State of the Economy 2016 - IPS report
In 2015, the Sri Lankan economy grew at a modest 4.8 per cent, capping a year of socio-political transformation in which electoral politics dominated the headlines. In the midst of the socio-political transition, the economy received little attention despite worrying signs of a deteriorating economic environment, particularly in the arena of public finances.
With a fiscal deficit of 7.4 per cent of GDP and public debt of 76 per cent of GDP in 2015, fiscal consolidation is necessary to ensure macroeconomic stability, a fundamental prerequisite for growth. Fiscal policy also has impacts on growth at the micro level through tax and spending policies across economic activities.
In this context, the IPS’ ‘Sri Lanka: State of the Economy 2016’ report focuses on the many interrelated problems constraining investment and productivity across the Sri Lankan economy owing to weak public finance management. For instance, Sri Lanka has witnessed a sharp increase in para-tariffs that not only distorts the import duty structure but also leads to policy inconsistency. Conversely, Sri Lanka has granted significant tax exemptions to attract FDI, which has contributed to weakening the country’s tax base and tax compliance.
FDI
Exports have continued to decline as a share of GDP, hitting a new low of 14 per cent last year and, with export earnings continuing to contract by 6 per cent in the first half of this year.
Similarly, Sri Lanka has failed to raise its FDI beyond 1.5 per cent of GDP even following the post-war economic euphoria.
FDI inflow fell by 30 per cent in 2015; they have fallen by a further 53 per cent in the first half of 2016.
Fiscal incentives also matter in raising investment and productivity in labour markets. Despite a relatively low unemployment rate of 4.6 per cent in 2015 – albeit up steadily from 4 per cent in 2012 – Sri Lanka’s labour market indicates significantly high educated youth unemployment as well as a low level of female labour force participation.
So far, well-meaning intentions to generate one million jobs and improve living standards of workers have been spelt out in the government’s Economic Policy Statement, but without much guidance on the precise direction or the urgency with which it will be implemented.
If one million jobs are to be generated, Sri Lanka will have to rely on those who are economically inactive, particularly females and youth and devise appropriate incentives to get them into the workforce.
Increasing the labour force participation of youth is intrinsically connected to the quality and relevance of education that equips workers with evolving skills demanded in a more globalized world.
Sri Lanka has relied heavily on public sector financed general education and tertiary education systems, including other measures such as the distribution of free textbooks, scholarships for disadvantaged students, free uniforms, and subsidized transport facilities, etc., to ensure high education outcomes.
However, even with public spending on education set to increase further, the resource gap to meet quality and equity issues in the education sector will of necessity require incentivizing private sector participation.
Demography
Private participation – as both providers and consumers of services – is already more heavily present in Sri Lanka’s health sector. The current total expenditure on health of 3-4 per cent of GDP falls short of comparable global averages even at present, and is set to increase with the country’s rapid demographic and epidemiological transition. Out-of-pocket expenses by households on health care is rising, raising issues of affordability and equity. Thus, improving allocative efficiency of healthcare expenditures and finding alternative sources of finance are high on the agenda to address improved health outcomes.
Sri Lanka’s demographic transition also holds important implications for fiscal policy reforms, including the provision of social safety nets.
Efforts to reform the country’s non-funded public sector pension schemes – as outlined in the 2016 budget proposal – have fallen by the wayside in the face of stiff opposition.
The cost-efficiency and effectiveness of current poverty reduction programs – primarily, the Samurdhi/Divineguma program – is doubtful. Although Sri Lanka has made progress in tackling poverty at the national level, the presence of significant pockets of poverty and rising inequality within the country means that considerable attention needs to be paid to bridging such disparities in the coming years.
There should be targeted efforts to narrow disparities between population groups – especially between urban and rural sectors of the economy.
Air pollution and urban slums are common undesirable outcomes of ill-planned big projects. In Sri Lanka, environment policy has been dominated by command-and-control instruments based on regulations and standards. However, owing to their limited effectiveness, high cost of implementation, low economic efficiency, and problems of sustainability, market-based instruments have been gaining ground. Such economic instruments– a shift from penalties for non-compliance to payments or adjustments in the systems of ownership rights – offer countries such as Sri Lanka a more fiscally effective means of environment management. - IPS
This is a part of an article from the comprehensive chapter on ‘Policy Perspectives’ in the ‘Sri Lanka: State of the Economy 2016 Report’ - the flagship publication of the Institute of Policy Studies of Sri Lanka.