Colombo Telegraph

Budget 2014: No Rupee Devaluation Shocks

By Hema Senanayake – 

Hema Senanayake

If I have any kind of expertise, it is in the subject of economics, especially in macroeconomics. Perhaps some CT readers might want to know my views on the budget 2014. Let me begin with the budget of 2013.  When the 2013 budget was presented, the Central Bank of Sri Lanka (CBSL) forecasted to achieve 7.5% GDP growth. Instead, I suggested that “Sri Lanka will never achieve 7.5% GDP growth” for the year 2013. My claim is on record. Why did I say that?  In the budget for 2013, it was proposed to reduce foreign borrowings dramatically in compared to the previous year. Pointing it out, I categorically said that if the government stick to the limit of foreign borrowings proposed in the budget, the government has to contain the private sector credit growth severely in order to avoid significant rupee depreciation and as a result it would not be able to achieve 7.5% GDP growth in the year 2013. My prediction was well backed by a reason.

The economy is a system; you can’t do whatever you want in one area without having impact in another area. The stability of rupee depends on the balance between the inflow of dollars (or foreign currencies) into the country and the outflow of dollars. And private sector credit growth is important to achieve higher GDP growth; ensuring private sector credit growth is not possible if the balance between inflow and outflow of dollars breaks negatively which means inflow of dollars reduced in compared to outflow. The proposed dramatic reduction of foreign borrowings in the budget of 2013 should have definitely broken the said balance negatively. This was a great mistake and as a result finally the government desperately pushed the National Savings Bank to borrow in dollars.

The said mistake has been avoided in 2014 budget. In this budget it has been proposed to increase foreign borrowings by 34.15% to Rs.331.5 billion; this will roughly amounted to USD 2.5 billion. Quickly you will guess that in the year 2014 there won’t be currency devaluation shocks. That is right. Another positive point is the proposal to reduce domestic borrowings by 22%. The combined effect of both proposals is that it provides a better chance to expand private credit issuances. If credit issuances (or credit growth) are not significant then there are chances to appreciate the value of rupee which is an indication that CBSL has to bring down the interest rates. This means in 2014 we will be able to see more stable currency, low interest rates and private sector credit expansion which combination helps to have a higher GDP.

When I say a higher GDP, it means a GDP value than the budget deficit which is known as deficit spending of the government. If the government’s deficit spending is 8% and the achieved GDP is 8%, I do not consider it as a good GDP value. The reason is that in the GDP calculation we added up basically four parameters, one parameter being the government expenditure. This means if the government borrows and spends Rs.100 then by that amount GDP goes up. Even with higher GDPs, such economies will collapse sooner due to debt crises or due to severe currency depreciations. In 2011, we had around 8% of deficit spending and the GDP grew by 8% and in the second quarter of 2012 there began a shocking currency depreciation. On the contrary, in 2014, we will have a good GDP value exceeding the amount of deficit spending.

However foreign borrowings come with an obligation to pay them back. This necessitates in increasing the inflow of dollars through non-credit sources through the promotion of exports and Foreign Direct Investments (FDIs). In this regard individual entrepreneur’s creative mind set is very important other than economic incentives. They should feel that they can do businesses independently without any fear. Respect for human rights is directly related to the promotion of exports. If human rights are respected now, the country can win back the GSP+; and that helps to promote exports to Europe and will justify the proposed foreign borrowings. Sometimes I tried to figure out the real political reason to impeach former Chief Justice. Whatever the reason was, I think the cost on the country’s democratic image was more than what was achieved politically by the impeachment; in economic terms we say that the comparative advantage of the impeachment of CJ is negative. So was the effect of Expropriation Act; this Act is needed to be repealed. For many countries like Sri Lanka democracy pays the country off.

Economic system is larger than anybody’s conceited thinking or feeling. Thinking high about your own thoughts can be known as conceited thinking. Some “patriots” or even Central Bankers with conceited mindset might have thought that Sri Lanka can do well by itself. This budget surrendered this conceited thinking by proposing to increase foreign borrowings. Economic system proved to be larger than any individual’s vision. This is positive. I think there is only one more step to take; shed the conceited political behaviour. That would pay the country off indirectly and directly on the ruling elite.

In the above we discussed about the increase of inflow of dollars through non-credit sources. Two important sources identified are exports and FDIs. Another two non-credit sources of increasing dollar inflow are the promotion of decent expatriate worker program and the promotion of tourism. Now think from the end. Do the BBS mischief acts help to have a good expatriate worker program or to promote tourism. Do the “rent-a-mob-activities” promote the country’s good image? In one extreme situation the main opposition party decided not to participate in CHOGM. How that decision reflected upon the country’s image? You may think in terms of comparative advantage. The government could have easily stopped the high handed mob activity at the Head Quarters of the main opposition party. Let us assume that it did not happen. In the event the seats reserved for the opposition at CHOGM would have been duly filled. Is that good for the country’s image?

Any proposal to increase foreign borrowings must have a promise to increase the inflow of dollars through non-credit sources. As we saw above, all major four such sources are directly linked to the promotion of country’s good image. In this regard accountability to the rule of law is the most important. Other features of good governance might arise from the rule of law.

Economies do not crash due to low GDP growth but crash suddenly due to monetary disturbances. That was what happened in Argentina in 1999, in the United States and Europe in 2008. That was what was about to happen in Sri Lanka amidst high GDP growth, in the middle of the year 2012, due to severe devaluation of rupee. All out economic crisis was avoided by containing credit growth. However, we will not see any monetary disturbances in the year 2014, if there is not much deferred foreign debt payment obligations for the coming year.

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