War Against Rajapaksa Regime Debts Begins

• Rajapaksas’ Targets In The Doldrums

by Amavasya Sirisena

“This time it is a war against massive debt!” the Ministry of National Policy and Economics Affairs announced.

“The unprecedented and senseless borrowing of the previous regime has resulted in a whopping debt burden of 8,475 billion rupees. This is equivalent to 75 per cent of the country’s Gross National Income. The annual debt servicing costs us 1.303 billion rupees, of which 509 billion rupees is for interest alone,” the announcement said.

 

Rajapaksa’s dream becomes pipedream

Although the Rajapaksa regime had an over-ambitious pipedream of reaching US$ 4,000 and a GDP (gross domestic production) of US$ 100 billion by 2016, economists and analysts opine that due to short-sighted economic planning by the former regime, the Indian Ocean Island economy is gravely short of its targets.

“GDP at current market prices amounted to Rs. 11,183.2 billion (US$ 82.3 billion) in 2015 compared to Rs. 10,448.5 billion (US$ 80 billion) in 2014. Accordingly, GDP recorded a 7.0 per cent growth in nominal terms in comparison to 8.9 per cent growth observed in 2014. This slowdown was a combined outcome of the deceleration of both real GDP growth and GDP implicit deflator. In real terms, GDP grew by 4.8 per cent in 2015 compared to 4.9 per cent in the previous year. Accordingly, real GDP in 2015 amounted to Rs. 8,622.8 billion in comparison to Rs. 8,229.0 billion in 2014,” latest annual report of 2015 published by the Central Bank of Sri Lanka revealed.

“GDP per capita was estimated at Rs. 533,398 for 2015 compared to Rs. 503,032 in 2014, recording a six per cent growth in comparison to 7.9 per cent in 2014. This was mainly attributable to the growth in nominal GDP in the midst of a fairly stable mid-year population growth level. Per capita GDP denominated in US dollar terms also increased to US$ 3,924 in 2015, from US$ 3,853 in 2014. Resulting growth in per capita GDP denominated in US$ by 1.8 per cent in 2015 was a deceleration compared to 6.7 per cent growth recorded in 2014, mainly due to the slowdown in nominal GDP growth.”

 

An overview of the economy

The Sri Lankan economy expanded by 4.8 per cent in real terms in 2015 compared to 4.9 per cent growth in 2014, accommodated by generally supportive fiscal and monetary policies and favourable weather conditions amidst challenges from both domestic and external factors. On the domestic front, a low and stable inflation environment and low interest rates continued supporting the economy. Fiscal measures such as increase in public sector salaries and downward revision of administrative prices also contributed positively to induce the demand. However, a change in policy direction amplifying transparency and corresponding attempts to re-evaluate several large infrastructure projects curtailed the overall growth momentum to a certain extent and delayed possible capacity expansion in the economy.

On the external front, spillovers from the subdued performance in the world economy weighed on economic activities. On the production front, growth was broad-based with positive contributions from overall growth in the Services, Industry and Agricultural activities. Services activities made the largest contribution to growth driven mainly by the financial services which benefitted from a conducive interest rate environment in 2015. Industries showed moderate performance due to the slowdown in large scale infrastructure construction activities. Meanwhile, agriculture largely benefitted from the favourable weather conditions.

As per the estimates of expenditure approach, both in nominal and real terms, the growth was buoyed by the domestic demand generated mainly through consumption which was stimulated by increase in household disposable income. Investment expenditure grew at a slower pace for several reasons including tightly contested general election which affected both public investments and investor sentiment. Net external demand in real terms, remained unfavourable due to the relative increase in imports when compared to exports. Import demand continued to increase fuelled by low global commodity prices and accessibility to credit though it was tempered by depreciation of rupee, increasing interest rates and revision of duties for certain categories of imports towards the latter part of 2015. Further, a slower than expected recovery in advanced economies, moderation in economic activities in China, and the economic distress in Russia and some Middle East countries dragged down the demand for exports. On the other hand, the export prices declined at a slower pace compared to the significant drop in import prices as reflected by the improvement in terms of trade.

Meanwhile, net services export improved in 2015. Accordingly, net external demand in nominal terms increased marginally. During 2015, domestic savings decelerated, led by government dis-savings and the slowdown in private savings. Meanwhile, net current transfers from rest of the world slowed down compared to the previous year, while net primary income contracted. These developments resulted in a deceleration in national savings and its share in Gross Domestic Product (GDP) compared to the previous year. However, deceleration in investments than the national savings resulted in a narrowing down in the savings-investment gap of the country as a percentage of GDP. Using estimates based on the income approach, the gross operating surplus was the main component of income generation of the economy and as an institutional sector, household sector contributed to the majority of income generated during 2015.

 

GDP

GDP at current market prices amounted to Rs. 11,183.2 billion (US$ 82.3 billion) in 2015 compared to Rs. 10,448.5 billion (US$  80.0 billion) in 2014. Accordingly, GDP recorded a 7.0 per cent growth in nominal terms in comparison to 8.9 per cent growth observed in 2014. This slowdown was a combined outcome of the deceleration of both real GDP growth and GDP implicit deflator. In real terms, GDP grew by 4.8 per cent in 2015 compared to 4.9 per cent in the previous year. Accordingly, real GDP in 2015 amounted to Rs. 8,622.8 billion in comparison to Rs. 8,229.0 billion in 2014. Meanwhile, the GDP implicit deflator decelerated to 2.1 per cent in 2015 from 3.9 per cent in 2014.

 

GDP Per Capita

GDP per capita was estimated at Rs. 533,398 for 2015 compared to Rs. 503,032 in 2014, recording a six per cent growth in comparison to 7.9 per cent in 2014. This was mainly attributable to the growth in nominal GDP in the midst of a fairly stable mid-year population growth level. Per capita GDP denominated in US dollar terms also increased to US$ 3,924 in 2015, from US$ 3,853 in 2014. Resulting growth in per capita GDP denominated in US$ by 1.8 per cent in 2015 was a deceleration compared to 6.7 per cent growth recorded in 2014, mainly due to the slowdown in nominal GDP growth.

 

Gross National Income (GNI)

GNI, which is estimated by adjusting GDP for net primary income from rest of the world increased to Rs. 10,932 billion recording a growth of 7.1 per cent in nominal terms during 2015 compared to 9.0 per cent growth in 2014. The net primary income from rest of the world, which consists of compensation of employees and investment income, remained negative as the primary income paid to the rest of the world exceeded the primary income received from rest of the world. The negative growth in primary income was a combined outcome of the decline in both the compensation of employees and the investment income in 2015 compared to last year.

 

Contribution from the Institutional Sectors

The gross value added of the Agriculture, Industry and Services activities under the production estimates can be further classified into institutional sectors as Non-Financial Corporations (NFC), Financial Corporations (FC), General Government (GG), Households (HH) and Non-Profit Institutions Serving Households (NPISH). HH and NPISH are considered together in the National Accounts estimation process. Considering the sectoral estimates for 2014 and 2015, the HH and NPISH together represented the majority of economic activities. In 2015, the HH and NPISH’s share in the economy was 51.0 per cent compared to 51.2 per cent in 2014. The HH and NPISH together grew by 6.1 per cent in nominal terms during 2015 compared to 9.5 per cent growth recorded in 2014. Meanwhile, NFC, the second major sector of the economy, grew by 5.3 per cent in 2015 in comparison to the 6.5 per cent growth recorded in 2014, representing 34.5 per cent of the economy. Further, the GG and FC grew by 13.6 per cent and 7.8 per cent, respectively, in 2015 compared to 14.3 per cent and 13.1 per cent growth, respectively, recorded in the previous year. Consequently, the GG and FC represented 10.1 per cent and 4.5 per cent, respectively, of the economy in 2015.

The gross value added of the agriculture, as well as services activities were driven by the HH and NPISH, while industry activities were driven by the NFC sector in 2015. Accordingly, 81.9 per cent of the gross value added in agriculture activities was generated from HH and NPISH in 2015, while the balance was from the NFC sector. It was observed that the contribution of the HH and NPISH sectors was higher than that of the NFC sector in most of the agricultural activities. The highest contribution to the agricultural activities by the HH and NPISH was observed in marine fishing activities, while the contribution of the NFC sector was strong in the areas of animal production and growing of tea. Meanwhile, the NFC contributed 60.5 per cent of the gross value added in Industry activities in 2015, followed by 36.9 per cent from the HH and NPISH, and 2.6 per cent from GG. Gross value added in manufacture of food, beverage and tobacco products mainly contributed to the Industry share of the NFC, and HH and NPISH sectors, while the contribution from the GG was mainly visible in construction activities. In the meantime, the highest contribution to the service activities was from the HH and NPISH, which represented 53.7 per cent, followed by the NFC, which represented 23.7 per cent. Further, the GG and FC sectors contributed 15.3 per cent and 7.4 per cent, respectively, to services activities in 2015. The HH and NPISH contribution to the services activities mainly came from transport activities, while the contribution of the NFC sector was mostly in wholesale and retail trade activities. The GG sector largely contributed to public administration and defence; compulsory social security activities, while the FC sector contribution came from financial services and auxiliary financial services.

 

Agriculture

Agriculture, forestry and fishing activities grew by 5.5 per cent in value added terms during 2015 compared to 4.9 per cent growth in 2014. The growth in agriculture activities was largely attributable to the significant expansion in the growing of rice, as a result of the bumper harvest recorded during the year and the substantial contribution from the growing of vegetables. Moreover, growing of fruits, animal production and growing of oleaginous fruits (coconut, king coconut, oil palm) also significantly contributed to this growth. Further, forestry and logging, growing of spices, aromatic, drug and pharmaceutical crops, other perennial crops and other cereals, and plant propagation and support activities to agriculture contributed positively to the overall growth in agriculture. However, the contraction in fishing, growing of rubber, tea, sugar cane, tobacco and other non-perennial crops and other beverage crops (coffee, cocoa etc.) dampened the growth in agriculture in 2015.

 

Services

Services activities, the major contributor to the economy grew by 5.3 per cent in gross value added terms in 2015 compared to 5.2 per cent growth in 2014, accounting for 56.6 per cent of the GDP. This growth was largely buoyed by the robust growth in financial service activities, supported by the transportation of goods and passengers including warehousing, real estate activities including ownership of dwellings, and wholesale and retail trade activities. Further, the expansion in public administration services, other personal service activities, insurance, human health activities, telecommunication and IT programming services positively contributed to this growth. However, professional services, education, accommodation, food and beverage services, and postal and courier activities contracted in 2015 compared to 2014, decelerating the overall growth in services.

 

Industries

The industrial activities comprise mining and quarrying, manufacturing, electricity, water, waste treatment and construction. These activities collectively grew by 3.0 per cent in value added terms during 2015 compared to 3.5 per cent growth recorded in 2014. This was mainly buoyed by the robust growth in manufacturing activities. Meanwhile, electricity related activities, sewerage, waste treatment and disposal activities, and water collection, treatment and supply activities positively contributed to the growth in the Industry. However, mining and quarrying, and construction activities recorded a contraction during 2015, adversely affecting the growth in Industry activities.

 

Strongest pro-growth fiscal stance

Although the latest economic outlook report published by the World Bank – South Asia Economic Focus Spring 2016 – emphasizes that on one hand Sri Lanka’s expenditure should be controlled whilst on the other hand revenue should be increased, the report also lauds Sri Lanka for recording the strongest pro-growth fiscal stance in recent years.

“Progress in boosting government revenues is slow. Relative to GDP, revenue generation and collection is well below the emerging market or peer standards in most of the region. This should not come as a surprise in a conflict-affected country like Afghanistan, but it is also happening in fast-growing Bangladesh and in relatively wealthier Sri Lanka… There is agreement that reforms geared at increasing the tax base and improving tax administration are a priority across the region. Tax collection in particular remains well below estimates or targets across most South Asian economies…. Overall, South Asia displays one of the largest fiscal deficits across all regions.”

 

Expenditure

The recent experience of the largest economies in South Asia is quite diverse in this respect. Capital expenditures by the government can be measured in at least two ways. One of them involves the budgeted amount, the other the actual spending. The former reflects the stated priorities of the government, the latter is affected by implementation capacity as well as unexpected developments such as highway projects getting stalled because of slow land reclamation. The fiscal stance in relation to growth can be assessed by measuring the change in budgeted or actual capital expenditures from one fiscal year to the next. The numbers need to be interpreted with caution, as government expenditures are not classified in the same way across countries.

The strongest pro-growth fiscal stance in recent years was in Sri Lanka…. Under the previous Sri Lankan government, the development model was very much anchored on public investment. It is less clear that this infrastructure-driven model will continue under the new government, and it may not be affordable in any case.

 

Fiscal deficit

“With slow-growing revenue, reducing fiscal deficits requires containment with the expenditure side. This is particularly challenging in a context where government consumption has been an important driver of GDP growth in recent years. Against this backdrop, many South Asian countries are delivering a gradual fiscal consolidation at best.”

The fiscal deficit rose sharply in 2015 due in part to two successive election-time budgets, with increased salaries and subsidies, reduced consumption taxes, and increased interest costs on resultant deficit financing. Although one-off revenues proposed in the 2015 budget helped mitigate the impact, the deficit increased to an estimated 6.3 percent of GDP from a budgeted 4.4 percent of GDP. A high primary deficit, rising real interest rates and the currency depreciation increased the public debt to GDP ratio from 70.7 percent in 2014 to an estimated 75.2 in 2015, while treasury guarantees are estimated at 5.8 percent of GDP. The fiscal deficit is projected at 5.6 percent of GDP for 2016 after considering a few key policy measures, including the increase in VAT rate, announced as amendments to the Budget.