OBG Talks to Changyong Rhee

Interview: Changyong Rhee

To what extent will consumption and private investment be affected in the short to medium term by the IMF programme?

CHANGYONG RHEE: The state is implementing revenue-based fiscal consolidation, reducing the fiscal deficit by raising tax revenue. This is necessary because of the country’s high public debt and low revenue-to-GDP ratio. The state has also committed to reduce the deficit significantly, from a primary fiscal deficit of 2.2% of GDP in 2015 to a surplus of 1% of GDP in 2018.

The Sri Lankan economy so far has sustained the fiscal adjustment relatively well. Real GDP growth slowed to 3.7% in the first three quarters in 2017 relative to the same period in 2016. This mainly reflects a contraction in agriculture due to the lingering effects of earlier floods and droughts, which unfortunately took a heavy toll on Sri Lankans.

Nonetheless, in the first three quarters of 2017 private consumption along with gross capital formation grew by a healthy 3.5% and 5.2%, respectively. Thanks to improvements in tax collection, the government has been able to keep public investment broadly unchanged. Going forward, the state should accelerate pro-growth structural reforms in order to improve the investment climate.

Which sectors face short- to medium-term growth risks from Sri Lanka’s fiscal consolidation, and how can these be best mitigated?

RHEE: Fiscal consolidation can affect all sectors of the economy through its impact on domestic demand. To mitigate the impact, governments should make consolidation measures as pro-growth as possible, for example by relying on tax base broadening and preserving infrastructure spending. In the case of Sri Lanka, the government has pursued tax base broadening for VAT and income taxes, while ensuring that fiscal space for public investment is preserved. As a first priority, the government should pursue an outward-oriented trade policy so that Sri Lanka can integrate into regional and global supply chains.

This should be accompanied by efforts to attract foreign direct investment (FDI) through improving transparency of the investment regime. Further, growth could be made more inclusive by fostering female labour force participation and strengthening the social safety net for vulnerable families.

In your opinion, what can the IMF and other institutions do to assist Sri Lanka in attracting FDI?

RHEE: We closely coordinate with development partners for Sri Lanka, and assist the government in the areas of our expertise. The new Inland Revenue Act — the landmark reform undertaken with technical assistance from the IMF — is expected to promote FDI by simplifying the income tax system and transforming the past regime of widespread tax incentives to rule-based, investment-linked incentives.

How can Sri Lanka’s economy effectively balance the risks and rewards of participation in the Belt and Road Initiative (BRI)?

RHEE: We see China’s BRI as an important initiative that could help foster regional cooperation in the areas of trade, investment and finance. In doing so, the scheme could bring much needed infrastructure and connectivity to countries such as Sri Lanka, which in turn could support trade and growth.

Nevertheless, the programme could also entail a certain number of risks, including issues of debt sustainability and limited positive spillovers to those countries on the receiving end.

The key is to implement the BRI projects well, which will include ensuring high project quality, debt sustainability, governance standards, open procurement, and encouraging private sector participation. This would minimise the risks above, while maximising the potential benefits for a country such as Sri Lanka.