Breaking the vicious cycle of the deficit increasing the debt and debt increasing the deficit is no easy task. Nevertheless it is a fundamental requirement for economic stabilization and economic growth. The cyclic nature of the problem discussed last week makes it imperative to put in place immediate measures for decreasing the fiscal deficit.
The reduction of the fiscal deficit to 7 per cent of GDP last year was an important step in the right direction. The containment of the fiscal deficit to 6.8 per cent this year and reducing it to 5.2 per cent in 2012, though difficult to achieve, must be realised.
Cutting down the fiscal deficit is difficult for many reasons. The limited revenue base of only about 15 per cent of GDP is low for a country with the current level of per capita income and attempts to increase revenue has met with limited success. There is a huge expenditure on public service salaries and pensions that cannot be pruned down and in fact is an area where there is a likelihood of increasing expenditure.
The big losses in public enterprises; a large defence expenditure (that was increased for 2011); wasteful conspicuous state consumption and expenditure on subsidies and welfare are other areas that are difficult to curtail. Many of these expenditures which are already committed expenditures, have rigidity and are difficult to reduce.
Paradoxically, these large expenditures provide the opportunities for expenditure reductions that would trim overall government expenditure. The very difficulties in bringing down the fiscal deficit are pointers to where the resolution of the problem lies. In some cases it may not be possible to reduce expenditure, but expenditure could be maintained at around the same amount as in the previous year. To achieve a curtailment of expenditure there has to be a realization of the seriousness of the problem and an appreciation of its impact on the country’s economic stability and growth in the long run.
Opportunities and challenges:
Defence expenditure
The reduction of military expenditure is one of the important means by which public expenditure could and should be reduced. Now that the war is over, there should be a curtailment of defence expenditure. In spite of the end of the war defence expenditure has increased partly owing to obligations, such as differed payments on armaments purchases in the past. Military hardware expenditure could be brought down and fresh recruitment of personnel should be minimal.
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If the expenditure on defence can be brought down from about 4 per cent of GDP by even 1 per cent of GDP, then its burden on the public finances could be eased significantly. The defence expenditure to GDP ratio declined from 3.9 per cent of GDP in 2009 to 3.4 per cent of GDP in 2010. However this decline in the ratio was due to the growth of the GDP and not as a result of a reduction in expenditure. In 2011, defence spending was originally estimated at Rs.214 billion or 3.4 per cent of forecasted GDP for 2011, but it was increased by Rs. 20 billion to build a new defence headquarters, taking the share up to about 3.7 per cent. Although the war is over, defence expenditure has increased from Rs. 190 billion in 2009 to Rs.234 billion in 2011. It should be possible to reduce defence expenditure owing to purchases of military hardware declining.
Losses in public enterprises
Public enterprises such as the Ceylon Electricity Board (CEB), Ceylon Petroleum Corporation (CPC), Sri Lankan Airlines, Mihin Air and other state enterprises, are incurring huge losses and thereby increasing public expenditure. Without reforms of these public enterprises an important means of expenditure cuts would be unavailable. In the past the privatization of loss making enterprises, such as the estates, provided both relief to public expenditure as well as revenue from the privatization proceeds to offset the deficit.
This option is no longer available due to the government’s policy of not privatizing public enterprises. Conversely, the government has increased expenditure by purchasing shares of loss making enterprises. In this policy context, the government must take measures to reform public enterprises and reduce their losses. There is an inadequate thrust to restructure and reform loss making enterprises.
In 2010 the government transferred Rs 12.4 billion to loss making enterprises. This was a decline from that of the previous year, but indications are that it would increase this year owing to heavier losses. While cutting this expenditure on losses of government enterprises is important to make a dent in the fiscal deficit, it should not expand public ownership to incur further losses, such as in Sri Lankan Airlines.
Salaries
Other public expenditure such as salaries of public servants and pensions, subsidies such as for fertilizer and Samurdhi payments are not likely to be reduced. In fact the salaries bill may once again increase due to both salary increases and further recruitment. Increasing unemployment among the educated youth would probably result in another wave of public service recruitment. The government resisted both these in the Budget for 2011 due to fiscal stringency and the need to keep government expenditure down. How long it could hold out is left to be seen.
Unproductive expenditure
Although the government has been conscious of the need to restrain public expenditure, such as the increasing of salaries, there are continuing high expenditures on unproductive activities. The curtailment of wasteful expenditure is vital to achieve the fiscal targets. This has been a serious lacuna in fiscal management. Even in the case of economic infrastructure projects, there is doubt that these have been on a basis of economic priority and productivity. Infrastructure development that does not contribute to economic productivity should be reduced and even eliminated.
Increasing revenue
There has been an improvement in revenue collection. The increases in imports and trade activities have generated higher revenues. Revenue collection has increased due to the increase in imports by lowering tariffs. Although this has increased government revenue, it has worsened the trade balance. In fact the yawning gap between export earnings and import expenditure is a concern. Increasing government revenue is an important means of fiscal consolidation. Much is expected in this direction from tax reforms in the last budget.
The revenue to GDP ratio of 15 per cent is below levels of countries with Sri Lanka’s per capita income. Tax avoidance and tax evasion are important reasons for this shortfall in revenue. The expectation is that tax reforms would significantly reduce past fiscal slippages and increase revenue. The reform in trade and excise taxes, a broader tax base and more effective tax collection are expected to achieve higher revenue collection that would reduce the fiscal deficit. Increasing revenue depends very much on the realistic nature of the tax reforms, the administrative capacity of the Department of Inland Revenue and the honesty of its officers.
Summary and conclusions
The road to the realization of a reduced fiscal deficit is not an easy one. However, containing the fiscal deficit is vital for stabilization of the economy and economic growth. Inflationary pressures generated by large fiscal deficits increase the cost of living and cause severe hardships, especially to the lower wage earners, pensioners and fixed income earners. This in turn leads to strikes with demands for higher wages and industrial unrest. Wage increases enhance the costs of production and reduce export competitiveness. The depreciation of the currency to restore export competitiveness would lead to further inflation and increased hardships to people. Large fiscal deficits lead to borrowing and in turn to huge debt servicing costs. The massive public debt and crippling debt servicing costs distort public expenditure priorities and hamper economic development.
Regrettably, there have been no signs of fiscal prudence. The government continues to spend on unnecessary and wasteful expenses. It requires a strong resolve on the part of the government to undertake reforms and to spend public money carefully. Reform of public institutions and reduction of wasteful government expenditure are as much needed as efforts to increase revenue.
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