessment shows the following.
(click image to view full size)
Under Scenario A, 4% of private sector employees (amounting to 123,747) and
17% of semi-government employees (amounting to 38,617) were liable to pay
PAYE tax, resulting in revenue of approximately LKR 6.5 bn (Table 2).
Moving from Scenario A to B, in addition to those liable under Scenario A, 11% of
public sector employees are liable to pay PAYE tax. Under this scenario, the
improvement on tax revenue is evident. The total number of tax liable employees
increases from 162,364 to 244, 731 (a 51% increase), which in turn raises tax
revenue from LKR 6.5 bn to LKR 8.0 bn (a 23% increase in revenue).
Distributional analysis within this preliminary assessment further reveals that the
distribution of tax contributions among all tax liable employees becomes more
progressive, i.e., the rich paying a larger share relative to the poor, highlightingthe positive impact of tax reforms on improving equality in taxation and income
distribution.
However, according to the Budget 2011 announcement, the tax liable thresholds
will also be revised, taking us to Scenario C. The tax free income threshold per
month has been raised from LKR 27,000 to LKR 50,000 and tax rate bands have
been reduced from 5%-35% to 4%-24%. Accordingly, only 3.5% of all employees
are liable for PAYE taxes. Under this scenario, tax revenue falls dramatically
from the initial LKR 6.5 bn to LKR 4.0 bn (a near 40% drop), and the number of
tax liable employees falls from the original 162,364 to 148,080.Revenue Hit, but Equity and Expansion Achieved
Hence it is clear that the tax policy reform announced in the Budget 2011 to
extend PAYE tax liability to public sector employees, combined with the overall
raising of the tax free threshold for all employees results in a decline in tax
revenue compared to the status quo of the pre-Budget scenario. However, the
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key anomaly under the previous tax policy regime the lack of tax equity is
corrected under the new policy. This provides a positive signal to private sector
employees that they are no longer treated in a discriminatory manner with regard
to tax liability. The question that arises, though, is will this positive signal
incentivize more people to comply with taxes, as a key contention earlier byprivate employees was why should we accurately declare tax liability, when
public servants are completely exempt from tax?
Additionally, under this reform, a key objective of the government will be
achieved, which is expanding the tax base and ensuring that more people
become compliant with their tax obligations to contribute to national
development.
The key question, moving forward is, given the reduction in revenue with this
proposed policy change, coupled with the reductions in corporate and individual
income tax rates, can the government bridge the immediate drop in revenuebuoyancy? Raising sufficient revenue to fund post-war reconstruction is a
pressing need, and it will be interesting to see how these progressive reforms
impact on it
The synopsis of Dr. N.M. Pereras 106th Birth Anniversary Memorial Lecture
delivered at the Dr. N.M. Perera Centre on 6 June 2011 by Dr. Saman Kelegama
is produced below:
Sri Lanka is at a threshold of economic
growth and development in the aftermath of three decades of war and conflict.
Slogans such as winning the economic war and making the nation the Wonder
of Asia have been frequently used to describe the priority that economic
development has received in recent years.
Sri Lankas current strategy as articulated in the Mahinda Chinthana: Vision for
the Future is to achieve growth rates of above eight per cent per annum and
thereby aim at doubling the current per capita income to reach around US$ 4000
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by 2016. Mention is also made that Sri Lanka will aim at achieving US$ 18 b
exports by 2016.
My focus today will be on achieving growth rates above eight per cent in the next
five years. If we examine Sri Lankas growth rates during the last decade, the
following facts become clear. The average growth that the country achieved
during 2000-2005 was four per cent (could have been more if not for the -1.6 per
cent very low growth the country saw in 2001), whereas during 2006-2010 Sri
Lanka achieved an average growth of 6.4 per cent (could have been more if not
for 3.5 per cent growth in 2009). The high growth rate in the latter period was a
significant achievement despite the war inflicting the economy from 2006 to partof 2009.
A closer examination shows that the following factors contributed to the high
growth during the period: rapid growth of the global economy during this period,
especially during 2006-2008; increasing public investment to average close to six
per cent of GDP and the fiscal stimulus associated with it; improved connectivity
associated with rapid progress in infrastructure: road development, telecom and
electricity sectors; stimulus from underdeveloped areas of the north and east
rapidly taking off in the aftermath of the war, etc.
These achievements have clearly shown that the mixed economy model based
on the twin engines of growth (both private and public sectors) is workable in Sri
Lanka as was the case in most East Asian countries during the 1980s and
1990s. The current economic model of Sri Lanka has all the features of a mixed
economy with elements of neo-liberalism, state intervention, Keynesian fiscal
stimulus, and so on.
The private sector performance as indicated in the annual reports of various
companies show record profits, where 45 companies showed profits over Rs. 1 b
in 2010/11 compared to 20 companies in 2009, clearly indicating that no
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crowding out is taking place due to the relatively larger presence of the public
sector.
We are seeing today US$ 6 b worth of infrastructure projects on the move the
second infrastructure revolution in the country after the accelerated Mahaweli
Development Programme and the Urban and Housing Development we saw from
late-1970s to mid-1980s. Just like during that period, large public investment and
foreign assistance are playing a key role in the infrastructure drive although we
could see some differences in regard to sources and quantity of foreign
assistance then and now.
Boosting investment to 33% of GDPWe have seen a growth of eight per cent in 2010 and sustaining high growth
momentum in the first quarter of 2011. The question remains whether we could
sustain this trend and aim at a higher level of growth under the current economic
strategy. The aggregate level of growth is mostly determined by the level of
investment in the economy and the efficiency of the economy in converting that
investment to output (called the incremental capital output ratio or ICOR).
The current ICOR in the economy is close to five but if we assume that with all
the improvements made in economy and with better connectivity that the ICOR
reduces close to four, then with a level of investment between 32-35 per cent of
GDP, Sri Lanka will be able to sustain a growth rate of above eight per cent. The
challenge therefore is to increase the level of investment to this level from the
current 27.8 per cent of GDP (the 2010 level).
If we disaggregate this 27.8 per cent of GDP investment level, we find that 21.6
per cent of GDP investment has come from the private sector and the remainder
of 6.2 per cent of GDP from the public sector. I will show later that there are limits
to increasing public investment above the current average of six per cent of GDP.
Therefore the increase in investment has to come from both the domestic and
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external private sector, in other words, from the local private sector and FDI.
For overall investment to reach the level of say 33 per cent of GDP, the
additional investment should be around five per cent of GDP and realistically
three per cent GDP of this additional investment has to come from the local
private sector and the remaining two per cent of GDP from FDI. The current FDI
level of 1.5 per cent of GDP should therefore increase to a level of 3.5 per cent of
GDP. Can we enhance both local private investment and FDI in the coming years
and what are the key impediments? This is the challenge for Sri Lanka.
The traditional determinants of investment are well known: macroeconomic
stability, consistent and predictable economic policy, low interest rates andtaxation, stable exchange rates, investment friendly labour and other laws,
minimum red tape and bureaucracy, etc. The investors always examine these
areas before they put their money on risky long-term ventures. And it is all the
more in the case of FDI.
It is unfortunate that Sri Lanka does not rank highly in Doing Business Indicators
(DBIs) report produced by the World Bank and neither does Sri Lanka rank
favourably in the World Competitiveness Report produced by the World
Economic Forum. Sri Lanka ranked 102 out of 181 countries in the Ease of Doing
Business Index prepared by the World Bank.
A recently released World Banks Logistical Performance Index (LPI) report ranks
Sri Lanka 137 out of 154 countries and Sri Lanka ranks lower than a least
developed country like Bangladesh. We can criticise these reports as we usually
do, and say that they are not accurate and they have not considered various
other factors, but at the end of the day it is the ranking of these reports that the
potential investors take into account before taking a decision to invest.
While infrastructure development improves connectivity and improves DBIs, that
alone is inadequate. Specific problems in regard to delays in doing business
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have to be addressed at the root. The initiative taken by the Central Bank to
release the document called Step-by-Step Guide to Doing Business in Sri Lanka
in April this year is a positive step. The aim seems to be to take Sri Lanka among
the top 30 in DBIs by the next two to three years. Improving DBIs will not only
enhance investment but it will also contribute to improving the efficiency in the
economy, i.e., lowering ICOR.
Equally important is the consistency and predictability of policy. Ad hoc policy
reversals and frequent change of policy have to be avoided as far as possible to
give the best signals to the private sector. Perceptions matter in regard to
attracting FDI and in this context, managing perceptions on governance becomesa vital area to focus in the coming months.
Limitation on enhancing public investment
I mentioned earlier the limitations of enhancing public investment. Sri Lankas
revenue (with grants) amounts to 15 per cent of GDP, while the current
expenditure amounts to 17 per cent of GDP. So the overall revenue is still not
adequate to cover the current expenditure, thus leaving a current account deficit
in the Budget. Late Dr. N.M. Perera used to say that good budgeting means
producing a surplus in the current account so that you borrow only for your
capital expenditure, but today you borrow not only to meet capital expenditure
but also to meet part of your current expenditure.
The Presidential Taxation Commission report was submitted in October last year
and it came with a number of proposals to enhance revenue to a level close to
18-20 per cent of GDP. Some of its recommendations (in adjusted form) were
implemented in the 2011 Budget presented in November last year but a lot more
needs to be done.
While implementing the rest of the recommendations, concerted effort must be
made to restructure current expenditure. Wages and salaries (5.4 per cent of
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GDP), interest payments (5.6 per cent of GDP), and subsidies and transfers (3.3
per cent of GDP) amounted to 14.3 per cent of GDP overall in 2010.
This is almost 95 per cent of the revenue earned and in some years they
accounted for the entire revenue collected. This means that three expenditure
items are cutting into all other areas of current expenditure and dominating the
expenditure patterns in Sri Lanka. It is high time this anomaly is rectified. Interest
payment on public debt has thankfully come down from a level of 6.4 per cent of
GDP in 2009 to 5.6 per cent of GDP due to the lower interest rates, if not it would
have remained a burden on the expenditure side.
Subsidies and transfers occupy a significant position because of the large sumsallocated to the loss making state owned enterprises (SOEs). In 2007, the losses
in these SOEs amounted to 1.7 per cent of GDP and there are reasons to believe
that this level has not come down significantly by 2010. In this context, the recent
announcement by the Secretary of the Ministry of SOE restructuring that six
SOEs will be leased out for 30 years to the private sector and that a Voluntary
Retrenchment Scheme will be introduced to some other SOEs is a positive step.
Wages and salaries are also a large expenditure item with a 1.2 million large
public sector work force. This expenditure is bound to go up with recent demands
for wage increases by University academics and others. As long as public sector
workers are productively engaged and contributing to economic activities, such
large sums can be justified but not otherwise. In this regard the recent
deployment of armed forces for urban development and infrastructure
development activities is a positive step.
Given this situation in regard to lopsided current expenditure and borrowing to
meet all capital expenditures, there are limits to borrowing to enhance public
investment especially when the debt to GDP ratio is still above 80 per cent. Thus,
the government has to seriously look at various public-private partnerships (PPP)
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the US dollar against other major currencies. In this context, the appreciation of
the Sri Lanka rupee vis--vis the US dollar is a concern because the value of the
rupee against the US dollar is more important for Sri Lankas exports, as over 70
per cent of trade takes place in US dollars and even exports to other regions
such as Euro are priced in US dollars. There are some who argue that the Sri
Lankan rupee has depreciated against some major currencies but these are not
our major trading currencies and therefore such depreciation does not give much
benefit to exporters. Amidst large capital inflows, managing the exchange rate is
not easy.
What is important here is to make a clear distinction between appreciationsagainst maintaining a stable currency and some flexibility. It is the latter that
needs attention in the context of sustaining the growth momentum of the export
sector which is vital in the long run.
Missing the demographic dividend but all is not lost
While speaking about investments contribution to growth, we must not forget
about social transformations taking place in Sri Lanka and their impact on the
growth process. Here, I would like to speak a few words about the demographic
dividend. What do economists mean by a demographic dividend? It is meant to
indicate the gains to a nation consequent to the change in the age-wise
composition in the population.
For example, if youth workers are urgently required in a large number at a
particular juncture in economic development and they are readily available in the
market due to demographic transition, then the situation will generate a
demographic dividend. The magnitude of the demographic dividend appears to
be dependent on the ability of the economy to absorb and productively employ
the extra workers, rather than be a pure demographic gift.
ADB analysis shows that a large part of East Asias spectacular economic growth
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derives from a working-age population bulge. This bulge represented a
demographic dividend or a demographic gift because it carried with it an
increased space for economic growth. East Asia has had relatively more workers
(and savers) and relatively fewer non-workers (and non-savers) compared with
other parts of Asia, and with the rest of the world at the time of economic take-off
(Emerging Asia: Changes and Challenges, ADB, 1997).
According to Ghani (2011), demographic dividend impacts growth through five
different channels. First, swelling of the labour force, as baby boomers reach
working age. Second, society being able to divert resources from spending on
children, to investing on physical capital, job training, and technological progress.Third, rise in womens workforce activity that naturally accompanies a decline in
fertility. Fourth, working age also happens to be the prime years for savings,
which are key to accumulation of physical and human capital and technological
innovation. Fifth, boost to savings that occur as an incentive to save for longer
periods of retirement increases with greater longevity.
Sri Lanka missed the demographic dividend when the workforce was at a peak
level due to a number of factors and the country is now witnessing a rapid ageing
of the population. The above 60 years population is going to increase from the
current 11.5 per cent to 18.6 per cent by 2021. Thus, the working force is ageing
and growing slowly than in the past compared to competitor countries in the
neighbourhood. The ratio on working population to total population peaked in
2005 and it will now only decline. The dependency ratio is projected to increase
over the next 40 years while the rest of South Asia, especially India, will benefit
from a decrease in dependency ratio and a demographic dividend. But there are
two redeeming aspects for Sri Lanka. First, is the relatively low female
participation rate of about 35 per cent. Second, a large stock of skilled migrants
will return if improved growth generates new opportunities. So there exists scope
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to offset some of the loss of the demographic dividend by policies aimed at
raising the female labour force participation rate and number of returned
migrants.
Five hubs need more opening of the economy and stronger regional linkages
My next submission is to address an equally important area where the growth in
the next half a decade will be enhanced by other frameworks that the
government is intending to promote. The area that immediately comes to mind
are the five hubs: knowledge, maritime, aviation, energy, and commercial. The
hubs will certainly boost the overall economic growth but there are a number of
questions that we must ponder about. Can we promote Sri Lanka as a hubwithout selectively liberalising the economy in specific sectors? Can we bypass
regional powers like India and become a hub in shipping and aviation?
Take for instance the objective of promoting a knowledge hub. Can we create a
knowledge hub by just inviting foreign universities and the ongoing higher
education reforms? How are we going to promote more of the IT industry, and
encourage more BPOs? Are we increasing R&D expenditure with focus on
Ayurvedic medicine, bio-technology, nanotechnology, etc.? We will have to
seriously look at various global models and take a cue and should not assume
that the geographical location per se will be adequate for the hubs to take off.
Concluding remarks
Moving from a middle-income country to a high income country is more
complicated than moving from a low-income to middle-income range. Moreover,
growth strategies that proved successful in the early stages of development are
less effective when moving up to high income level.
While focusing on strategies to enhance growth, Sri Lanka should ensure that it
does not get into a middle income trap where reliance on cheap labour based
competitiveness and traditional ways of doing business no longer work. Many
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