Economists point at regressive taxes, higher inflation and interest rates as main causes
Regressive taxes, rising inflation and slowdown in credit amid rising interest rates will result in lower consumer demand in 2016, dealing a considerable blow to corporate Sri Lanka, according to top economists.
Ex-Central Banker and economist Dr. W.A. Wijewardena said Budget 2016 had made the income distribution further unequal due to the highly regressive tax policy.
This has made life easy for the rich while making life difficult for the lower income earning category, who are the driving force behind consumer demand.
“Budget 2016 has made even the direct tax regressive by applying a flat (tax) rate on everyone. So, what happens is the rich will pay a lesser tax while the lower income earners will have a higher tax burden.
In an economy, the rich consist of a minute share but the lower and middle-income earners are the majority, who drive the consumer demand,” Dr. Wijewardena told Mirror Business.
Indirect taxes are by nature regressive because a flat rate is applicable for everyone irrespective of their level of income. This results in higher tax payment by the poor compared to the rich, who enjoy higher income levels.
Budget 2016 brought down the personal income tax rate to a flat 15 percent from 16 percent and increased the tax-free income threshold from the current Rs.750,000 to Rs.2.4 million while doing away with the different income brackets. This is the lowest personal income tax rate enjoyed by the country’s wealthy and possibly the lowest personal income tax rate in any country.
Shaheen Cader, the Managing Director for Nielsen Sri Lanka, a leading market research firm, which tracks the monthly business and consumer confidence, said consumer confidence in November had come down by a notch, although it is higher on a year-on-year basis.
This demonstrates a reversal from the boom in consumer demand, which was seen for the most part in 2015, largely due to a significant amount of excess liquidity, fiscal stimulus in the form of wage increases and reductions in prices of a number of commodities, according to Deshal de Mel, a senior economist.
“In 2016, the impact of these factors would diminish as excess liquidity has now declined and interest rates have already begun to increase. One could expect interest rates to continue to increase in 2016 as global borrowing costs increase and the government is also likely to have increased credit demand in domestic markets next year,” de Mel said in an e-mail response.
Meanwhile, the Chief Economist attached to the Ceylon Chamber of Commerce, Anushka Wijesinha, said under such a scenario, if the government resorted to the domestic market to fund its fiscal gap, there would not just be further upward pressure on the interest rate but also would crowd out the private sector.
“The rating agencies are concerned of the lack of fiscal consolidation in the Budget and they are watching the developing fiscal scenario here. If they decide to downgrade our sovereign rating, it will further increase our external borrowing cost,” Wijesinha remarked.
Both de Mel and Wijesinha expect imported inflation to have a dampening impact on the consumption growth due to the expected weaker rupee in 2016.
Wijesinha however does not expect a huge drop in consumer demand unless there is a sharp rise in the interest rates, which will make the consumption credit more expensive.
Inflation is similar to an indirect tax on the people, economists say. Sri Lanka is highly import-dependant, even for her basic needs.
Verité Research Senior Analyst and Head of Economics Subhashini Abeysinghe expressing similar sentiments said the consumer demand is likely to slow down going forward as the demand the country saw in 2015 is not sustainable.
De Mel said the longer-term sustainable growth in consumption requires real income growth, which in turn is driven by improved productivity and competitiveness of labour markets.
“Thus, economic reform that is geared to enhancing competitiveness and productivity in all factor markets is necessary to create sustained growth in consumption,” de Mel further added.
Lower consumer demand is similar to a vicious cycle where an economy slows down due to less appetite for investment as manufacturing is not required at the levels seen before in an economy where products are not demanded.
This could even result in layoffs in certain industries, which could also add on to the existing social woes in an economy.
In 2015, Sri Lanka’s growth to a larger extent was driven by consumption as opposed to the construction sector-led infrastructure development model adopted by the previous regime.
The International Monetary Fund (IMF) last week cautioned that the country’s monetary easing cycle and recommended the Central Bank to begin monetary tightening i.e. higher interest rates and lower credit by the banks.
Dr. Wijewardena said the Central Bank is now facing a very difficult problem to solve, where they can neither increase rates nor afford to cut rates.
“The Central Bank is now trying to catch a tiger by its tail,” he said.