A Delicate Balancing Act
The policy-makers face a challenging balancing act with difficult trade-offs in formulating the Macroeconomic Road Map for 2013. They need to address the following objectives: the structural deficit in the budget and the trade deficits; the slowdown in growth currently well below the 8% target; and contain inflation which is currently above the desired mid-single digit level at 9.5%. In this context; it is necessary to: exercise caution regarding the relaxation of the macroeconomic policies too early; and initiate action to prevent the growth deficit from becoming too large. If policy is loosened too early, the twin deficits in the budget and the current account will be exacerbated and inflationary pressures will be elevated. The room for manoeuvre has been circumscribed even more following the recent Fitch assessment regarding the financial risks associated with the economy. On the other hand, if policy is too tight, growth and employment creating impulses in the economy will be squeezed.

Public sector employment in Sri Lanka has been increasing since the 1960’s, despite a decline in the size of government. Total public expenditure as a percentage of GDP has declined substantially from 1976 to 2011. There has seen a decline in the services provided by the government e.g. the removal of the food subsidy. Over the years, a few attempts have been made to arrest the growth of the public sector, including reductions in new recruitment and voluntary retirement schemes. Such policies were also promoted and supported by the multilateral donor agencies, such as the IMF and WB.

Key Targets
It is encouraging that the Budget Speech 2013 sets out a fiscal framework that seeks to continue the trajectory of much-needed fiscal consolidation. If successful, it will address a perennial problem that has plagued macroeconomic management in Sri Lanka for over four decades. The budget also announced several measures to strengthen the supply-side of the economy (i.e. boost domestic production) in relation to SMEs, agriculture, other import substitutes and capital markets. The capital account of the balance of payments was also liberalized further. Despite these measures, the prospects of achieving the following two outcomes that are built into the budgetary framework are likely to prove extremely challenging:

The Challenge- from borrowed to earned reserves and beyond
The challenge for Sri Lanka is to develop a policy framework that would stabilize the economy; boost investment and growth; and earn rather than borrow reserves. All shades of political opinion are now focused on these issues. The Pathfinder Foundation (PF) is, therefore, raising a number of issues in this piece to stimulate thinking and debate.

Declining Trend
The Treasury has recently indicated that the country’s economic growth this year will be around 6.5%. As the recorded growth rate of the first half of this year was 7.1%, this means that growth in 2H 2012 is being estimated at 6%. The growth momentum will inevitably slow down steadily during the course of this year, as the restrictive measures, particularly the 18% credit ceiling set for banks (23% where they have been able to borrow the incremental funds from abroad), take effect. The re-phasing of public expenditure, announced recently, will further dampen economic activity.

Commendable Achievements
Over the years Sri Lanka has gained a considerable reputation for its achievements in social development. It punches above its weight on the UNDP's Human Development Index. It has also performed very well in meeting the internationally agreed Millennium Development Goals (MDGs) which focus on indicators related to poverty, health, education and gender parity.

A wave of urbanization propelling growth across emerging economies is a welcome fillip for a world economy that continues to have pockets of acute fragility. Cities have been the world’s economic dynamos for centuries, attracting skilled workers and productive businesses and benefiting from economies of scale. But what is different about today’s wave of mass urbanization is its unprecedented speed and scale. It is not hyperbole to say that we are observing the most significant shift in the earth’s economics center of gravity in history.

Capital without labor means machines with no operators, or financial resources without the manpower to invest in. Labor without capital looks like Haiti or North Korea: plenty of people working but doing it with sticks instead of bulldozers, or starting a small enterprise with pocket change instead of a bank

Developed Economies Heading Towards a Recession
The global economy started off the second half of 2012 with a whimper as the latest data confirm that growth is faltering across all regions. Europe is clearly in the midst of an intensifying contraction, US consumers and businesses are pulling back in the face of increasing uncertainty, and a marked slowdown in emerging markets is testing their vitality. Last month, the question remained whether the slowdown was merely a soft patch or the onset of a more generalized “powering down” of the global economy. The accumulating evidence indicates that the developed economies are heading towards a recession (although some may still manage to eke out modest growth.

Introduction
McKinsey & Company, the leading management consultancy, has undertaken a great deal of work in assisting governments around the world to improve their delivery of services to the people. Their public sector practice has distilled seven lessons from this work. The Pathfinder Foundation (PF) acknowledges its debt to McKinsey & Co for authorizing publication of extracts from an article authored by Senior Partners Eoin Daly and Seelan Singham setting out these lessons.

Declining Growth
The balance of probability is that growth will decelerate sharply by the fourth quarter of this year to about 5% and inflation will be at a double digit level. There is urgent need for a mix of policies that not only curtail aggregate demand but also create the impetus for a robust supply response.

The Standard and Poor’s (S&P) Rating Services assigned a score of 8 (very high risk) to the Sri Lankan economy and banking industry last week. The role of ratings agencies in the lead-up to the global financial crisis (2008) was certainly highly questionable. There are also issues related to their accountability. Despite this, and setting aside the merits or otherwise of S&P’s assessment, this episode serves to highlight the following: