By M D P DISSANAYAKE

There are inherent dangers of the lack of  macro  and micro economic policies adopted in the formulation of the Revised Budget 2015 by the Minister of Finance Mr Ravi Karunanayake.

Budget sweetners:

The Revised Budget did contain sweeteners to appease the consumers of household goods  and some of the luxury items.  The budget was not intended to continue economic prosperity instead it was targeted at winning the next General Election to increase the vote base of the United National Party which is holding about 40 seats in the 225 seat Parliament.

The government was able  to increase the wages by Rs 7000 per month, as it had the capacity to increase with the vast revenue generated by the previous regime.

Cost-Push-Inflation:

In the production cycle, key components of labour and material costs need to be kept in a competitive manner.  Within the free market policy, Sri Lanka is open for business globally, without adverse restrictions on imports and exports.  In order to encourage locally manufactured products and services , the cost of production need to be kept under constant control.   The increase in labour costs, which is a key input component of production cost,  will direct impact on increasing the cost of production. The increase in cost of production is likely to decrease the aggregate supply of the goods and services.  With the demand for the goods and services remaining constant in the short and medium term, with the reduction in volume of supply, the prices of finished goods will increase.  In other words, this will bring about a Cost Push Inflation.

Unlike in Western countries,  in developing nations such as Sri Lanka Food items represent a larger percentage of cost of living.  The relief provided by the Revised Budget could be short lived.  When new labour costs resulting wage increases begin to take effect on the production costs, the manufacturers will not absorb the increased costs, instead pass it on to the consumers  in order to maintain the  producers’  pre-wage increase profit margins.  Eventually, the wage increases offered by the Revised Budget  will be wiped out as a result of  increase in cost of goods and services, as a result of cost push inflation.

Though it is still a very short period time since the formation of the new government, the Sri Lankan Rupee has already depreciated by almost 2%.  The rapid currency depreciation will cause further increases in inflation as a result of increase in cost of imported goods.  With extra cash in the pay packets,  Sri Lankans will favour to buy imported luxury goods, thus blowing up import volumes at increased costs.  The increase in cost of imports  due to fall in currency can be off-set by increasing the volume of exports of Sri Lanka.  To take advantage of currency depreciation and to increase the volume of exports,  there must be a surplus  or idle  production capacity  in manufacturing and primary producing sectors in Sri Lanka. Whilst cost push inflation due to increase in cost of imports is instant, the extra export revenue  resulting from cheaper Sri Lankan Rupee is cannot be achieved overnight.

Increase in  prices of goods and services, will naturally increase the volume of VAT (Value Added Tax) and Excise Duties collected from the consumers, which will also be another factor in cost push inflation.

Oil Prices and new price fixing formula:

The slump in the Crude Oil Prices started since 2014 due to oversupply by the competitors.  The OPEC in an attempt to maintain their share of the market,  allowed the crude oil prices to fall. The OPEC is now forecasting a recovery of demand and consequently an increase in crude oil prices.  This would mean the countries like Sri Lanka’s honeymoon of low prices at the gas stations will soon be over,  causing further  cost push inflation.

The proposed new price formula still being prepared by the Minister of Energy Mr Champaka Ranawaka will not be a substitute to overcome fall in Sri Lanka Rupee and increase in Crude Oil Prices in the world market.  The only controllable cost in such a formula will be the control of local costs, predominantly labour costs.  If Minister of Finance keep  increasing the labour costs to increase the vote base, the Minister of Energy’s  proposed new price fixing formula will be a futile exercise.

Conclusion:

The Revised Budget had been prepared within a short period of time and several amendments have already been made, causing uncertainty in the motor vehicle and other industries.

The expectations were high when Mr Ravi Karunanayake was compiling the Revised Budget.  The market expectations were economically responsible budget from a Qualified Accountant, unfortunately he has miserably failed to grasp the past, current and future economic trends in his maiden budget.