Wednesday, July 09, 2008

A reply to an Editorial in the Island newspaper

This is just another post where I'm saving something I wrote some time ago- this time a response to an editorial in the Island entitled 'Prabhakaran's luck'.

The main thesis of the editorial was, as I recall, that Prabhakaran has got away several times just when the army was about to capture him. The editorial wondered whether he would be allowed to escape again, because the Government was being pressured to re-enter peace talks and hence halting the offensive.

My response was written on the 9th of August 2007, the editorial appeared some days before that, I've not been able to trace it on the web.


Your editorial on the above poses the question: will Prabakharan be lucky once more? The short answer is yes, he will indeed be lucky, but to understand why we must look back to the events of 2001. Your editorial surmises, correctly, that the government is facing a financial crises. It was Napoleon no less who remarked that "an army marches on its stomach". An army needs to eat well to perform, but Napoleon 's real contention was the importance of the supply line. Logistics - getting food, clothes, and spare parts to the front - is often what makes or breaks a conflict. This in turn, is dependent on the ability of the government in question to finance a war.

To turn to the events of 2000-2001, the country's economy collapsed, this being driven by excessive government spending financed by printed and borrowed money. Public debt exceeded the output of the economy. This in turn lead to a balance of payments crises, the devaluation of the rupee (which went from 70 to the US dollar to a 100 before settling at around 90). Business confidence evaporated following the attack on the airport and the economy contracted by some 4%.

The UNP regime of 2001-3 restored fiscal discipline by cutting spending, bringing the budget deficit under control, enabling interest rates to fall as low as 10%. The CFA boosted business confidence resulting in increased investment. The tax amnesty announced in the 2002 budget brought in a lot of black money into the economy which sparked the construction boom, the tail end of which is still being experienced today. The majority of the mid and high rise building dotting the capital came up following this. The prevailing low interest rates helped boost these two further and also lead to increased consumption spending via credit cards and consumption based loans offered by banks. Other measures to simplify bureaucracy and the opening of the North East markets also helped.

After the coup d'├ętat staged by CBK in November 2003, the momentum of the measures taken by the UNP faltered momentarily but then continued. The tsunami of December 2004 proved a blessing in disguise, with a huge inflow of funds providing a massive stimulus to the economy. The growth of 2005 and 2006 was helped by all of these factors.

Mahinda Rajapakse's administration, drawing confidence from the sound performance of the economy in the past few years has thrown economic sense to the winds and expanded public spending. Pensions and salaries of government servants consume 57% of all tax revenues thanks to the expansion of the public sector. This has been financed by money printing (leading to high inflation) and borrowings. Thanks to high borrowings interest payments eat up 30% of total government revenue. It is worth noting that as per the last budget pensions and salaries (240bn) and interest (169bn) both exceed defence expenditure (140bn)- which in 2006 was doubled from the previous years 70bn . Public debt is once more hovering close to 100% of GDP, the rupee is under pressure, the government is imposing all manner of taxes and raising fuel prices to try to collect enough funds and failing to do so is resorting to money printing (some 20bn in the last couple of months) and is now in the process of trying to raise US$500m to finance further spending. Capital expenditure is being cut, which means citizens can expect further deterioration in infrastructure from broken roads, flooded sewers to erratic electricity.

In short, the government is close to broke and will shortly find itself unable to fund the war any further without risking a total economic meltdown. Foreign aid does not form a significant component of government revenue (some 24bn) the burden is mainly borne by the taxpayers of the country. If this situation continues on this trend the economy will collapse once more and Prabakharan will find himself confronting an enemy unable to defend its borders, and he will have Eelam by default.

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