Sunday, April 8, 2012

The massive effort to reduce the Balance of Payments Deficit - Will it pay off?

The shock of the Trade Deficit in January 2012, rising to US$1Billion triggered a lot of kneejerk reactions which we are now coming to grips with. In essence we buy US$2Billion a month from overseas and we export US$1Billion, giving us a monthly deficit of US$1Billion.

This in itself is OK if we can plug it by a monthly remittance figure of that same amount, as was the case all this time, but there did not seem a way out of this mess, short of a huge forced devaluation which would have had far worse consequences for a country still unable to produce their own food, despite much shouting to the contrary. It would have cause riots and the Govt. had to make a tough decision.

They looked at a simple way to plug this deficit. Anyone with common sense would have said that since the end of hostilities the vehicles on the road have ballooned which only says that the oil import bill has doubled since that time. A huge increase in fuel prices did not even dent the usage, much to the surprise of the authorities showing how demand inelastic this commodity is in Sri Lanka.

25% of all imports were just vehicles of one sort or another. So the easiest action was to tax all these vehicles, and that is exactly what they did. Assuming for a whole year it stops the imports, then there will be a definite help on the balance of payments. However to be effective it is the people who are in the lower income categories who are the hardest hit. After all the person who wants a motor bike, or a three wheeler where due to the numbers, much of the imports came from, is now priced out of this purchase.

So the effect of this is many fold. It will reduce the import of vehicles, it will reduce the rate of increase in the oil bill, though it will not necessarily CUT the oil bill as is being trumped around. It will not really increase the tax revenue at all despite the increased rates of taxation, due to the huge reduction of the quantity of vehicles coming into the country.

The spanner in the works is the level of duty free permits granted this year. That will NOT give Govt. revenue, it will increase imports or shall we say not reduce the dollar value of imported vehicles on a strata of society. It will increase the oil consumption, as these are permits for cars and SUVs and not for smaller bikes and three wheelers. This anomaly must stop if they are to level the playing field a little.

In short all those who were involved in this decision to increase the taxes, will all be able to buy a duty free vehicle as they are all Govt. servants!!

The Govt. is hoping the fall out will be minimal; that the economic benefit arising is worth taking this step when they did. This does not bode well for consistency of policy, something that has been a criticism all along in Sri Lanka. Without a clear consistent policy on matters, it is very difficult to take a long term view of planning this economy well. IMF directed knee jerk reactions in the economy must be avoided as consequences of inconsistency is very bad for business.

The self-interest of the various groups are now coming into the open. For example the three wheeler drivers who use their vehicles for hire, like the new rules which will reduce the imports, so they will face less competition. They are already in for a surprise as the economic woes, will reduce the ability of the existing three wheelers to earn a living as their customers will fall, and their costs will rise due to the higher import duties on the spares. So they can’t be smug, not knowing it is a false sense of security on another person’s distress.

With the ban of cars over a year old from manufacturing date, the second hand market of unregistered imports will die, and they will have to survive merely on being second hand car dealers of the local market.

The huge increase in the tax on motorcycles will prevent another 100,000 prospective buyers from buying a vehicle for them to do their basic work. Maybe it would be to go to their job, as the public transport system was in want. Many three wheeler owners use it as their family vehicle, and that segment has been declined their mode of transport, unless they wish to avail themselves of a higher duty.

The main dealers in these vehicles will now face some hard times, and have to make a few tough decisions with regard to their survival, causing another storm in the CSE with insider trading allegations. It is just a matter of time.

These actions should have been tied in with a huge improvement in public transport to take vehicles off road, as it would then be more practical to take public transport. This they have not. Without that it is regressive against the less well off.

Public policy to reduce the import bill on fuel is completely different to that which was recently adopted. It can work by increasing fuel prices further which will reduce consumption, and increase Govt. revenue both at the same time, and it will be paid by all who us vehicles. It will not be discriminatory, and so will be acceptable to society. It is fuel usage that needs to be cut drastically and when saturation point on vehicles is reached, to avoid a nationwide traffic jam, traffic management methods must be introduced immediately, mainly to reduce congestion, and therefore consumption.

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