The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Fiscal consolidation: The promised objective
The objective of fiscal consolidation in the forthcoming Budget, enunciated by the Secretary to the Treasury is indeed commendable and desirable. As we said last week fiscal consolidation is a cornerstone of good fiscal management and the foundation for long term growth. It is the intention of the Budget to bring down the current account deficit next year and if possible to eliminate it altogether. The overall deficit is expected to be contained at around 6 per cent of GDP.

Fiscal consolidation means the containment of the deficit arising from the difference between government revenue and government expenditure to manageable proportions so as to not induce inflationary pressures. This has been a stated objective for many years, yet an unattained one. In 2004 the deficit is expected to be around 8 per cent, according to Dr. P.B.Jayasundera. It is in fact likely to be more.

The long-term objective is to eliminate the current account deficit and reduce the overall budget deficit so that the government through its borrowing would not crowd out the private sector of funds for their investment. This objective was stated in the policy statement of the PA government and the PA's first Budget in 1994, restated by the UNP especially in regaining Sri Lanka, but not attained by either governments.

Will the fiscal outcome in 2005 match the rhetoric of Budget 2005? There are two sides to fiscal consolidation– government revenue and government expenditure. If the deficit is to be contained government revenue has to be increased from its present levels to match its expenditure. This has not been achieved in the past. In fact government revenue as a proportion of GDP has declined in recent years. Budget 2005 is expected to achieve a revenue to GDP ratio of 17 per cent, higher than that achieved in 2003 and higher than what is likely to be achieved this year. The revenue collection is presumed to increase in the coming years. The main strategy appears to be the enforcement of taxes and better collection. The enforcement and collection of taxes has been the problem that the government has faced in recent years.

Between 1990 and 2003 revenue as a proportion of GDP fell. In 2003 it was only 15.7 per cent of GDP compared with 21 per cent of GDP in 1990. This declining trend is a serious problem for public finances in the country. The budget expectation was to harness Rs. 331.5 billion in 2003, the actual revenue collection was only Rs 276.5 billion. The Secretary to the Treasury expects this to be reversed. He expects to realise a revenue to GDP ratio of 17 per cent in 2005 and to increase this in future years to 18 per cent.

The performance in 2004 is not very satisfactory. The indications are that revenue collection is not adequate this year too. In the first half of the year government revenue was only Rs.6.3 billion more than in 2003: it was Rs.143 billion compared with Rs. 136.7 billion in the first half of 2003 and less than half the amount budgeted for the full year. There have been new institutional reforms to enhance the efficiency of tax collection.Whether these would succeed is left to be seen.

Expenditure, on the other hand, was 21 billion more than that of the first half of last year and more than half the Budgeted expenditure. There are indications of increased expenditure and promises of still higher expenditure. Higher wages and new recruitment would mean substantial expenditure increases. The subsidisation of losses on account of the higher oil prices would also mean that government expenditure would increase.

However it is likely that the government would resort to "creative accounting". The increased expenditure may be bank financed and consequently not shown in the government expenditure figures. They will surface in later years.

The aspiration of the government to achieve fiscal consolidation is most unlikely. The root of the fiscal problem is the political condition. Decisions for long run economic viability is basically unrealistic until the country has a strong government that could take bold decisions in the long run interests of the country. The reduction of the public debt and its servicing cost is a fundamental prerequisite to fiscal consolidation. The success on the fiscal front would also depend on the economy moving on to a high growth path to facilitate the generation of adequate revenue resources to enable a progressive reduction in the fiscal deficit. The current political instability deters concerted action to reduce the deficit to achieve fiscal consolidation.

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