Political decision making process in gridlock

*      Partners in govt. pull in different directions
*      Questions over latest international bond issue? 
*      IMF programme in jeopardy
*      Street protests against VAT continue despite SC interim order


That this government has tied itself up in knots not only locally but internationally as well became apparent last week, when the former head of state Mahinda Rajapaksa - now the central personality of the opposition - was the only important to politician to send a proper letter congratulating the newly appointed Prime Minister of Great Britain Theresa May. President Maithripala Sirisena has sent only a twitter message. It is certainly true that Sirisena ran a jazzed up presidential election campaign designed to appeal to the younger generation with his name written as ‘My3’ – sms fashion. Yet, need this be taken so far as for an incumbent head of state to congratulate an incoming head of government with a twitter message? However he at least sent a twitter message. All we heard from the prime minister about the appointment of a new Conservative Prime Minister in Britain was a deafening silence.

The UNP especially is supposed to have a special relationship with the British Conservative Party both being members of the International Democratic Union – the global brotherhood of centre-right political parties. As such, for the UNP not to send a letter congratulating the new Conservative PM of the UK borders on deliberate rudeness.

This is a direct result of the Sri Lankan government needlessly getting involved in the internal politics of foreign countries. The present government sent a special ministerial team comprising of ministers of both the UNP and the SLFP to Britain to canvass among Sri Lankan expatriates on behalf of the ‘remain’ campaign. Even Suren Surenthiran of the Global Tamil Forum had the good sense to avoid getting involved in the Remain vs Exit controversy, giving their supporters the freedom of choice probably because they had a better awareness of the ground realities in Britain. Now with David Cameron, one of the foreign patrons of this government gone, there is an awkward silence on the part of the Sri Lankan government not knowing how to react to the new powers that be in Britain whose internal and external policies will be quite different to that of their predecessors.

However, until now the luck of the yahapalana government has held. Last week, on July 11, they managed to conclude a 1,500 million USD dual tranche sovereign bond issue with 500 million USD for 5.5 years and one billion USD for 10 years at interest rates of 5.7% and 6.8% respectively. The very same day the Supreme Court issued an interim order preventing the implementation of the recent tax reforms including the increase of the Value Added Tax from 11% to 15%, the broadening the VAT base by bringing in sectors that had been VAT exempt earlier, and broadening the Nation Building Tax base. If the SC had issued this order before the issue of the sovereign bond had been concluded, it could have queered the pitch for Sri Lanka. The reason why this sovereign bond issue went through at all with the Citigroup, Deutsche Bank, HSBC and Standard Chartered Bank facilitating it, is probably because Sri Lanka is now in an IMF program designed to get Sri Lanka out of the fiscal mess it finds itself in.


SLFP Sirisena faction runs for cover

One of the most important conditions imposed by the IMF (pre-conditions actually) was that the government of Sri Lanka should collect more revenue to meet expenditure and debt servicing requirements; and the VAT increase was the most important measure taken by the government in that regard. Now that the VAT increase and other tax adjustments have been suspended, government finances will take a serious hit – a hit that the government cannot afford. What makes the situation even more dicey is that with the opposition to VAT building up in the country, the SLFP Maithripala faction is running for cover leaving the UNP holding the baby. There is the possibility that the SLFP group in the government may not vote for the VAT increase legislation that is now before parliament. The government made a bad mistake by imposing VAT administratively in a hurry to meet the IMF preconditions for the release of the first tranche of the IMF loan.

If they had got the necessary legislation passed before the VAT was charged, the SLFP group in the government would be obliged to go along with the UNP on this matter. Now however, the SLFP group in the government seems set to take cover leaving the UNP fending for itself. Signs of this could be seen in last week’s ‘Wadapitiya’ on Derana TV where the SLFP Chief Minister of the Western Province Isura Devapriya clearly took the side of the anti-VAT protestors much to the embarrassment of UNP parliamentarian Mujibur Rahaman who appeared on the program with Devapriya to represent the government. What Devapriya said was that even though it is important to maintain the principle of collective responsibility in a government, they (the SLFP Sirisena faction) could not stand by when unreasonable taxes were being levied on the people.

Chief Minister Devapriya’s characterization of the VAT was that it was a case of piling taxes upon taxes and that there was no need to impose VAT on the retail trade. His suggestion was that this VAT should be charged at the point of import and stopped at that. He openly took the side of the anti-VAT agitators and said that SLFP traders in Pamunuwa (in Maharagama) had told him that there was going to be an anti-VAT protest in Maharagama and that the UNP traders were going to join it and wanted to know what they as SLFP supporters should do. Devapriya said that he had asked the SLFP traders to join the protest since the UNP traders were also in it. UNP parliamentarian Mujibur Rahaman tried to interject saying that these anti-VAT demonstrations were being orchestrated by certain groups who were distributing ‘chits’ to shopkeepers asking them to close their establishments.

However Chief Minister Devapriya brushed aside Rahaman’s claim saying that there may have been an era in the past when shops were forced to close by agents provocateurs who distributed ‘chits’ but that these anti-VAT demonstrations were based on a genuine grievance. The point to note here is that Devapriya is a very close protégé of Maithripala Sirisena and he would never have gone out on a limb like that without the president’s blessings. This situation raises many questions for the UNP. The president’s opposition to VAT stems obviously from his lack of understanding about fiscal matters. He is probably under the impression that this is a ‘condition’ imposed by the IMF and does not understand why the IMF imposes conditions. There is a simplistic belief among large sections of the population in Sri Lanka due to decades of ‘leftish’ propaganda that the IMF imposes conditions that are inimical to under developed countries. Those who subscribe to this way of thinking don’t see the IMF as a financial institution and the global lender of last resort but as an instrument of capitalist exploitation of underdeveloped countries.

The idea seems to be that the capitalist oppressor derives some fiendish and sadistic delight by imposing conditions that cause hardship to the ordinary people in underdeveloped countries. The reality that the IMF is the lender of last resort in the world and that countries go to the IMF only when they are dire straits and the IMF recommends (sometimes bitter) financial medicine to get that country back on its feet. In this case, the increase in VAT has been made necessary not due to any fault of the IMF but due to the present government increasing salaries and giving various concessions in order to win last year’s parliamentary election. Now the government has to collect taxes to pay for all that largesse. The IMF is not a charity organization and when they give a loan to a country, they also ensure that they will be able to recover the money lent while at the same time nursing the country back to fiscal health.


UNP left holding the baby

There are only two ways to meet additional expenditure - by taking loans or by increasing revenue. The IMF always stands by the latter because any country coming to them has exhausted other avenues of financing and the only way out is to increase taxes. The IMF is where the buck stops. Contrary to popular belief, the IMF is a healer not a destroyer. Now if these taxes are being opposed by a section of the government itself, this country is going to be in dire straits in the coming months. The Supreme Court has issued an interim order preventing the increase in VAT and the expansion of the VAT and NBT bases until parliament passes the necessary legislation. The government hurriedly got the legislation drafted and placed before parliament. Now this has got delayed further because an opposition MP has gone to the Supreme Court petitioning that such an increase will need a two thirds majority. The court process will cause an inevitable delay. If after these delays, the legislation is finally debated and put to a vote, what happens if the SLFP group does not vote for it? The UNP will still be able to get it passed with a simple majority with the TNA’s help.

The government will survive but with the UNP having to take all the blame for the VAT increase. As this columnist has been pointing out all along, at every turn the UNP has been left holding the short end of the stick. This will be yet another such occasion in this unfolding drama.

Coming back to the sovereign bond issue which the government managed to make in the nick of time before the VAT increase hit this snag, there is another matter to be taken into consideration. In making these sovereign bond issues, the issuer which is the government of Sri Lanka has to be absolutely honest with the investors and the banks that act as facilitators for the issue. There is firstly the Offer Circular which apprises the potential investors of the risks involved. Then before the issue is finalized there is a recorded telephone conversation between a designated authority in Sri Lanka and the legal team representing the banks facilitating the bond issue on behalf of the investors. The disclosures made in this recorded conversation have legal effect and if there has been any material non-disclosure or any misinformation conveyed by the government of Sri Lanka, the investors may have the right to recall the loan. The question now is whether the government apprised the potential investors of the situation that may arise because parliament had not passed the VAT increase into law as yet, and there was a petition before the Supreme Court challenging the legality of the VAT increase?

News coming down the grapevine indicates that the investors had been aflutter on June 11 when the Supreme Court suspended the VAT increase on the very day that the bond issue had been finalized. This was probably why the prime minister put out an urgent statement immediately saying that revenue collection will not be affected by the Supreme Court’s interim order and that the draft legislation was already before Parliament and that it will be taken up and passed on July 20 with retrospective effect. This had calmed the investors at that time. But what happens now that the passing of the VAT legislation has been postponed due to another petition filed in the Supreme Court? Apart from the postponement there is the distinct possibility that the SLFP component of the government may not vote for the VAT legislation in its present form and may propose amendments which will reduce revenue collection. The question now is whether this will be considered a case of non-disclosure by the bond investors? The funds pertaining to the 1.5 billion USD bond issue is to be transferred tomorrow (Monday).


Dr Mick Moore’s wisdom

A highly respected development economist formerly of the Sussex University and Harvard with expertise on Sri Lanka, Dr Mick Moore, said in a recent article that Sri Lanka holds the world record for the longest and largest unplanned decline in government revenue collection and that over a quarter century from 1989, the ratio of government revenue collection to GDP fell by a half, from 21% to 10.4% in 2014 and that the country really does have a revenue crisis. Dr Moore also observed that in recent years, the government has cut back severely on spending of all kinds, including on education and that it now has to pay a higher rate of interest on the money it borrows because with such large debts and low tax collections, borrowers are getting worried that it might be unable to repay its loans when they become due.

Dr Moore, a politically savvy economist also observed in his article that ‘while the government has achieved some success in raising additional taxes over the past 18 months, this has come at considerable political cost: rapid and humiliating policy reversals when ill-prepared proposals have met strong opposition; and continual protests against those revenue-raising proposals that are implemented – like the VAT increase and the additional charges on motor vehicle imports. He also observed that ‘Resistance to new taxes is particularly high in Sri Lanka. One reason is that there is little tradition of informed public debate about either taxing or spending policies. Voters receive little reliable information about how the government raises its money or how they spend it.’ It is difficult for them to judge any claim that the government makes about the need for new revenue or about the distribution of the tax burden. How many people realize that total revenue collection has declined largely because the tax burden has been lifted from the rich while remaining on the poor? At the same time, spending on programs that benefit the poor has steadily declined. The fiscal system has become heavily biased against the poor. If voters were more informed about taxes and tax policies, they might become more willing to support progressive revenue raising policies’.

We might add that the display of ostentation by politicians under all governments starting from the J.R.Jayewardene government of 1977 is one major reason why taxes are resisted so vehemently. The sight of politicians voting themselves expensive luxury cars in the middle of the recent natural and man made disasters is a case in point. The renting out of buildings to house ministries coujured up from thin air like that of Minister Sarath Fonseka’s are not designed to improve people’s attitude towards taxes. Dr Moore is certainly right in his argument – firstly, the tax burden has been reduced on those who can afford to pay, but has continued on those who can least afford to pay. Then at the other end, the ordinary man on the street sees all the wrong things when it comes to how the tax money levied on the public is spent.


UNP’s support base getting

hollowed out?

Quite apart from what is going on at the level of the Supreme Court, there are processes taking place in the streets that no one can ignore. Even after the SC ordered the suspension of the VAT increase, the traders of Pettah came out onto the streets to pressurize members of parliament not to vote for the VAT increase. The Colombo Pettah area is the very heartland of the UNP. Unlike in Ja-ela and Ampara where UNP politicians were able to ensure that some shops were kept open, Mano Ganesan and Mujibur Rahaman who were out on the streets in Pettah were not able to make the traders open their shops.

When asked about his attempt to get traders to open their shops, Mano Ganesan told the press that if some people can ask traders to close their shops, he has a right to ask them to keep their shops open. When asked whether he will vote for the VAT increase in parliament, he had said that he will be bound by the collective responsibility within the government. If the VAT is re-imposed in its earlier form, the UNP risks alienating a good part of their own constituency. If they don’t impose the VAT they risk the prospect of immediate financial collapse. Looking at these processes taking place at the political level and on the streets, we realize how prescient Moody’s and Standard and Poor’s was when they put out press releases immediately after the IMF approved a loan for Sri Lanka stating that they were not confident about SL being able to meet the IMF targets for revenue collection.

In fact Moody’s gave a provisional rating of B1 with a negative outlook to last week’s bond offer. The provisional status of the rating would be removed upon the closing of the proposed issuance and a review of its final terms. In giving the Sri Lanka bond issue that rating, Moody’s stated that the B1 rating is supported by the economy's ‘robust growth potential’ (the key word being potential) and higher income levels than similarly rated sovereigns. They were also hopeful that the reforms associated with the IMF program would be able to tap a significant potential revenue base. At the same time they warned that there is a risk that the IMF program may not deliver the outcomes that are currently expected and that this could lead to deterioration in Sri Lanka's credit metrics. Explaining why they changed SL’s outlook from stable to negative in June this year, Moody’s said that they were motivated by two considerations - slower economic growth and the possibility that the fiscal reform process may be less effective than expected.

 They had said that if the outlook is to be changed from negative to stable, Sri Lanka will have to show a lasting improvement in tax collection and more stable external financing conditions. They had also warned that if tax collection is ineffective or the government’s commitment to revenue collection wavers, and if there is a further fall in government reserves, the rating that they had given Sri Lanka may be downgraded. Well what we are seeing in the SLFP Sirisena faction’s waffling over the VAT increase is in fact a ‘wavering’ of the government commitment to revenue collection. The only positive factor in the question of revenue collection is the UNP’s apparent determination to stay the course no matter what.

With the rising protests against VAT the government once again decreed that certain essential food items ranging from chicken and milk food to sprats and dhal would be sold at controlled prices. The present government had done that before without much success. Indeed hardly had they announced the controlled prices that traders were telling TV crews to ask the government to provide the goods at the prices they mention so that they can retail the same to the public. It looks as if the government is heading for another confrontation with the traders over the controlled prices.

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