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The new United National Party government's first budget gives virtually everything the business community wants but has failed to tackle the problematic budget deficit and provides little relief to the average consumer.
What the budget promises is different from what can realistically be achieved. It appears that a set of proposals has been squeezed into a package with no explanation as to how they would be implemented.
Take, for example, Finance Minister K.N. Choksy's proposal to eliminate pensions of new entrants to the government service. New recruits will be placed on a contributory pension scheme perhaps for the first time since Independence. But there appear to be some contradictions in the proposal because the Minister in the same breath speaks of adjusting salaries accordingly.
What does it mean? Is it possible that salaries will rise to make up for the eight percent that the employee has to contribute from his salary? (The government contributes 12 percent). If that is the case, the status quo remains and we are not actually doing away with pensions. This is one of the proposals that need clarification.
There is general agreement that the existing pensions scheme for government servants must be scrapped as such non-contributory pensions are not sustainable. If not, by 2010 our pensions bill would be 20 percent of expenditure - something which the country clearly cannot afford with Sri Lanka having the largest public sector in this part of the world on a per capita basis.
The budget appears to be silent on the cost of living implications of the proposed new measures and light on detail. Hopefully, the proposals would become clear after the gazette notification is published.
Another example is the government's offer of a voucher or coupon subsidy for farmers without explaining whether the current fertiliser subsidy would be abolished. It is unlikely that both subsidies would be given. A government with empty coffers simply cannot afford it. Likewise, there are many proposals, including those on taxation, that are unclear.
The old argument that reduced taxation would boost tax revenue and cut the number of tax evaders and that low tax rates would lead to more investment - which is the message in this budget - is not considered by many economists to be valid anymore. They feel tax evasion will continue even if the rates are reduced. This appears to be a Sri Lankan 'tradition'. Increasing investment in the economy has more to do with the investment climate and a stable political environment and less with taxes.
Economists agree that the budget contains everything or most of what the International Monetary Fund and the World Bank had been pressing for. These include the pension reforms, the Value Added Tax that has replaced the Goods and Services Tax and the National Security Levy, the pricing formula for petroleum products linked to international oil prices and the exchange rate and the sale of so-called unproductive state assets.
The new VAT system also needs to be explained more clearly though one point is certain - the wholesale and retail sector will also come under VAT. This was not so in the case of GST. Already there are fears that the VAT would lead to increased prices.
Despite the rhetoric about streamlining or reducing welfare handouts, a notable feature in this budget is that the allocation for Samurdhi, widely seen as a poorly targeted welfare scheme that favours ruling party supporters, has actually been increased. And despite assurances that the budget deficit would be financed from non-bank sources there are doubts whether this is indeed possible.
Even more worrying is that capital expenditure has been cut sharply to 5.4 percent of Gross Domestic Product from 5.9 percent with the government depending on the private sector to deliver the goods. For a government to cut capital expenditure is an unhealthy trend. The previous regime too resorted to this same tactic - given the parlous state of its finances.
The amount of money that can be saved on defence spending in the light of the indefinite cease-fire and the prospect of peace is also unclear. One billion rupees is not a big saving when compared with the Rs 75-80 billion that was spent on defence last year. The public was hoping that the 'dividend' from the indefinite cease-fire agreement between the Tigers and the government and the prospects of a peaceful settlement of the conflict would have been bigger.
By Muttukrishna Sarvananthan(
The Sri Lankan econo
my today faces two
fundamental problems; one is the structural and institutional weakness in the macro-economy and the other is the civil war-induced economic woe of the country.
The much-awaited first budget of the new government presented belatedly on March 22 has failed to adequately address both of these fundamental problems in the economy.
Firstly, the Budget 2002 has proposed very little structural and institutional reform of the economy, which are long overdue. Secondly, the government has not taken advantage of the cease-fire agreement with the LTTE by infusing public investment in infrastructure like roads, power, and telecommunications in the war-torn areas that could have boosted the overall economic growth.
Public Expenditure
The total public expenditure for 2002 (January 01 to December 31) is proposed to be almost LKR 346 billion, out of which LKR 220 billion is recurrent expenditure and LKR 126 billion is capital expenditure. That is, out of the total public expenditure proposed 64% is recurrent expenditure and 36% is capital expenditure.
Accordingly, defence expenditure (including Defence and Interior Ministries) is once again the single largest public expenditure consuming almost 20% of the total public expenditure.
The Finance Ministry consumes the second largest with 18% (this does not include debt repayments). The Ministry of Home Affairs, Provincial Councils and Local Government (12%), and the Ministry of Public Administration, Management and Reforms (8%) incur the third and fourth largest public expenditures respectively.
The Health and Education expenditures, with around 7% of the total public expenditure each, consume the fifth and sixth largest public expenditures respectively. The public expenditures on defence, health and education as proportions of total public expenditure in 2002 are greater than in 2001. In sum, 15 Ministries (and combination thereof) as catalogued in Table 1 receive 92% of the total public expenditures earmarked for 2002. These figures indicate that there is no letup in the militarisation of the economy of Sri Lanka despite an indefinite cease-fire being in place.
The Samurdhi poverty alleviation programme receives 4% of the total public expenditure during 2002 (Table 1), which is higher than last year in absolute amount as well as a proportion to the total public expenditure.
A Welfare Benefit Law is proposed in the budget that would define eligibility and exit criteria for claimants of Samurdhi benefits and outline statutory management procedures for the Samurdhi programme.
However, it would be very difficult to legally verify a household's income or wealth, especially among marginalised income groups. If so many people can evade income tax payments then what guarantee is there that the proposed Welfare Benefit Law would weed out ineligible claimants of Samurdhi benefits? There is no convincing proposal in the budget to reform the much-criticised Samurdhi programme.
The Ministry of Women's Affairs receives a negligible 0.04% (LKR 145 million) of the total public expenditure which is the same as last year. However, in absolute terms there is a drop of LKR 5 million on women's affairs this year compared to last year. This meagre budgetary allocation goes against the government's pledge in its election manifesto to improve the livelihood of women. However, the government spending on women could come out of other ministerial allocations as well.
Peace Dividend
The anticipated peace dividend has two components; one is the anticipated reduction in defence expenditure, and the other is the anticipated increase in domestic and foreign investment, foreign aid, tourist arrivals, etc, due to the cease-fire and restoration of normalcy throughout the country. However, disappointingly, the peace dividend expected from a reduction in defence expenditure has not materialised in the Budget 2002.
In fact, the defence expenditure as a proportion of the total public expenditure has risen from 18% in 2001 to 20% in 2002 (both these figures are derived from budgeted expenditures and not the actual expenditures).
The recurrent expenditure of the defence budget has increased by 10% from LKR 52.54 billion in 2001 to LKR 57.87 billion in 2002, while the capital expenditure of the defence budget has decreased by 12% from LKR 10.85 billion in 2001 to LKR 9.57 billion in 2002 (again these are budgeted expenditures and not the actual expenditures).
In the past several years the actual defence expenditure has always been considerably higher than the budgeted expenditure (the actual defence expenditure during 2001 will be known only by end of April 2002).
The expected boost to the Sri Lankan economy as a result of the MoU may accrue from two sources; one is through the revival of the economy in the North-East province as a consequence of the lifting of the economic embargo, and the other is through the increased productive activities in the rest of the country. The anticipated rise in domestic and foreign investment, foreign aid, tourist arrivals, etc, due to the MoU is expected to take sometime to materialise.
Further, there is a long way to go to realise the potential benefits to the national economy by the revival of the North-East economy due to a variety of factors; primarily due to infrastructural bottlenecks and taxation at both sides of the territorial divide. The roads in the LTTE-held areas are in a deplorable condition, which increases the transport cost of goods.
Even after the opening of the A9 highway from Vavuniya to Jaffna the road transport cost is expected to be abnormally high because of heavy wear and tear to vehicles plying that route. Further, the arbitrary tax imposed on both sides of the territorial divide on vehicles carrying goods is another key factor that pushes up the transport cost even higher.
The lack of electricity and telecommunications is another major impediment to the economic revival of the LTTE-held areas in the North and the Jaffna peninsula. The lack of electricity in the LTTE-held areas prohibits manufacturing activities. The limited number of electric generators used is totally inadequate to cater to the needs of the producers and consumers alike.
The limited supply of power in the Jaffna peninsula is far short of the requisite. The absence of telecommunication with the rest of the country greatly increases the transaction cost of businesses in the LTTE-held areas. Even the limited telecommunication facilities available in the Jaffna peninsula are totally inadequate to fulfil the demand.
Furthermore, storage facilities for agricultural and fishery produce are also lacking for want of suitable buildings and ice manufacturing plants. Therefore, the export of perishable agricultural and fishery produce of the LTTE-held areas to the rest of the country is undermined. This calls for the revival of the construction industry in those areas.
However, due to the dearth of bank finance (loans and overdraft facilities) to fund construction activities the construction industry is still dormant despite the lifting of the embargo on construction materials such as cement, bricks, asbestos, tiles, etc.
Another critical factor inhibiting the realisation of the full potential of the lifting of the economic embargo is the arbitrary taxation of goods en route to the LTTE-held areas by the Tamil paramilitary groups in Vavuniya, and taxation by the LTTE on their side. The taxation by the LTTE, though is justified in order to run a parallel administration in the territory under their jurisdiction, extends to goods meant for personal use as well. This arbitrary taxation at both sides of the territorial divide is debilitating to the entrepreneurial instinct of the masses, especially in the LTTE-held areas.
Therefore, in sum, early realisation of the peace dividend is a mirage despite a lot of hype about it.
Fiscal Profligacy
The previous government exhibited fiscal profligacy in the last quarter of 2001, as political survival became the priority. The government breached its own undertaking to enforce a moratorium on public sector hiring on several occasions. The armed forces (army, navy, and airforce) continued to recruit personnel.
The recruitment of schoolteachers went on unabated. In October 2001, the government made over 40,000 casual employees in the public sector permanent as a gesture of goodwill to the masses in light of the impending parliamentary elections in December.
Again as a gesture of goodwill to the masses in light of the impending parliamentary elections, the employees of pubic service, semi-governmental institutions, and public corporations and statutory boards were provided a pay hike of LKR.1,200 per month effective from October 2001. As a corollary, pensioners were also offered a hike of LKR 750 per month. Whilst acknowledging the rapid rise in cost of living during 2001 and the consequent hardships faced by the masses, those pay hikes were premature for an ailing economy.
There were other fiscal sweeteners to the electorate as well; diesel vehicle taxes, save the nation contribution, and import duties on raw materials of the construction industry were abolished.
All these pay hikes, tax concessions, and public sector recruitment were a manifestation of fiscal irresponsibility by a defunct government amidst a deepening economic crisis and political morass.
These politically motivated relief measures were a demonstration of fiscal opulence an ailing economy could ill afford.
The short-sighted fiscal profligacy during election times has become a hallmark of Sri Lankan democratic polity.
This was the case in1994 and again in 2001. Therefore, it is high time Sri Lanka introduces a system of statutory controls on public expenditure, during normal times as well as during election times. History has shown that politicians (whichever political party they belong to) cannot be trusted to manage the public finances prudently and efficiently. It is time to stipulate legally binding targets and ceilings on public expenditure by any government in power. For instance, there should be statutory ceilings on the budget deficit and defence expenditure as proportions of the GDP and the total public expenditure respectively.
Further, there should be statutory targets for public spending on social sectors such as education and health. That is, a maximum threshold of public spending on defence and a minimum threshold of public spending on selected social sectors as proportions of total public expenditure should be statutorily earmarked. Likewise, a statutory ceiling on the budget deficit as a proportion of the GDP should be stipulated.
The total outstanding public debt (both domestic and external) of Sri Lanka was more than the total GDP of Sri Lanka in 2001. This is not the first time the total public debt has surpassed the GDP in a particular year. During several years in the 1980s this has happened. Therefore, it is not a new phenomenon and has no political colour.
Fiscal Measures
The government's decision to increase the threshold income for personal income taxation, the proposed reduction of the top rate of personal income tax and the corporate tax in the next couple of years, and a series of tax incentives to the private sector are designed to improve compliance and reward entrepreneurship.
The proposed amalgamation of the Goods and Services Tax (GST) and the National Security Levy into a Value Added Tax (VAT) is a positive step.
However, the VAT rate on essential goods and services will be 10% and on other goods and services will be 20%. It is important to note here that hitherto essential goods were exempted from the GST. Hence, the VAT covers more goods and services than the GST. Therefore, the cost of living may rise as the government revenue is expected to increase by LKR 3.5 billion in 2002 as a result of the introduction of the VAT.
The rationalisation of fiscal instruments in the budget indicates a continuing reliance on indirect taxation rather than direct taxation. The indirect taxation is regressive while direct taxation is progressive, because the latter is based on one's ability to pay whereas the former is not.
Sri Lanka is fast becoming a middle-income country and high time it relies more on direct income taxes rather than indirect taxes.
As a way of broad-basing the direct income tax regime the public sector employees should be made to pay income tax. The public sector employees in India, for example, pay income tax and contribute to state pensions.
Almost one-fifth of the total labour force in Sri Lanka is in the public sector (including public corporations, statutory boards/authorities, and semi-government institutions). That is, about 1.2 million out of the total labour force of 6 million was in the public sector in 2000. The public sector in Sri Lanka is already overstaffed. There was one public sector employee for every 24 citizens in Sri Lanka in 1978, which has shrunk to one per every 16 citizens in 2000. The per capita public sector employee in Sri Lanka is the highest in Asia.
The Sri Lankan population has become very dependent on the State to provide jobs, free health care, free education, free pensions, etc. This dependency has resulted in gross inefficiency and low productivity in the public sector. More alarmingly, in a survey conducted among the youths of the island in the late-1990s Prof.
Hettige found that the major aspiration of the rural youth (both in the South and the North) is obtaining public sector employment. It is high time that this dependency culture is discouraged.
The most important incentives for people to seek public sector employment are the exemption from Pay As You Earn (PAYE) tax and non-contributory pension scheme. Therefore, the best way of dissuading the youth from seeking public sector employment is to withdraw these two privileges enjoyed by the public sector employees. In this regard, the proposal to make the new recruits to the public sector contribute 8 percent of their salary to their pensions in this budget is opportune.
However, the government should go further and net the public sector employees into the PAYE scheme. It is high time to inculcate the principle of paying direct income tax according to ability in Sri Lanka.
The debit tax of 0.1 percent proposed on all debit transactions in all formal financial transactions is a regressive step. Sri Lanka is perhaps the only country in the world that has introduced such a regressive tax. Though it is mentioned in the budget that this tax is temporary there is no time limit mentioned. This tax may encourage informal financial transactions.
Structural and Institutional Reforms
It is disheartening to note that very little structural and institutional reform of the economy is proposed in the Budget 2002. The reform of the bloated bureaucracy, state-dominated financial sector, antiquated labour laws, and the state-ownership of 80 percent of the land area of Sri Lanka are some of the critical reforms that needs to be undertaken.
These reforms are long overdue. There are no concrete proposals at all to reform the public sector or the financial sector. But, there is some indication in the budget about the proposed labour and land market reforms.
It is always politically convenient to undertake unpopular but necessary economic reforms in the early years of a new government. With the public endorsement of the government policies in the recent local government elections it would have been easier to push through long overdue structural and institutional reforms of the economy. The government's reluctance to bite the bullet, so to speak, is disappointing to say the least.
Conclusion
The government's decision to increase the proportion of public expenditure on defence is self-defeating, because on the one hand the government seems to be quite optimistic about the current peace process but on the other hand has not delivered its own peace dividend to the economy. This dichotomy of government policy in the political and economic spheres provides a confusing signal to the potential investors (both local and foreign) and the foreign donors alike.
Moreover, the government has shrugged off the opportunity to inject public investments in infrastructure such as roads, power, and telecommunications in the war-torn areas that could have been a catalyst to kick-start the ailing economy of Sri Lanka. Only a paltry sum of LKR 300 million is earmarked for public investment in infrastructure in the war-torn areas for 2002. Perhaps the government is expecting donor assistance to undertake these critical investments.
The allocation of LKR 2,800 million or just 0.81 percent of the total public expenditure to the Ministry of Rehabilitation, Resettlement, and Refugees is yet another indication of the government's failure to deliver its own peace dividend to the beleaguered economy.
Out of the total allocation of LKR 2,800 million only LKR 466 million is allocated for capital expenditure. Perhaps the government is expecting the international donor community to foot the major part of the bill on rehabilitation and resettlement.
If the government could not demonstrate its faith in the peace process by slashing the huge defence budget how can it expect the private sector, foreign investors, and the foreign donors to have faith in the peace process?
Further, if the government does not want to put its money where its mouth is how could it expect the private sector, foreign investors, and the donors to do it? An economy in the red requires a bolder and faster economic reform agenda than what is proposed in the Budget 2002.
(The author is a Research Fellow at the International Centre for Ethnic Studies, Colombo.
This paper was presented at the seminar on Budget 2002 organised by the ICES on March 26. Views expressed in this paper are solely of the author and not of the ICES.)
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