Stopping subsidies, refraining from funding SOEs seen as essential for economic recovery

By Hiran H. Senewiratne

The main elements of any market-based financial system are to restore confidence in it by correcting current imbalances, reducing the vulnerabilities of the financial system to further shocks and implementing finance and economic reforms. However, it is most crucial that the government stops providing subsidies and refrains from funding state-owned enterprises, former Acting Governor of the Reserve Bank of New Zealand Prof. Grant Spencer said.

“Apart from that other key elements would be to remove short-term emergency restrictions and improve the long- term economic performance of Sri Lanka, Prof. Spencer said during a special lecture titled, “Key Elements of a Market-based Financial System”, conducted on November 1, at the Central Bank of Sri Lanka auditorium.

Prof. Spencer added: ‘At this juncture a simplified and uniform tax system is important by targeting the most needy segments in the country, which system is now being slowly and steadily implemented by the Sri Lankan government as a recommendation of the IMF.

‘It is necessary to put public sector finances on a sustainable footing, while restructuring the external debt. An independent Central Bank is a prerequisite. This is needed for improving the resilience of the banking system. Because the Central Bank must earn trust and confidence from the government and financial markets.

‘To put public sector finances on a sustainable footing, it is required to reform the tax base, particularly for direct income taxes, thereby simplifying the tax rules by removing exemptions.

‘Moreover, it is important to stop subsidies and cheap loans to favoured sectors, restrict growth in government spending with targeted assistance to the most needy and set clear and achievable fiscal objectives.

‘International creditors must agree to a haircut and lengthened debt maturities, whilst clearing the way for the IMF programme with money going to current uses rather than repayment of existing loans.

‘There is a need to commit to an independent accountable Central Bank. To this end, it is essential to pass the new Central Bank Act which will help to ensure price and financial stability over the long- term.

‘An Independent CBSL with government agency functions removed, will help to ensure that public finances remain in balance.

‘It is essential for vulnerable banks to bolster their balance sheets potentially through mergers and the Central Bank needs to prepare contingency plans for potential banking sector stress.

‘Correcting the fiscal imbalance, stabilizing the external debt, creating an independent CBSL and ensuring resilience of the banking system will help to restore international and domestic confidence in Sri Lanka’s future.

‘It is important to reduce the risk premium in Sri Lanka’s interest rates and exchange rate, encourage a recovery of remittances and return of capital into the country and encourage the re-opening of capital markets.’