Mahoshada

“Our main business is not to see what lies dimly at a distance but to do what lies clearly at hand.” Thomas Carlyle (1795-1881)

Conditions for conducting business in Sri Lanka have deteriorated markedly during the last year; this according to the World Bank’s annual publication Doing Business 2007, which provides a comprehensive international comparison of business conditions. (Details on the findings presented in Doing Business 2007 can be obtained at www.doingbusiness,org.) What should be all the more troubling for the government is that while the business climate in Sri Lanka was becoming more difficult, much of the rest of the world was doing better. In other words, Sri Lanka is continuing to fall behind in the country’s ability to compete in both the regional and the global economy.

It is important to keep in mind that the World Bank report looks only at indicators of the regulatory environment, reflecting the basic costs of doing business, including the costs businesses face in starting and closing businesses, complying with government regulations, the burden of taxes and the barriers to international trade. These assessments do not address key attributes of the broad investment climate, such as macroeconomic conditions, quality of infrastructure, security and crime rates.

The International “Scorecard”
In terms of the international rankings presented in this report, there were two of the ten areas examined where Sri Lanka showed significant gains: dealing with licenses and closing a business. In both of these areas, Sri Lanka gained six places in the rankings from the previous year (2005). However, it should be noted that in absolute terms there was little or no improvement in the actual conditions that businesses faced.

For example, three criteria were used in assessing the costs of complying with required business licenses: the number of procedures, the time this entails and the average costs of compliance. Comparing 2005 and 2006, the number of procedures required actually increased, from 17 to 18; the time required remained constant at 167 days; and the compliance costs measured as a percentage of average per capita income fell slightly, from 151 to 144 percent. So, while there was some relative improvement as measured against other countries, the actual conditions facing business showed no substantial improvement.

In seven of the remaining eight areas used to assess the costs of doing business, Sri Lanka did relatively worse. Some important examples include:
• The largest fall in international rankings, nine places, related to international trade. However, once again, in terms of the criteria used to assess this area suggested that in absolute terms it was more a case of not making any improvements while a number of other countries were introducing reforms. In both 2005 and 2006, imports required eight different documents and an average of 25 days while exports required 13 documents and an average of 27 days.
• The costs associated with registering property also led to a fall in the international rankings, in this case by five places. In this area, Sri Lanka ranks low relative to other countries, 125th out of 175 countries included in the analysis. And this is also a case where there was little absolute change in the criteria used: eight procedures required, 63 days to complete the registration process at an average cost of 5.1 percent of the property value.
• The costs associated with starting a business also remained approximately the same from last year’s survey: eight procedures are required, with 50 days on average to complete and a cost in terms of average per capita income of 9.2 percent. Yet again, remaining more or less constant meant a decline in the international rankings, this time by five places.

One area deserves special mention, the effective tax that a medium size company in Sri Lanka must pay during a year. Businesses in this country must make 61 payments that require on average spending 256 hours. But most surprisingly, the average tax rate in 2006 was estimated at 74.9 percent of gross profits – a substantial increase over the average tax rate calculated for 2005 of 49.4 percent. (The number of payments required also increased substantially, from 42 to 61, which would have led to a comparable increase in the time required to comply with a business’s tax commitments.)

This suggests that in the last year there has been a major increase in the tax burden on businesses in Sri Lanka – both in terms of the average effective tax rate and in the costs of compliance. The average tax rate for all of South Asia is 45.1 percent. For East Asia and the Pacific, the average tax rate is 42.2 percent. Sri Lanka’s average rate of 74.9 percent is even higher than that for Africa, the highest regional rate reported – 71.2 percent. Such a high average tax rate makes Sri Lanka less competitive in attracting investment and creates an environment that breeds corruption.

A high average tax rate and the high costs of compliance associated with this also helps to explain why the country has a higher share of informal economic activity – estimated to be 44.6 percent of GDP. Within the South Asia region, the levels of informal economic activity are generally significantly lower: India at 23.1 percent of GDP; Pakistan at 36.8 percent; and Bangladesh at 35.4 percent.

Standing Still Will Not Work
The World Bank ascribes the broad improvements that have taken place in many countries to the more rapid introduction of policy and regulatory reforms during the last year. According to the Bank, there were 213 important reforms introduced in 112 countries which reduced the time required and other costs needed to comply with legal and administrative requirements. There have been few if any important reforms introduced in Sri Lanka during the last year.

The fact is that the government has become complacent if not actually contemptuous of the need to actively reform the regulatory environment in which business must operate. Seemingly motivated by short term political considerations, the government has largely disengaged with the economic financial and technical assistance provided by the international financial institutions, such as the World Bank, the Asian Development Bank and the IMF. (The country’s Poverty Reduction Strategy Paper, usually referred to as the PRSP, which was agreed by the Boards of Directors of the World Bank and the IMF in 2003 has since been abandoned, with no alternative yet put forward.) In addition, a number of the economic policy and regulatory reforms agreed with these international agencies by the previous two governments have been abandoned, (e.g., the reforms to be introduced in the CEB).

While it can be difficult for some governments to work effectively with the international financial institutions, it should be recognized that maintaining active programs with these agencies can be a useful impetus for moving forward policy and regulatory reforms. It is of course neither necessary nor sufficient for a country to be engaged with these agencies in order to introduce policy and regulatory reforms. Indeed, it can be argued that governments that introduce reforms on their own, without outside pressures are likely to be more effective in the long run. However, whether the policy and regulatory reform processes are domestically driven or are done in conjunction with the international agencies, it is important that these processes move forward. Standing still is not a viable option in today’s world.

Doing Business 2007 makes clear that Sri Lanka has a long way to go in establishing a competitive set of business regulations. Overall, the country is ranked right in the middle of the 175 countries included in the analysis (i.e. 89th). But as the report indicates, there are many countries actively working to make substantial improvements. (Many of these are done as part of their PRSP programs.)

And the report provides a useful guide for the government on those areas where reforms in these areas are most urgently needed. For example, Sri Lanka is ranked in the bottom ten percent of countries in terms of the burden and administrative requirements of the business tax system. At a time when the government continues to run very large budget deficits year after year, it should be readily apparent that fundamental reform in this area should be given high priority. Sri Lanka also ranks very low, in the bottom 30 percent, in terms of the requirements for registering property. There is no need for continuing to impose such high and unnecessary burdens on business activity in the country.

The government cannot say that it does not have adequate manpower to design and implement many of the reforms that would be needed to substantially improve the business environment and make the country more attractive for potential investors. There are more than one million employees in the public sector, including many well educated people who would be able to contribute substantially to these tasks if the government were committed to reform.

However, in this regard there is a key factor that seems to be lacking in the government’s approach to managing the economy: The government seems to have little appreciation of the requirements for remaining competitive in the global market economy today. Globalization is a fact of life and businesses in Sri Lanka must compete against businesses throughout the world. Unnecessarily adding to the costs of doing business in Sri Lanka makes this task increasingly difficult. It wastes resources that could be more productively used in other ways and to the country’s benefit. As a result of this apparent lack of understanding of current economic realities, there has been little or no commitment to even begin to address these issues in any meaningful or comprehensive way. Until this changes Sri Lanka’s economic performance will continue to fall behind the rest of the world.