Daunting economic challenges for the new

government

Sunday, September 27, 2015

Enormous economic challenges confront the coalition government. Facing up to these
economic problems after months of political preoccupations and electoral politics is no
easy task. It is much more than changing the mindset from electoral politics to
economic management as it has to deal with more serious fundamental economic
problems than before the elections.
A strong resolve that transcends immediate
political popularity is essential to solve the
deep-seated economic weaknesses. Can
the coalition government with diverse
ideologies and policies implement the
essential reforms?
Economy destabilized
The macroeconomic fundamentals have
worsened during the year. The trade deficit
is increasing, foreign reserves are
declining, the balance of payments is
deteriorating and global conditions, except the drop in international fuel prices, are not
favourable. Government finances are precarious with expenditure rising without
commensurate increases in revenue. The increasing fiscal deficit, public debt and
trade deficit are closely connected and arise from the fiscal deficit to a large extent.
Political preoccupations neglect economy

Political preoccupations resulted in the neglect of these economic problems. From

about the middle of last year the governments focus was on the re-election of the
incumbent president. After the new president was elected, the preoccupation shifted to
the general election. During both these run ups to elections economic policies were
aimed at winning elections rather than stabilising the economy.
Expenditure
Extravagant expenditure, including lavish
entertainment at Temple Trees, duty concessions
and duty waivers, free motor cycles to public
officials, among other giveaways increased public
expenditures and contributed to increasing the fiscal deficit to 6.0 percent of GDP
exceeding the target of 5.2 percent of GDP that the Treasury repeatedly said would be
achieved. This increase in the deficit was despite a decrease in debt servicing costs
due to lower interest rates and a cut in capital expenditure.
Interim Budget
The Interim Budget of January 2015 too focused on giveaways rather than
mobilisation of resources. Many of the concessions had adverse fiscal impacts and
were responsible for increasing this years trade deficit that is likely to exceed last
years high deficit of US$ 8.3 billion. Imports increased due to the reduction of tariffs
and increasing aggregate demand due to increased disposable incomes and low
interest rates. On the other hand, the Interim Budgets rash revenue proposals were
not implemented.
Foreign debt
The government debt that increased to US$ 49 billion at the end of last year was 75
percent of GDP, much above the safety threshold of 60 percent of GDP. With further
borrowing it would have increased further this year.
Formidable challenges

The government is faced with the formidable challenges of decreasing the fiscal
deficit, reducing the trade deficit and tackling the deteriorating external finances. Will
the coalition of diverse economic views, be able to forge common consistent economic
policies and take bold unpopular measures to revive the economy?
Budget 2016
The answer to this question will be evident in November when the Budget for 2016 is
presented. Will this budget that is being formulated within a medium term framework of
economic policies address the problem of inadequate government revenues, the
curtailment of government expenditure by reducing losses in state owned enterprises
and adopt prudent practices in government expenditure? Will there be effective
policies to contain the public and foreign debt? Will fiscal policies reduce aggregate
demand to reduce the trade deficit?
Incapacity of coalition economics
There is considerable scepticism of the governments capacity to address these issues
adequately. The hybrid government with its internal policy differences and ideological
variance would find it difficult to pursue bold economic measures that are needed. The
coalition government with diverse views and ideologies are likely to hamper adoption
of consistent and pragmatic policies. The implementation of policies too would face
stumbling blocks. The government is likely to be like a large slow moving elephant with
several mahouts giving different directions.
Law and order and the rule of law
There have been political gains after the election of the new government that would
benefit the economy. Law and order and confidence that the rule of law will prevail are
important gains, not only for the freedom and dignity of the nation and its individuals,
but a positive contribution to the economy as good governance and the rule of law are
vital preconditions for economic development. However, they alone would not suffice.
There have to be good economic policies and effective administration of the economy.

Erosion of confidence
Despite these favourable conditions there has been erosion in business confidence
that was expected to be boosted by the election victory of the UNP. This did not
materialise due to the poor economic management and inadequate policy directions.
Another reason for the erosion of confidence in the government has been the
departure from the constitutional provision of limiting the cabinet to 30 members by the
19th Amendment. This positive development for good economic governance was
undermined by using the loophole left in the amendment of forming a national
government. This disillusioned most people who had voted for change, good
governance and good economic management.
Jumbo cabinet
Confidence in the new government has been severely eroded by forming a jumbo
cabinet of 48 and a large number of other ministers. Such an unwieldy cabinet is not
conducive for consistent economic policy formulation. Implementation too is likely to
be inefficient and ineffective. It is widely believed that the choice of portfolios left much
to be desired as well, especially in key areas of economic policy formulation and
management.
Advantages
The government has several advantages. It can blame the previous government for
this state of the economy even though most of the ministers of the previous
government are reincarnated as ministers in the current coalition government. Then it
has a commanding majority in parliament and there is no doubt of unpopular
measures not being passed in parliament or a defeat of the government in parliament.
A third advantage is that the government is assured of a five year term of office.
These advantages must be exploited to adopt good economic policies that would be
unpopular at the beginning but can rescue the economy and bring benefits that would

make the government popular at the end if its five year term. The alternative is to not
adopt pragmatic and essential policies now and compound the economic problems
and face unpopularity at the end of its five year term.
Posted by Thavam