Wednesday, February 29, 2012

The souring of the economy

Indi has written an interesting post on the bubbly nature of things.

It is quite astonishing to see how rapidly the mood has changed. One month ago a lot of people were happy with things, many accepting the view that we were growing well, even if we were not exactly the wonder of Asia. The falling currency and rising prices have suddenly soured the mood. Were things as good as they seemed and can things go so bad, so quickly?

Just to turn the clock back back to 2009, just after the war tourism picked up but not a lot else happened. Things remained slow for some months until the following happened:

1. Taxes on household goods (electrical appliances) were cut.
2. Interest rates were forced down.
3. Income tax was cut in the budget.
4. Vehicle duties were cut.

This sparked demand. Low interest rates enabled people to borrow. Finance companies sold household goods on hire-purchase and cars on leases. Banks lent to the finance companies and leasing companies.

Corporate profits in general improved because of low interest rates and lower taxes. Some investment activity began to take place, repairs, reconstruction, refurbishing. All this was positive and people did feel the benefits, at one level or another.

The problem was with sustainability. Five or six years of bottled up demand for cars was suddenly released. A similar tale with electrical appliances. Once the pent up demand is satisfied, things will slow naturally. There is nothing wrong with this, it just happens.

With the end of the war tourism will naturally pick up, but growth is dependent on the state of the world economy, how cost competitive the country is and how well it is marketed. Rapid increases in prices coupled with regulations on minimum prices caused things to slow down a little after April last year.

In order to build sustainable growth we need investment, that will create jobs and boost incomes. In order to do that we need to cut regulations, taxes and generally have a friendly investor climate. A functioning legal system, low corruption, low taxes and consistent policy are all things that will help.

An over-large state that is actively involved in every sector of the economy impedes investment, because it displaces the private sector. Further to run these extensive operations they need to tax and this takes money out of the consumers pocket.

The factors that drove growth in 2010/2011 were lower taxes and interest rates. In order to keep these cuts in place the government needs to cut expenditure, which is not happening. Now that the taxes have gone up everything slows. The moment the Government increases its local borrowings, interest rates will rise.

The great saving grace of Sri Lanka has been its ability to export its unemployed. Whenever things get difficult, more people go abroad. They then send money back that sustains their families-and the local economy. If it were not for the workers in the middle east many families could not survive. Almost every family has someone abroad and the remittances they send pay the bills. As long as this option remains open, we will stumble along in some fashion. If that closes, we will be in real trouble.


half full said...

Tax cut were good. Unfortunately it is monetary policy that backfired.
Rates should have been raised earlier

Jack Point said...

Half full, agreed.

Angel said...

I never really thought of foreign employment in that way... yet I am running out of fingers when counting the people I know who have "someone" abroad who "helps out" with the bills!


Jack Point said...

We have some 3m migrant workers and about 4m households, so it works out that, roughly speaking, almost 75% of households have someone out there.

Anonymous said...

No wonder when the Rupee dips to Rs125 to the US$ they will also benefit as they will receive more rupees for the remittances.

However the price rises overall in the economy will nullify that somewhat, at least they will not be worse off unlike those who just do not have any one to help them out and have to live out of business or income earned only in the island.

This is the saving grace for the Govt. survival and they know it. We who are on fixed income not from any foreign source are in for some serious belt tightening.

I have just decided to cut one whole meal in the day for starters.

One has to give up something!!
BTW I don't drink alcohol nor smoke any form of tobacco either!

I am a few kgs overweight

Jack Point said...

Ha ha anon, a bit drastic, but what to do?

I went off alcohol after they raised the duties to ridiculous levels in 2005.