ECONOMYNEXT – Sri Lanka will review the impact on state revenues and growth from the Easter Sunday bombings in June, State Minister for Eran Wickramaratne said amid an import collapse triggered by a credit contraction due to the operation of a soft-peg with the US dollar in a contradictory policy.
Sri Lanka is expecting tourism arrivals to fall at least 30 percent in 2019 after Easter Sunday bombings and has cut value added tax (VAT) on tourism to 5 percent from 15 percent until March next year.
Last year, Sri Lanka had earned 18 billion rupees from value added tax on tourism.
Tourists are estimated to have spent 4.2 billion US dollars in Sri Lanka on hotels and other services, which have a cascading impact on other activity.
Tourists also buy goods from supermarkets, which are subject to VAT and other turnover taxes and travel on three wheelers and cars whose owners pay high taxes on petrol. Some travel on diesel-driven vans and buses which pay hardly any tax.
“We will allow May to go by and conduct a detailed review on revenues and growth in June,” Wickremaratne said.
Sri Lanka’s private domestic credit turned negative in January and was barely positive in February, following the collapse of the rupee from August 2018 due to excess liquidity generated by the Central Bank and a political crisis triggered by President Maithripala Sirisena in October 2018.
A steep fall in domestic credit leads to a collapse in economic activity and imports generating revenue and growth losses.
In Sri Lanka, due to so-called Mercantilist false doctrine and lack of classical economic knowledge, monetary instability in the form of exchange rate collapses and balance of payment deficits are blamed on trade rather than Central Bank policy where credit is driven by printed money.
Sri Lanka was planning to cut the budget deficit – before currency depreciation – to 4.4 percent of gross domestic product in 2019.
But when credit slows, printed money can be withdrawn by mopping up purchases of foreign exchange in the course of operating a peg stronger than a currency board and re-build forex reserves lost during the period money was printed.
But it will also slow economic activity.
When private credit is slow or negative, the government can usually borrow and spend without pushing up inflation, unless it is done to excess due to savings exceeding investments.
Sri Lanka’s currency instability dates back to around March and April 2018 when the Central Bank started to print money just as the economy started to recover from a currency collapse in 2015/2016.
Currency collapses destroy real incomes and also real capital as the prices structure of the country goes up. Prices first go up through the traded sector and then through the non-trade sector. Firms will borrow larger volumes of credit but engage in the same real activity as before.
As inflation picks up, revenues will inflate and be restored to the same real level as it was before the currency collapsed, but there is no real progress.
However, special interests like hard goods export business owners may make profits from a real fall in worker salaries.
Workers in all other businesses will also suffer a real fall in salaries from a currency collapse, which may lead to political unrest.
Because of the fall in real incomes due to the currency collapse, all domestic businesses will suffer weak demand, leading to more bad loans, making the recovery period longer. It may require external demand to push the economy back on track, unlike a country with a stronger currency.
During the East Asian crisis, Hong Kong, whose currency cannot collapse as it is illegal to print money, was the first to reach pre-crisis gross domestic product. Singapore which has a modified currency board, had the least bad loans.
Sri Lanka’s soft-pegged exchange built in 1950 brings unsound money and monetary instability to Sri Lanka, and has been identified by some critics as perhaps the biggest economic challenge to improving people’s economic lives. (Colombo/May08/2019- SB)