The Government’s new budget proposals impact significantly on every segment of society. The implications of these proposals, and their practical effect, are worthy of serious reflection.
I. The Need for Certainty and Stability
As a preliminary point, it needs to be said that the main feature of a budget should be certainty and predictability of consequences.
Especially at a time when there is an urgent need for confidence, which is the foundation for investment on a substantial scale, crucial actors in all areas of the economy must be provided with definite information, to be relied upon by them within a continuing time-frame, as the basis of decisions in respect of entry and participation.
The budget is the main vehicle through which such information, essential for systematic forward planning, is made available authoritatively.
It is, therefore, a matter for both surprise and regret that there are, in fact, for the current financial year, two Budgets, the latter purporting to supersede and supplant vital proposals set out by its predecessor.
In the sphere of agriculture, where the acuity of the problems is being visually demonstrated, no relief is offered for the farming community, in particular for paddy farmers and for tea and rubber small holders.
Fertiliser available at Rs. 350 per bag (Containing 50 kilograms) during the previous regime, now costs about Rs. 2,500, and is not freely available even at that price. While an abundant harvest is coming in, the difficulties regarding marketing are proving insurmountable, with the farmer hard put to recover even the cost of production. The guaranteed price scheme has broken down altogether. During the previous administration, when the minimum guaranteed price for paddy was Rs.30 per kilogram, it was generally possible for the farmer to obtain a price of approximately Rs. 42. Today, even Rs.20 is unobtainable in most of the paddy growing districts.
III. Changes in the Value Added Tax
The changes with regard to Value Added Tax (VAT) will certainly have a seriously detrimental impact on all strata of society, especially on the urban middle class.
This tax, which previously operated at the level of 11 per cent, is now to be increased to 15 per cent. While an increase of 4 per cent will have an appreciable impact on the cost of living across the board, it is unrealistic to assume that this will be the extent of the negative impact.
What is important to note is that exemptions, which applied previously to significant sectors like telecommunications, private education and private health, are to be removed entirely. All telephone charges will immediately move upwards. Private health, it must be remembered, is no longer the exclusive preserve of the wealthy. Clinics and diagnostic facilities in cities and suburban areas, and even in the rural sector, are typically patronised today by the middle class.
Given the eagerness of parents at the present time to use their resources, however inadequate, to give their children the benefit of exposure to a quality education, removal of exemption from VAT for the whole spectrum of private education will involve, for an influential part of the community, an onerous burden in the form of a substantial increase in fees and related expenses.
The consideration not to be lost sight of, is that, in respect of telecommunication, private health and private education, the VAT increase is not 4 per cent (from 11 per cent to 15 per cent), but actually 15 per cent (from zero to 15 per cent). The effect of this, of course, will be felt very sharply. This is over and above the proposal to impose VAT on selected (But as of now unspecified) retail and wholesale items hitherto enjoying exemption from VAT.
IV. Innovations in Respect of the Nation Building Tax
The Nation Building Tax (NBT) is imposed on turnover. While the current initiative abandons the previous Budget proposal to increase NBT from 2 per cent to 4 per cent, and retains it at 2 per cent, there are two changes: (i) The threshold of turnover at which the tax becomes applicable, is lowered from Rs. 3.75 million to Rs. 3 million per quarter, so that exposure to the tax is significantly widened. (ii) More importantly, existing exemptions on electricity, lubricants and telecommunication are done away with. This means that electricity bills (in respect of which the increase is substantial, because they were totally exempt from NBT previously) will be much heavier in the future, and the effect will spread right across society, the greatest hardships naturally being visited on the less affluent.
Removal of the exemption with regard to lubricants will increase the cost of services at petrol and service stations. The maintenance costs of a small vehicle owned by a middle class family are materially affected by this proposal. The most seriously affected will be three wheelers and taxis. Available statistics indicate that 1 out of every 3 persons in Sri Lanka now owns a vehicle of some kind.
V. Imposition of Import Duty on Essential Food Items
Consumer items required by the population, as a whole, will immediately become more expensive. During the 100 Day Programme, which was implemented after the change of Government on 8 January 2015, the cost of essential consumer items was brought down by the expedient of removing almost the whole of import duties levied on these commodities. This relief has now been withdrawn, and with the re-introduction of customs levies previously imposed, these essential consumer items will become a good deal costlier. The items affected include wheat grain, milk powder, dhal, canned fish and dry fish. The prices of flour and sugar have been increased already, signalling an increase in the cost of all products of which these items form an ingredient. The ripple effect, and the incremental increase at each step in the sales trajectory, will be considerable.
VI Repercussions on the Leasing Industry
An obvious casualty, with far-reaching consequences, is the leasing industry, which has served in the recent past as a major instrument for social upliftment, at the disposal of enterprising individuals and groups denied opportunity up to now. It is by the use of leasing facilities that new vistas of advancement have come within the reach of large segments of society, both urban and rural. Leasing has enabled innumerable families to accomplish, for themselves, their employees and the community they serve, a social transformation. They have been able to do this by obtaining access to resources which empower them to purchase, for example, a tractor, a truck or a van for the transport of school children, or agricultural produce to the market.
These will now cost more, and the added cost will engulf a multitude of transactions. By virtue of the greater burden on the lessee, the farmer who contracts for the use of the tractor, and the parents using the van to send their children to school, will be called upon to pay more. Also affected – and this is of special practical importance – will be machinery and other equipment used in factories. Much of this is today procured by leasing, but because of the greater outlay which the factory now needs to incur, employment which it is able to offer will be limited, and the goods produced will be sold to the customer at a higher price.
VII Consequences for the Local Industrialist
There is no doubt as to the grave adverse consequences for the local industrialist. During the period of the previous administration, there was a concerted effort made to identify thrust industries, which could be nurtured and developed appropriately for the benefit of the small and medium local industrial sector. The principal industries so identified were agriculture, tourism, the construction sector and information technology. As an impetus for expansion, the tax threshold in respect of these industries was fixed, by way of a calculated concession, at 12 per cent. This is now raised, by the new proposals, to 17 per cent. The superadded burden, which will become part of the manufacturing expenses, will impact on competitiveness and profitability, and inevitably result in the selling price of the goods produced becoming higher. Employment, again, is affected because of strain on the viability of the enterprise.
VIII. Increased Cost of Capital: Interest Rates
The onus of enhanced taxation on productive local entrepreneurs is aggravated by the increased cost of capital. During the last few years, the interest band was between 6 per cent and 7 per cent. It is now to be within the range of 8 to 10 per cent. Consequently, debt servicing will be more burdensome, and cannot but operate as a disincentive for the expansion, and in some cases even the survival, of local industries, already hard pressed, in the small and medium category.
IX Rapidly Declining Value of the Sri Lankan Rupee
Yet another factor relevant in this regard is the swift and continuing depreciation of the Sri Lankan rupee. As far as goods intended for the domestic market are concerned, and especially in respect of access to imported items required in the manufacturing process, the diminishing value of the rupee is a serious negative factor. In January 2015, when the government changed, the rate of conversion was Rs. 131 against the U.S. dollar. It is today Rs. 146, and the value of the rupee continues to fall. This compounds, to an appreciable extent, the problems arising from rising interest rates and the heightened incidence of direct as well as indirect taxation.
X. The Higher Echelons: Capital Gains Tax
Even the higher income groups find themselves assailed by the uncertainty of prospects for the future. This will necessarily dampen enthusiasm for investment, with harmful consequences for growth of the economy. This is exemplified by the proposal regarding revival of the Capital Gains Tax which was abolished in 1987.
The decision to re-impose the tax has been announced, but the mechanics of it, including the different tiers and the rate applicable to each band, with the central criterion dependent on the length of the period between acquisition and alienation of the asset, have yet to be disclosed. To cite some examples that spring readily to mind, the negative impact on purchase of apartments and other forms of property as an investment, as well as trading in stocks and shares, if brought within the purview of the tax, will be immediate. Contradictions and anomalies within a comprehensive vision for economic development are all too evident.
XI. Multiple Interactions and Cascading Effects
In assessing the overall impact of the new budgetary package, its elements have to be considered not piecemeal but in combination.
There are many proposals which have the unavoidable effect of reducing incomes drastically. Collapse of the minimum guaranteed price, the unavailability of fertiliser at affordable prices or, indeed, in some areas, at all, rock bottom prices in the open market for the paddy harvested, more arduous access to leasing facilities, the higher cost of capital for employment generating ventures, an elevated threshold of direct taxation for local industries, and the rupee almost in free fall (With a depreciation of about 12 per cent in the last year) are among the factors which will precipitate diminished incomes and reduced spending capacity. The other side of the coin consists of increased pressure compelling expenditure on essentials. Port charges have already been increased by 2.5 per cent, with the consequence that the prices of all imported goods will rise sharply. This is exacerbated by the re-introduction (After a 10 month respite) of import duty on essential food items, and the increase of VAT by as much as 15 per cent on some essential commodities and services in consequence of removal of crucial exemptions in the setting of both the VAT and the NBT regimes. The cascading effect of these measures will push the cost of living to new heights. The price of bread has already been increased. Some local industries, already vulnerable, will be further endangered. An example is the construction industry, with dependence of about 90 per cent on imported materials.
XII.Privatization: A New Conceptual Approach
The Government’s thinking in this regard is encapsulated in the proposal to bring all State Owned Enterprises (SOEs) under a Government owned holding company similar to Temasek Holdings of Singapore by transferring shares of these enterprises to a Public Wealth Trust (PWT).
This appears to mistake the wood for the trees. The malaise with regard to SOEs has little to do with their identity as distinct and separate entities. Consequently, an initiative to bring them together under one umbrella does not offer any realistic solution. The salient weakness of this approach is that it provides a plausible foundation for the fear that the steps outlined in the Government’s proposal represent the thin end of the wedge: it is the initial step towards privatization.
The Temasek model in Singapore is the product of a culture emanating from an entirely different set of historical and social circumstances. In Sri Lanka there is the deep and widespread conviction that there are some pre-eminent sectors of the economy which cannot be left complacently to the interplay of market forces, a role for the State being indispensable for imparting substance to the concept of a safety net for vulnerable segments of the community.
Water, electricity, health, education, transport and, to some extent, banking and insurance are some of these sectors. Some degree of equity, especially with regard to delivery of essential services, is a necessary corollary in a society such as ours for accomplishment of political stability. From a community point of view, the most important SOEs in Sri Lanka are the Ceylon Electricity Board, the Ceylon Petroleum Corporation, the Water Supply Board, the Sri Lanka Ports Authority and the Civil Aviation Authority.
There is vibrant public opinion in our country that these institutions must continue to function in the public domain, and any attempt to privatize them by having recourse to strategies, direct or oblique, is likely to be resisted strongly. This is equally true of pivotal institutions in the agriculture sector where production of essential commodities and animal husbandry are justifiably considered necessary components of food security.