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Vehicles for the Rich

This piece serves as a gambit to a relatively unpopular budgetary reform that should be pushed through. In Sri Lanka as in the rest of the world the vehicle is a status symbol. It’s role as a status symbol is however more pronounced in Sri Lanka. High duty, petrol costs, and realizable value in the secondary market make the vehicle a reliable indicator of wealth. The significant costs in owning a vehicle combined with the considerable ease with which it can be offered as collateral make it popular as an asset class amongst businessmen. Businessmen also use the transferability of the asset class to cover taxable income or unexplained wealth. Vehicles are the preferred form of collateral outstation (any region outside the Western Province) indicating problems with financial deepening and distribution.

True on so many levels

One must consider vehicle drivers, owners, service providers, financiers, and then agents from a social lens. Revisiting the list, one sees that they are ordered in ascending order in terms of wealth. Ishara Chinthaka Nanayakkara, Indra Silva, the Yaseen family, David Pieris, and Arthur Senanayake come to mind. It is my sense that vehicle dealing has overtaken tea as a creator of disproportionate wealth. This is odd as it doesn’t take much in the way of intelligence to import and then sell a vehicle. People notice vehicles. The school run of the British School of Colombo is a significant eye sore to those averse to gaudy displays of wealth by the newly rich. One would imagine that there is a daily gala occurring at the WTC by observing the way in which people roll up to work. There is considerable social angst against this.

False on the most significant one

Vehicles are a signifier of individual wealth. They are not however a signifier of societal wealth. A vehicle is only as important as it is in Sri Lanka when your infrastructure is poor. Wealthy nations have efficient public transport used by a considerable portion of their population. Rich Sri Lankans will still have to feel poor amongst their foreign counterparts who have more equitable taxation and better mobility. We must start to think of vehicle taxation as part of wealth distribution and more importantly as part of a wider transport policy.

Please share your ideas by commenting to help formulate this idea into a budget suggestion.

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What is Inflation Targeting?

“Given that Sri Lanka is a twin deficit country, in terms of budget deficit and current account deficit, the chances that Sri Lanka attracting new money at this juncture is very minimal indeed. By increasing interest rates, we will not be able to attract new money or keep the money already invested.”
Indrajit Coomaraswamy 02.10.2018
Inflation targeting as defined by Bernanke in one of his papers1
“The hallmark of inflation targeting is the announcement by the government, the central bank, or some combination of the two that in the future the central bank will strive to hold inflation at or near some numerically specified level.”
In the same paper he goes on to say
“We believe that it is most fruitful to think of inflation targeting not as a rule, but as a framework for monetary policy within which “constrained discretion” can be exercised. This framework has the potential to serve two important functions: improving communication between policymakers and the public and providing increased discipline and accountability for monetary policy.”
To put it in a local context, the movement to a flexible inflation targeting framework does not mean that we wholly ignore foreign reserves. It just means that we will consider other things as well. The governor signaled that he was looking to increase the growth rate in the second half of 2018 to close to 4% and to a lesser extent that he was hoping to close the output gap that exists.

Why rates will come down in the long term?

To put it simply the government is just better at borrowing now. It borrows less frequently and for less ambitious purposes. This is in a context of a complete legal overhaul of the way in which government financing occurs. We have a new bond issuance system, a new active liability management act, and most importantly significantly lower budgetary deficits proportional to GDP. The budget deficit for 2019 is close to 4.1% of GDP.
The relevant section of the active liability management act2 is as follows;
“The Parliament may, during a particular financial year from time to time, by resolution, approve to raise sums of money, the total of which shall not exceed ten per centum of the total outstanding debt as at the end of the preceding financial year, as a loan whether in or outside Sri Lanka.”
This gives the government the capacity to refinance and pre-finance any government obligations. This allows government financing to take place more smoothly. This and the capacity to tap international markets pre-emptively will help reduce the financing costs of the government. My sense is that the CBSL is now in a much better position to reject bids than it has been before. With inflation at current levels it is also forgivable for the CBSL to print money and end up at the upper band of the inflation target.

What About Foreign Reserves?

Here this article agrees with the consensus that reserves will slightly deteriorate. This however does not pose a significant risk to the economy as the magnitude of such deterioration will be small. We must remember that this is not a government that wastes foreign reserves on protecting the exchange rate and as such the level of reserves will not fall to a point wherein a crisis occurs. One must also account for the Samurai and Panda Bonds which are to be issued.
Further the halting of duty-free vehicle imports and the upcoming budget which many economists suspect will increase the cost of the yearly vehicle revenue license in a unit rate like fashion will ease pressures on the demand for foreign exchange. The revenue license hike would look to tackle the problem that high duties are realizable in the secondary market for cars and as they are FX denominated reward people who buy cars as a bet against the rupee.

Revisiting the exchange rate in this regard

Many analysts are concerned about the reserve position with the flow of funds back to the US and further the rising costs of oil. Our low rates of FDI should bring confidence about the magnitude of the fund flow back to the US. There is also much scope to increase FDI and foreign investment will invariably flow to build up the Port City project. With regards to the costs of oil there is little that interest rate policy can do.

Going long on government securities

Let us remind ourselves that the average AWPR in 2015 was 7.40%. The Central Expressway, the only heavy financing requirement so far, has been financed through an external party. Inflation is below 5%. An 11.32% yield on the secondary trading of a 9.91-year treasury bond as at 03.10.2018 seems a good deal.
We are a country with a primary surplus on our budget. A fiscally conservative government in the long run will bring down rates.
Footnotes

  • Inflation Targeting: A New Framework for Monetary Policy? Author(s): Ben S. Bernanke and Frederic S. Mishkin Source: The Journal of Economic Perspectives, Vol. 11, No. 2 (Spring, 1997), pp. 97-116 Published by: American Economic Association
  • ACTIVE LIABILITY MANAGEMENT, ACT, No. 8 OF  2018, Parliament of Sri Lanka