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Bringing down the fiscal deficit to at least five percent of GDP in the next few years is vital to ensure economic stability and growth. However difficult it is to achieve this target, it is an economic imperative for economic and social development.

Fiscal objective

Prime Minister Mahinda Rajapaksa in his 2021 budget speech recognised the need to reduce the fiscal deficit from its current nine percent of GDP to around five percent in 2024. In the conclusion of his budget speech, he said that it is planned to maintain the budget gap at nine percent of GDP in 2021 since private investments that amounted to 32.3 percent of GDP in 2014 decreased to 27.6 percent in 2019.

He explained that since it is required to provide a robust start by the government to revive economic growth that had stagnated recently the 2021 deficit of nine percent would be brought down to five percent of GDP in 2024. Such a progressive fiscal consolidation is a precondition for the stabilisation and growth of the economy.

Imperative though difficult

The fiscal stimulus strategy, the extensive economic and social development programme of the government and the economic dislocation due to the corona make the immediate reduction of the fiscal deficit impractical. However the progressive reduction of the fiscal gap to around five percent of GDP or less is a fundamental requirement for economic stabilisation and growth. Reducing the gap between revenue and expenditure, in the next few years though imperative is difficult owing to the global and domestic conditions.

Current economic conditions

Admittedly current economic conditions are not conducive to adopting stringent fiscal measures. The large committed recurrent expenditure, need to provide a fiscal stimulus, essential expenditure to contain COVID, provide relief to the large numbers of persons who have lost their livelihood and are threatened with starvation and the proposed expansive programme for economic and social empowerment make the containment of the deficit impractical next year and difficult in the next three years.

Political courage

Despite these difficulties, the containment of the fiscal deficit is imperative. The recognition of the need for fiscal consolidation requires bold and politically courageous decisions to reduce public expenditure and increase revenue. Does the Government have the political courage and political will to achieve this?

Elusive

Containing the fiscal deficit to desired levels has proved elusive for several decades. In fact what we have witnessed in recent years is an increase in the deficit. The deficit that ballooned to 7.6 percent in 2015 was brought down to 5.7 percent in 2016, 5.5 percent in 2017 and 5.3 percent in 2018. It rose to a disputed and uncertain figure of eight or nine percent in 2019 owing to expenditure to gain political popularity.

Election years

An oft repeated tale in public finances is the increased expenditure in election years when, in Sir Ivor Jennings inventive phraseology government’s “truckle” down to people and increase populist expenditure that widens the fiscal deficit.

Uncertain

It is not clear whether the 2020 fiscal deficit would be nine percent or more. Bringing down the deficit to five percent in 2024 is a tough task owing to the large committed fiscal expenditure, huge losses in public enterprises, ambitious development programme, impacts of COVID on production, employment, income and livelihood and economic output (GDP).

Fiscal bind

The Government’s committed expenditure for salaries, pensions and interest payments absorbs the entirety of government revenue. In 2021 these expenditures would be higher than in the past with employment of large numbers in new government jobs, employment of unemployed and unemployable graduates, additional expenditure on containing COVID and welfare costs of those affected by the lockdown measures, unemployment and income deprivation.

Development expenditure

It is in this dire fiscal and economic bind that the government has proposed expansive economic development and social empowerment programmes. Realising the ambitious “Vistas of Prosperity” in the next four years, though desirable, would be much more than a challenging task. How the Government would increase its revenue in the next few years is not known.

Larger fiscal deficit

There are several reasons why fiscal consolidation is a very challenging tough task. First, there is an inbuilt committed large expenditure on salaries, pensions and debt servicing that cannot be reduced, but would increase. Second: there is a huge expenditure on over 300 loss making state owned enterprises that are not likely to be reformed and may have higher losses. Third: expenditure on containment of COVID and needed welfare expenditure could escalate. It is on top of these that the Government has an ambitious programme of rural infrastructure development.

Why fiscal consolidation

Reducing the fiscal deficit to manageable proportions is imperative as a large deficit would compound the weak macroeconomic conditions further. Large fiscal deficits increase the public debt and debt servicing costs, creates inflationary pressures that diminishes the real income and purchasing power, especially of low fixed income earners and retirees, raises the cost of production and decreases the country’s international competitiveness. It would then depreciate the currency and heap fresh burdens on the people.

In brief it is like diabetes that affects every organ of the body. It affects every aspect of the economy adversely. The containment of the fiscal deficit is especially important for an export-import economy like ours.

Conclusion

Bringing down fiscal deficits is a prerequisite to macroeconomic stabilisation and economic growth. Achieving the desired four to five percent fiscal deficit by 2024 is indeed a challenging tough task. Bold decisions are needed to enhance revenue by a comprehensive programme of progressive taxation, cutting down non-productive and wasteful expenditure, reform loss making state enterprises to reduce government expenditure and an effective implementation of development projects that increase the country’s output and exports. Without fiscal stabilisation the country’s economic and social development cannot be achieved.