PROFESSIONAL TENETS

SUBSIDIES IMPEDE PROGRESS

Rajatha Wijeweera analyses the national economy's growth curve.

Mihiri Wikramanayake takes note of the context: rising oil prices.

Each year, a country's economy is critiqued, reviewed and revisited - and the economic outlook is previewed by economists, bankers, accountants and financial wizards. And so, Rajatha Wijeweera, an economist at The World Bank in Sri Lanka has his work cut out. With the Sri Lankan economy being subject to numerous fluctuations due to internal and external shocks, predictions can change like the wind.

"In recent times, our economy has been doing quite well," Wijeweera avers. The economy performed satisfactorily during the last three quarters of 2005, recording above six per cent growth in each quarter and ending the year with a per capita income close to US$ 1,200. Last year's performance reflected, in part, the impact of post-tsunami reconstruction, the large inflow of aid and the prevalence of a relatively peaceful environment through most of the year. Favourable weather conditions and increased private remittances also paved the way for high growth.

According to Wijeweera, Sri Lanka could achieve even higher growth in the medium term, provided peace - or the absence of war - holds and the appropriate strategic policies are implemented. The island nation is exposed to a number of internal and external vulnerabilities. Obviously, internally, the progress made on the peace front will have a strong bearing on the performance of the economy. However, other factors such as fiscal and monetary management, as well as promotion of investment and trade, would also be crucial in determining the rate of growth in the medium term.

This economist believes that on the external front, the most important factor will be the skyrocketing price of oil and its impact on the domestic economy. "On the positive side, we expect the global economy to remain buoyant this year, with an estimated growth of about 3.2 per cent - the same as in 2005 - which would lend support to export, tourism (provided that relative peace holds) and increased remittances," he says.

Wijeweera adds that in a continually rising oil-price scenario, governments find it difficult to sustain subsidies indefinitely. At some point, the fiscal stress of continued subsidisation would be unbearable - and this would inevitably lead to price adjustments, as well as passing down of costs to the consumer.

In Sri Lanka, it is widely believed that fuel subsidies tend to favour the rich more than the poor. Also, an increase in fuel prices will have a one-off effect on consumer price indices, or inflation. Nevertheless, in the medium term, this would not have as significant an impact in comparison to inflationary tendencies, which could arise due to a higher fiscal deficit resulting from continued subsidisation.

Moreover, when fuel prices increase, consumers have an incentive to conserve energy and look for more cost-effective means of getting about their daily business.

So how could the government handle the most recent hike in global oil prices, and what real options does it have?

Wijeweera believes that if the government adheres to its budgeted fiscal-deficit target, it would not be in a position to absorb a subsidy bill substantially in excess of its budget. Therefore, amidst increasingly costly fuel and given the negative side effects of fiscal spillovers, the government may be compelled to pass on the higher costs. The formulaic price-revision system which was introduced some time ago would, therefore, be the best policy prescription in such a milieu. Further, as higher fuel prices bring about a 'conservation consciousness', the government should also perhaps facilitate this adjustment to demand by looking at encouraging fuel (and energy) conservation and establishing an efficient public-transportation system.

And how much emphasis should the business community place on expansion in the north and east?

According to Wijeweera, "the business community would obviously look at risk and return profiles, before committing any investments in the north and east or any other part of the country". However, it is heartening to note that following the signing of the CFA, many private-sector entities - especially banks and telecommunications companies - did invest in the north and east. The east is richly endowed with arable land and a productive coastline, while the north holds much promise on account of agriculture and farm production. However, at present, the entire north and east combined account for only eight per cent of the country's GDP.

Wijeweera observes that the donor community, in conjunction with the government, has committed finances and resources for the rehabilitation and reconstruction of the north and the east. "There is considerable scope to increase the region's contribution to the national economy if these planned rebuilding efforts and programmes aimed at strengthening livelihoods can make progress within a peaceful and secure Sri Lanka," he concludes.
