By C. R. de Silva. Ex-World Bank.Courtesy The Island

October 6, 2016, 9:15 pm
RECENT IMF REVIEW

The IMF Review Mission in September for the $ 1.5 Billion EFF to Sri Lanka (in seven semi-annual instalments) started as a love fest on a familiar note under a well-known mission leader, and some ten days later, ended on an undiplomatic tone, with unfamiliar mission leaders throwing the book at Sri Lanka, in an overt, uncharacteristic display of interference in domestic policy, and threatening to delay further payments if IMF diktats were not complied with in a timely manner.

The media reported at the outset of the mission that “the IMF admired the progress made in the right direction under the reform agenda … and expressed the hope that the Government would be able to achieve desired economic progress in the near future with the stimulation provided by that agenda”. Minister of Finance Ravi Karunanayake in turn thanked the IMF for its “timely assistance” although only $ 168 million had been actually received.

Some ten days later the IMF mission stressed to the Minister that any further delay in passing the VAT increase legislation could lead to the postponement of the second tranche (of another $ 168 million). The (new) mission chief was effectively dictating to the government by stating : “We want to see the VAT Amendment Bill to be submitted (sic) to Parliament…if it does not happen in a timely manner we might have to postpone the next review”.

The mission discussion also identified another area of disagreement between the IMF and the Government, with the IMF noting that they see the enhanced VAT level as a permanent revenue measure in contrast to the Government claim that the VAT increase to 15% was a temporary ploy, until other direct revenues came on stream. The IMF also expected the Government to revise its income tax structure in order to bring direct and indirect taxes into balance given that today it is in a 20%/80% ratio, respectively. Further divergences in judgement followed with the IMF estimating Sri Lanka’s GDP growth at 5% during 2016-17, disagreeing with the earlier 6.5% target of the Government.

Lastly, an unprecedented and undiplomatic measure of disrespect was shown to the Minister of Finance by this IMF mission arriving at the concluding meeting 45 minutes late, as highlighted in front page news, reportedly causing the Minister to “complain of IMF harassment”. This whole regrettable episode not only symbolized an unexpected attitude but also a rather uncommon IMF mission strategy, if it was one, which clearly contravenes long-established codes of conduct, viz. for IMF/World Bank staff to be diplomatic and very discreet in the confidential policy exchanges with the Government, and absolutely correct and courteous in interacting with government personages, which is well known conduct to both IMF and World Bank staff, in this writer’s three decade experience at the latter institution’s headquarters. To arrive so late for a mission wrap-up with the IMF’s Governor for a member country is unknown conduct in Washington D.C.

PROTOCOL RULES & CULTURAL QUIRKS

The failure to observe established rules of well known protocol and orders of official precedence in dealing with foreign officials on the part of governmental authorities result in the strong likelihood of the above-mentioned types of episodes taking place. In India, these rules are strictly observed, and it is this writer’s experience that IMF and World Bank mission staff at the operational level do not ever get to meet the Minister of Finance. Their mission work is strictly regulated and managed at Deputy Secretary level, while meetings for Department Heads from the international institutions are always arranged at Joint Secretary level. It is only the Heads of international institutions like IMF and World Bank, currently Christine Lagarde and Jim Yong Kim, respectively, who get to even call on the Minister of Finance, who is also Governor for the member country on the Boards of Governors running these institutions as their shareholders. In like manner, in Washington D.C. headquarters, the Minister of Finance will only relate to the same heads of institutions, and discuss any outstanding policy issues that the country may have with them. Unlike in Sri Lanka, in most Asian countries including India, negotiations with visiting operational mission staff will never take place at Ministerial level. Sri Lanka flouts these rules of protocol and diplomacy to the disadvantage of its officials, and it leaves very little or no space for these bureaucrats to interact as equals with the staff of international institutions, reducing their power and discretion in the process, and resulting in instances of potential disrespect to our Ministers, like the occasion reported above in daily newspapers.

International officials brought up in the Confucian cultures of China and the East Asian tiger economies, where everyone is very accustomed to march unquestionably and single-mindedly, being highly disciplined as nations mostly schooled under historic dictatorships, to the tune of a single drummer, who calls the shots; will have difficulty appreciating the inherently raucous democratic milieu of the South Asian polity; especially in a coalition regime in which historically opposing parties try to reach a difficult policy consensus, even at the very top, and where opinions diverge, and reaching agreement on issues among diverse opinions, affecting the large mass of the people take much longer than in some other Asian countries. This is a singular reason for such foreign nationals demonstrating impatience and imposing “the fierce urgency of now” in Sri Lanka’s present circumstances on a country that cannot cope with that exceptional level of crisis management in compliance with unreasonable deadlines carved in stone, over which the authorities do not even have complete control.

ECONOMIC PROGRESS

The not-so-veiled threat extended by the IMF mission to a sovereign government, to suspend the grant of the second tranche of $ 168 million, assumes easy passage of amending legislation and approval by Parliament before November, and that it will not be subject to judicial review again. Such an assumption is quite unjustified; especially given the latest results of best efforts made by the Government over the past eighteen months to improve macroeconomic fundamentals, such as the fiscal deficit which is an obsession of the IMF, rate of inflation, balance of payments (BOP) deficit, foreign reserve position and local currency valuations, all recording improvements. The fiscal deficit has contracted significantly by an impressive 18% from the first half of 2015. Inflation is showing signs of a downturn by over !% to 4.5%. The one-year Treasury yield has declined impressively to over 10% in the primary market. The historically recurring increases in the BOP deficit seems largely in abeyance by mid-2016, following an overseas bond issue. Foreign reserves have stopped declining with prudent management of foreign exchange and depreciation in the value of the Rupee is also showing signs of greater stability. That said, all this is not to forecast that macro challenges do not remain on the immediate horizon including reduction of the budget deficit even more, the importance of increasing both export income and raising domestic revenue, and the difficult prospect of curtailing inflation as direct as well as indirect taxes rise with amending legislation when brought into effect. (Enterprise Ceylon Capital, October 2016).

ISSUES ARISING FROM IKF DIKTATS

VAT ISSUES. While the Government has no option but to increase revenue through higher indirect taxes, it does not help to enhance business confidence, because it adversely affects the already declining export sector whose inputs, including most raw materials, are imported and the finished product, already hurt by the depreciating rupee, becomes less competitive in export markets. Higher VAT will also mean a pull back in local consumer demand, again affecting economic growth

VAT is a good taxing tool in developed economies where payments and receipts are digitally or electronically documented and business accounts are routinely audited, so actual turnover is not in question, but of controversial value with small and medium enterprises in Sri Lanka, where business documentation is not always accurate, receipts are unreliable or nonexistent, and therefore, business volumes can be deliberately under-counted. Which goods are eligible for the increased VAT also seems undecided, as also the effective date from which higher VAT wiil be collected – attempts at giving retrospective effect to the legislation to May 2, may result, quite possibly, in further judicial review for the third time.

RETROSPECTIVE VAT IMPOSITION

A daily newspaper commented editorially on 30 September 2016 : “under the proposed VAT law amendments, retrospective legislation is included in the agenda…from 2 May 2016… such retrospective legislation would also apply in respect of the VAT threshold for business activities other than wholesale and retail sectors…such as services and manufacturing…with retrospective effect from 1 April, 2016”. The same editorial added that the Principal in charge of Tax and Regulatory Affairs at KPMG Sri Lanka, a globally reputed audit firm, has commented that such “retrospective legislation is bad in law”.

Similar comments have also been made in the relevant literature for a long time, that a tax can be made retroactive only when it does not thereby attach consequences that taxpayers could not have reasonably foreseen or expected, especially by the poor and middle class.

A December 2015 comment has recently appeared there that “such dishonest steps are taken by a government to undo some decision of a supreme or other high court, which the governing authorities do not like”. The confidence of good taxpayers or of the business community is shaken by such acts as retrospective tax legislation. It may also lead to foreign direct investment being diverted elsewhere due to the precedent that it establishes, which could be repeated in the future, and it may hinder the continuing stability of business activity, since it impairs and prejudicially affects existing rights and obligations under contracts already in force.

So, to pre-condition a second IMF tranche of what is effectively ‘dollar peanuts’ (given the massive foreign exchange requirements of our economy) and the attempt to effectively “blackmail” the authorities into jumping through all these hoops, not totally within the Government’s control, in such a public manner, to reach a preset tax target, is an unbelievable saga coming from a ‘last resort’ lending agency, committed primarily to relieve short-term BOP constraints of member countries.

Higher VAT will also mean a pull-back in local consumer demand, when higher retail prices are in force with the tax increase being passed on to consumers. In fact, some slowdown in growth had already been identified in 2016, which the IMF mission attributed to the drought and floods, but such a consequential slowdown in GDP growth was already forecast by the rating agencies as a result of this mandated VAT increase, even before the fact.

VAT ON TELECOM SERVICES

The imposition of higher VAT on telecommunication services, which are now enjoyed by a vast cross-section of the public countrywide, who are armed with cell phones, has already caused open controversy and criticism among civil society, businesses as well as sector experts. This indirect revenue tool also adversely affects greater penetration of the country by BroadBand services, an avowed objective of the Government, and is significantly an essential component in the country’s quest to move to a ‘knowledge’ economy, on the path to digitization and the introduction of ‘smart’ cities etc. A pull-back in demand and consequently in investment in these innovations is going to obstruct the country’s quest for the vaunted ‘lift-off’ in the Sri Lankan economy that the IMF forecast is the real objective of the economic reform agenda.

Since Sri Lanka enjoyed some of the world’s lowest data tariffs, BroadBand, leased-line and satellite connectivity were widely available, and ICT export revenues increased from $ 128 million in 2007 to $ 713 million in 2013, and are forecast to top $ 1 billion this year, the question arises whether increased VAT applicable to telecommunication services, including BroadBand, will seriously slow down the significant growth in ICT revenues, particularly exports, in Sri Lanka’s quest to remain a top global destination for business process outsourcing (BPO) and ICT. Therefore, broad applicability of increased VAT could again operate in reality as a double-edged sword inhibiting the forward march of export revenues and increasing the overall cost of living, with potentially serious political repercussions.

VAT ON HEALTH CARE SERVICES

In regard to the very principle of applying increased VAT on healthcare services, even though some specific items have been exempted in response to civil society protests, it has been pointed out that in the absence of a national health insurance scheme in Sri Lanka or social security payments for seniors, imposition of a steep 15% VAT on most healthcare services, and payable by those who are sick, in a country where the vast majority of patients are either working class or lower middle class, or are seniors in a fast aging population, none of them eligible for health or social insurance, but have no choice but to seek private healthcare facilities, is unconscionable and quite unjustifiable, especially when done on a IMF mandate to qualify for a few million dollars. The traumatic experience of indigent patients seeking treatment in unequipped public health facilities should be personally experienced to be believed.

It has also been pointed out that a 2014 Price, Waterhouse Coopers’ review found that 31 out of 32 OECD countries (the rich man’s club, whose member countries have health and social insurance) and 24 out of 25 African countries, either had a VAT exemption or a reduced rate of VAT on healthcare services. So, the question arises : Is it humane or fair to expect such poor or aging patients to subsidize the colossal financial losses of badly run state-owned enterprises (SOEs) like Sri Lankan Airlines, the Petroleum Corporation and one hundred other SOE’s, which have attracted the criticism of the IMF ? But as this writer commented in a previously published article on “Sri Lanka – The Case for a $ 3-4.5 Billion IMF/EFF” in The Island on 13 May, 2016, “but who in this cash-strapped, poor so-called Third World country, said to be in post-conflict transition, will take risky issue with the uncompromising staff of the Oracle of Delphi, since 1946 located on 19th Street N.W. in the U.S. capital ?

CONCLUSION

While the recent IMF review mission has publicly sought to make agreed timely legislation of increased VAT a significant enough issue to make or break the continuity of IMF/EFF’s $ 168 million (several) tranche instalments, in a seemingly narrowly focused dialogue with the Government which appears mainly to concentrate on improving the purely fiscal position in which the country finds itself, IMF authorities do not seem to publicly highlight the other structural issues which have to be addressed, also in a timely manner, if the originally stated overriding IMF objective of the current $ 1.5 Billion EFF operation, when it was approved earlier this year, is to “help the Government achieve ‘lift-off’ of the economy and fully tap Sri Lanka’s significant economic potential” during the 3-year period of its disbursement. These are summarized below, but their elaboration belongs in another place and at another time:

First, currently Sri Lanka’s sovereign foreign debt stands at near $ 50 Billion and annual debt service payments at about $ 5 Billion. Several prominent economists have commented that this high level of foreign debt is not sustainable, and concluded that the country is already in a debt trap. According to the U.K.-based Jubilee Debt Campaign (JDC), a global movement “demanding relief from the slavery of unjust debts”, countries like Sri Lanka with a foreign debt over 30% of GDP and debt service payments exceeding 15% of external revenue, have unsustainable foreign debt. JDC classifies Sri Lanka in a group of 22 countries already in a debt crisis, which include the Eurozone countries of GREECE, Portugal, Ireland, Spain and Cyprus, which have all at some point received the tender, loving care of IMF economic and financial panacea. See Sri Lanka – Avoiding the ‘Road to Greece’ in The Island of 13 June 2016. Sri Lanka should raise at the highest level at the IMF/World Bank Annual Meetings the question of restructuring its massive foreign debt, and stretching out periodic repayments to make them affordable, without waiting for last minute IMF intervention. See “Sri Lanka – Reliability of IMF’s Judgements and Program Efficacy” in The Island on 3-4 August 2016.

Second, comment is unavoidable on the IMF’s very controversial judgement that the 3-year reform program under the EFF which it outlined for the Government, narrowly focused mainly on fiscal issues, “will help the Government to achieve ‘lift off’ of the economy…”. For a middle income developing country at the lower ranges to achieve that kind of giant economic leap forward or ‘lift off’ to the next level of development, will require very much more planning, innovation, investment and structural change, than satisfaction of a few identified, mostly unpopular, policy reform measures, supported by a very modest $ 1.5 Billion EFF, doled out in $ 168 million tranche payments over a three-year period.

Third, given the rapid advances now taking place in the new technology revolution, with robotics and artificial intelligence replacing human thinking and even skilled labour, and sweeping the world from the western countries to China, Japan and India, and Sri Lanka’s own massive investment program in the planned ‘smart cities’ included in the Western Region Megapolis Project (WRMP), revolutionary structural changes are called for in education curricula, vocational training and technical education to prepare the work force to be able to cope with coming information and communication technology (ICT) developments – if a crisis later in employment is to be avoided. However, the authorities have not proceeded beyond the first World Bank-financed “e-Sri Lanka Project – an ICT Development Road Map”, already completed years ago, which has only created a satisfactory platform for further ICT development in Sri Lanka. No follow-up initiative has been taken by the Government to request further multilateral assistance. See “The New Technology Revolution – Impact on Sri Lanka” in The Island of 2-3 September 2016.