{"id":104676,"date":"2020-07-21T00:21:37","date_gmt":"2020-07-21T06:21:37","guid":{"rendered":"http:\/\/www.lankaweb.com\/news\/items\/?p=104676"},"modified":"2020-07-20T17:18:23","modified_gmt":"2020-07-21T00:18:23","slug":"deficits-and-implied-taxation","status":"publish","type":"post","link":"https:\/\/www.lankaweb.com\/news\/items\/2020\/07\/21\/deficits-and-implied-taxation\/","title":{"rendered":"Deficits and Implied Taxation"},"content":{"rendered":"

The Prince of Kandy<\/em><\/span><\/h2>\n\n\n

I am not saying it is a life and death matter when you print money. During my period it isn\u2019t that we didn\u2019t have excess printing but every time the treasury secretary asked me if we could accommodate the government with an excess of treasury bills I always got a date by which it was settled. We made sure that was settled. It is like a good bank manager.<\/em> \u2013 Former Central Bank Governor Ajith Nivaard Cabraal[i]<\/strong><\/a><\/p>\n\n\n\n

To take on a loan one of the most important questions a bank\nwill ask you is how you expect to pay it back? Loan applicants must submit\nbusiness plans, offer collateral, provide credit histories, and offer lenders\nenviable access into their ledgers.<\/p>\n\n\n\n

Banks try to forecast revenue streams to predict whether you\ncan pay them back. For a business one would look at sales, for an individual\none would look at salary, and for a government, one would look at taxation.<\/p>\n\n\n\n

The Central Bank as alluded to by the former governor also\nhas the capacity to fund the government. This funding comes in the form of seigniorage.\nBy printing money, the Central Bank is creating assets for itself as the value\nof the money tends to exceed the cost of printing it.<\/p>\n\n\n\n

By providing the government with increased purchasing power\nat the expense of public purchasing power, it imposes what is metaphorically\nknown as an inflation tax on the public.<\/p>\n\n\n\n

Implied Taxation<\/h3>\n\n\n\n

Given that the government is running a deficit estimated at\n8.5 percent of GDP[ii]<\/a>\nfor 2020 at some point in the future it will have to raise tax revenues to pay\nthe debt. This can be likened to someone planning to go on a diet.<\/p>\n\n\n\n

A person choosing to exceed their budgeted caloric intake on\none day must make economies on the next if their diet is to have an impact. In\nthe same way, society impose judgments on people going on diets, we also are\nquite divided on the debt dynamics of a government. <\/p>\n\n\n\n

Debt not only plays into intergenerational politics within\nsociety but also on issues such as class and regionalism. Whose burden it is to\nservice the debt and for whose benefit the debt is created are highly\npolitically divisive issues.<\/p>\n\n\n\n

It however is economic orthodoxy that high debt is a risk\nfactor for any economy. As an excessive diet may lead to things like heart\ndisease an excessive debt burden can lead to for example severe fiscal\nconstraints on the government, a run on the currency, insolvency, and a loss of\nbusiness confidence.<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n
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Debt Dynamics <\/h3>\n\n\n\n

Let us ignore the volume of debt on which as alluded to earlier\nwe might be divided on given our varying demographic characteristics. Instead,\nlet us draw our attention to the cash flow implications of debt servicing.<\/p>\n\n\n\n

Sri Lanka is not Japan. Japan\u2019s debt is denominated in its\nlocal currency and they with their long-lasting export-strength have built up reserves\nand stakes in important global institutions like the Asian Development Bank.\nSri Lanka is not the United States. The United States has hegemonic power over\nenergy, military, and international institutions and is the global reserve currency.\n<\/p>\n\n\n\n

If our debt dynamics become worse, we are likely to face\nfurther downgrades to our already dangerously weak credit rating. This will\nskyrocket the cost of debt and thus the cost of projects requiring external\nfinancing. In simple terms, if our debt dynamics weaken the costs of developing\nroads sans the political commission will become even higher than they are now.<\/p>\n\n\n\n

Cash Flow<\/h3>\n\n\n\n

In terms of going concern the sovereign is treated\ndifferently than a legal entity or person. Markets value sovereign debt based\non cash flows and reserves in a more forgiving manner. This is odd because if\nentities had the same wastage, excesses, and grandiose plans as the government markets\nwould surely be closed to them.<\/p>\n\n\n\n

This is to say that the markets assume that even if Sri\nLanka is to default on debt payment it would continue to exist the next day.\nFor instance, land in Greece still has a positive value. Having defaulted\nGreece can both issue new debt and retain ownership of their assets. Greece\ndoes not become part of Germany just because it has defaulted to Germany.<\/p>\n\n\n\n

This contrasts with let us say when one of our many highly\nindebted holding companies goes insolvent or worse bankrupt and though they may\nhave viable subsidiaries it is difficult for them to part with the asset\nwithout their creditors getting worked up.<\/p>\n\n\n\n

Insolvency<\/h3>\n\n\n\n

Imagine learning that you have lost your wallet on public\ntransport. Regardless of what you look like you will quickly be treated as if\nthough you are as a busking beggar. You will most likely be asked to get down\nat the next stop.<\/p>\n\n\n\n

Here Sri Lanka\u2019s borrowing to China is important as though\nthey insist that the terms are good it does not happen through the same\nchannels as traditional lenders. Traditional lenders like the Asian Development\nBank have established offices and interface with the treasury with\nwell-established formal procedures whereas the Chinese come through promoters\nand the political system.<\/p>\n\n\n\n

This is most exemplified in the Central Expressway. Chinese\nfinanciers linked to the state won contracts[iii]<\/a>\non the expressway and subsequently withheld funds and delayed progress on the\ninfrastructure. On the return to power of their political puppet,[iv]<\/a>\nthey will resume the project.<\/p>\n\n\n\n

Intelligent Economic Policy<\/h3>\n\n\n\n

This can become an economic crisis. Not only big\ncountries but also small countries have Central Banks that have acted. In the\nUS they have taken a US $ 600 billion action. The US Federal Reserve commits to\nuse the full range of tools to help the economy through unprecedented times.\nWhat has our Central Bank done? Nothing. Our Central Bank does not use a single\ntool they just sleep. Give Rs 150 billion to these businesses. <\/p>\n\n\n\n

Due to the mistakes of the past, there are debts owed\nby the government to companies. Let companies collateralize that debt to run\nthe economy. This is money circulation. This is the basics of economics. <\/p>\n\n\n\n

Your mistakes are perceived to be that of the government. Look at the failure of the finance companies, it is the fault of the Central Bank. All of you are economists who take large salaries. You have a duty in this crisis to act. <\/em>– President Gotabaya Rajapaksa[v]<\/strong><\/a><\/p>\n\n\n\n

These statements look to deflect heat towards the Central\nBank which does not have to stand for election and suggests that the Central\nBank is behind the economic failings of the interim government. The monolithic\nmedia structure backing the SLPP has gone on overdrive under the premise that\nthe public is concerned with a cricket match played in 2011 to deflect from the\nmassive economic failings of the government.<\/p>\n\n\n\n

Central Bank actions, directly and indirectly, influence monetary\naggregates. Monetary transmission in Sri Lanka takes about six months. In other\nwords, it takes time for the major levers of Central Bank policy to have an\nimpact on the economy. <\/p>\n\n\n\n

Ignoring the health risks to improve cash flow in the\neconomy it would have been more effective to open the economy. It would have\nbeen even better if the COVID-19 relief fund were distributed earlier as\nopposed to just before an election.<\/p>\n\n\n\n

Fiscal policy is a much better tool and the interim\ngovernment had already exhausted that measure through their massive tax\nhandouts. These policies were a joke with VAT reductions not resulting in price\nreductions.<\/p>\n\n\n\n

Developed countries could take larger action proportional to\ntheir economies because they had built reserves that our Central Bank has not.<\/p>\n\n\n\n

Intelligent Action<\/h3>\n\n\n\n

We live in a country where the two major spenders in the\nupcoming election (the SJB and SLPP) are dogged with huge corruption scandals.\nThe SJB leader spent the central cultural fund as if it were his own and the\nparty of the current interim government\u2019s scandals are well known. Parliament will have its fair\nshare of idiots and they will invariably push the country into more tender\nfraud.<\/p>\n\n\n\n

We live in a country wherein despite considerable evidence\nto the contrary people watching the news at 7 feel informed. They watch as\nnewscasters picked mostly on the sole basis of their sexual appeal speak on the\neve of an election on whether a cricket match played in 2011 was rigged. A bipartisan\nopinion would agree that the cricket administration is corrupt but would also agree\nthat cancer will cross the political aisle.<\/p>\n\n\n\n

We are not a country that is capable even after the\nPresident makes a big deal of the Central Bank to consider the fact that the deposit\ncost of funds to the banks has reduced further than their average lending rates\nto the economy. Ignoring impairment during the crisis the net interest margin\nof the banks widened.<\/p>\n\n\n\n

Central Bank Stupidity<\/h3>\n\n\n\n

Sri Lanka\u2019s commercial banks are at present in a state of massive excess liquidity. They are sitting on a huge amount of cash but there are no matching loan applications to dispense it. Hence, on a day to day basis, they have been parking their excess cash in an interest-earning deposit with the Central Bank under its Standing Deposit Facility or SDF at 5.5%. At the time the Board decided to cut SRR by 2%, the banking sector was with excess liquidity of about Rs. 100 billion which they had deposited with the Central Bank under SDF.<\/em> – W A Wijewardane[vi]<\/strong><\/a><\/p>\n\n\n\n

Instead of going into the secondary market on long term\ngovernment securities and providing the economy with a true monetary stimulus\nthat ordinary businesses can use the Central Bank chose to create liquidity for\nwheeler-dealers looking to make a quick buck as foreigners escape our banana\nrepublic.<\/p>\n\n\n\n

The construction sector will require a nuclear level of\nmoney printing to be bailed out. It is the only sector in the country that\nimports manual labor and the signs that it has overheated are clear to any\ncasual observer. Take the Labour Department building amongst many others which\nis for the most part empty while the government continues to procure more\nbuilding space at a ridiculously high spec.<\/p>\n\n\n\n

Debt\nManagement of the Government<\/h3>\n\n\n\n

The\nCentral Bank management of Government debt has been concerning for decades now.\nThere are huge conflicts of interest in the issuance of debt for the government\nby the Central Bank.<\/p>\n\n\n\n

Despite several public statements made in recent years about plans for the management of government debt to be transferred to an independent agency, no progress appears to have been made. Whether this is due to bureaucratic inertia or active resistance to change by vested interests, the net result is slow progress on modernizing capital markets.<\/em> \u2013 Arjuna Mahendran 4 July 2020[vii]<\/strong><\/a> <\/p>\n\n\n\n

Consider\nthe way monetary aggregates are being increased and the quality of government\nsecurities. The General public would find it very difficult to get government\nsecurities. The primary dealer network is very poorly regulated. Though people lead\nby the quite weak financial press may look to focus on Perpetual Treasuries\nthey fail to remember Entrust Securities. Entrust Securities put to question\nthe entire issuance system established by the Central Bank. Ignoring those two\ninstitutions we also have stand-alone Primary Dealers who pose significant\ncounterparty risk to the system and have exposure to the microfinance sector.<\/p>\n\n\n\n

Given\nthe Domestic Operation[viii]<\/a>\nDirective on 3 July the Central Bank has gone from completely messing up\ngovernment debt issuance to outsourcing it to the government. This allows the\ngovernment without going to parliament to issue Promissory Notes that the\nBanking Sector must recognize. This effectively creates money and hands that\npower directly to the Minister with no checks and balances. The Central Bank\nloses control of Monetary Aggregates in the system.<\/p>\n\n\n\n

Construction\nBailout<\/h3>\n\n\n\n

The\nMonetary Board has approved a \u2018Liquidity Facility to the Construction Sector\u2019\n(LFCS), \u2026 for the construction sector enterprises to borrow from LCBs, backed\nby a \u2018Letter of Acceptance of Payments of Outstanding Bills Due to Contractors\u201d\n(LAPC)\u2026 In turn, Licensed Commercial Banks provide promissory notes secured by\npledged Treasury Bills and Treasury bonds in their holding to the CBSL to\nobtain credit facilities at a concessionary rate of interest. \u2013 Operating\nInstructions No: 35\/03\/023\/0001\/002<\/p>\n\n\n\n

The above\nquote was a directive sent to all bank CEOs. The economic consequences of a\ndelay to the construction of a bridge or road pose a much smaller existential\nthreat to the construction industry than for instance the ability of a bakery\nto keep its doors open the next month by paying it\u2019s bakers a salary. Why is it\nso pertinent that the construction sector be bailed out first? My take is that\nthe workers in those industries tend to be Chinese and that is where the\ngovernment seems to be seeking credit. <\/p>\n\n\n\n

When Greece\nwas bailed out by the European Central Bank those funds were used to pay down\nGreek bonds that apart from the stock that we managed to get our hands on were held\nby German banks. Power is what gets bailed out. The bailout to the construction\nsector already makes the SME bailout seem miserely.<\/p>\n\n\n\n

Solving the Cash Problem<\/h3>\n\n\n\n

The financial markets identified the problem as one of cash\nflow early on. Why did not the Central Bank look to fix that issue? Let\nordinary people withdraw from their time deposits with no penalty. Let\nemployers delay their EPF contribution or divert those funds directly to the\nemployee. Invest EPF funds in the stock market to boost liquidity and take\nadvantage of low prices.<\/p>\n\n\n\n

Reducing the statutory reserve ratio still requires the\nbanks to intermediate to get cash into the real economy. That takes time. It\nalso is unsustainable as the rate will invariably have to rise and with no\ntimelines on when this will happen it will be driving more uncertainty into banking\ndecisions. As alluded to before this move only exists to get money into the\nhands of wheeler-dealers to be put on the stock exchange or into the election. <\/p>\n\n\n\n

Reserves are not just a tool to control monetary aggregates\nbut also ensure banking stability. With such a low rate is the Central Bank\nrisking the entire payment system?<\/p>\n\n\n\n

Prediction<\/h3>\n\n\n\n

Given that the Central Bank details the debts of the\ngovernment and when they mature it is easy to predict that whichever government\ncomes into power, they will have to implement a high tax regime[ix]<\/a>.<\/p>\n\n\n\n

Inland Revenue has been clever and pushed through a new system\nfor Income Tax[x]<\/a>.\nCommendations are due as this system will make it more difficult for people to\nlower their effective rate of taxation and not disclose income. <\/p>\n\n\n\n

In the past, people would only be subject to WHT on their\nformal instruments and would receive payment in cash for their clinic or legal\nservices. Inland Revenue could not feasibly investigate people. Under the new\nsystem, any formal instrument would be a giveaway as through the submission of a\nstatement of estimated tax you would no longer be lying through means of\nomission and actively misleading the government.<\/p>\n\n\n\n

Thresholds were lifted so people would lose concern in\nincome taxation and shall be shocked when they realize that both thresholds and\nthe system have changed. The tax code will have to be retrospectively enacted. This\nis an election year. Do not buy into the marketing. As stated earlier you\nshould be getting out of taxable assets.
<\/p>\n\n\n\n

\n\n\n\n

[i]<\/a> Sampath Securities Investor Symposium – Post COVID 19\nImpact on the Economy and CSE:<\/em>https:\/\/www.youtube.com\/watch?v=GUQ_Vkh1s_Q<\/a><\/p>\n\n\n\n

[ii]<\/a> https:\/\/economynext.com\/sri-lanka-eyes-8-5-pct-of-gdp-deficit-in-2020-rs440bn-revenue-loss-after-stimulus-70809\/<\/a>\n<\/p>\n\n\n\n

[iii]<\/a> http:\/\/www.themorning.lk\/chinese-funds-for-expressway-project-delayed\/<\/a>\n<\/p>\n\n\n\n

[iv]<\/a> http:\/\/www.adaderana.lk\/news\/64825\/pm-on-observation-visit-to-central-expressway<\/a>\n<\/p>\n\n\n\n

[v]<\/a> https:\/\/www.youtube.com\/watch?v=TKBEcVfVazo<\/a>\n<\/p>\n\n\n\n

[vi]<\/a> http:\/\/www.ft.lk\/columns\/Accelerating-credit-flows-Address-structural-issues-first\/4-701937<\/p>\n\n\n\n

[vii]<\/a> https:\/\/www.colombotelegraph.com\/index.php\/bond-scams-were-caused-by-a-broken-bond-market-part-iii\/<\/a>\n<\/p>\n\n\n\n

[viii]<\/a>https:\/\/www.cbsl.gov.lk\/sites\/default\/files\/cbslweb_documents\/laws\/cdg\/dod_20200706_operating_instructions_no_35_03_023_0001_002_e.pdf<\/a>\n<\/p>\n\n\n\n

[ix]<\/a> https:\/\/www.cbsl.gov.lk\/gosl-debt-securities-series-available-for-investors<\/p>\n\n\n\n

[x]<\/a> http:\/\/www.ird.gov.lk\/en\/publications\/sitepages\/apit_tax_tables.aspx?menuid=1503<\/p>\n","protected":false},"excerpt":{"rendered":"

The Prince of Kandy I am not saying it is a life and death matter when you print money. During my period it isn\u2019t that we didn\u2019t have excess printing but every time the treasury secretary asked me if we could accommodate the government with an excess of treasury bills I always got a date […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"footnotes":""},"categories":[102],"tags":[],"class_list":["post-104676","post","type-post","status-publish","format-standard","hentry","category-economy"],"_links":{"self":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts\/104676","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/comments?post=104676"}],"version-history":[{"count":0,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts\/104676\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/media?parent=104676"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/categories?post=104676"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/tags?post=104676"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}