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.