The government is now committed to bringing down the fiscal deficit to 7 percent of GDP this year and to only 5 percent of GDP by 2011. These are conditions on which the IMF stand-by facility has been granted to the government.
The pruning down of the fiscal deficit to modest proportions is indeed a sine qua non of economic stabilisation and a precondition for economic growth. This is an undisputed principle in economics and many advisors to the government have underscored this fact. Yet over the recent past fiscal deficits have been high.
The Institute of Policy Studies (IPS) has repeatedly stressed the need for fiscal consolidation. The IPS report--The State of the Economy 2008-- once again emphasised the need for fiscal discipline and the urgency in containing the deficit. It said: “Indeed the failure to put public finances in order has been an enduring constraint on sustaining a higher growth momentum in the country.” It has repeatedly pointed out the need to bring down the gap between revenue and expenditure by curtailing wasteful expenditure, decreasing losses in government enterprises and improving revenue collection. All these avenues have been ignored and the fiscal deficit has tended to be around 8 percent in recent years. Many international agencies such as the Asian Development Bank, World Bank and visiting economists and business leaders have pointed out that a fundamental weakness in the economy is the large fiscal deficit.
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Successive governments have recognised the importance of containing the fiscal deficit and paid lip service to it, but their fiscal operations have failed to achieve the acknowledged fiscal objectives. The annual average fiscal deficit in the last five years (2004-2008) has been 8 percent of GDP. It was particularly high in 2005, when it was 8.4 percent of GDP. Last year the fiscal deficit was 7.75 percent of GDP compared to a budgeted deficit of 7 percent of GDP. Reducing the deficit to 7 percent this year is no easy task in view of the performance of fiscal operations thus far this year. Revenues have fallen sharply while expenditure has increased significantly.
In recognition of this, parliament itself enacted the Fiscal Management Responsibility Act of 2002. With the enactment of this useful piece of legislation the government was expected to keep to the targets specified in it. While Budget Speeches paid lip service to the goals in it and presented budget figures that brought down the deficit, the outturn of the budgets were different. The revenue collection stipulated in the budgets was not attained. Coupled with the shortfall in revenue collection was an overrun in expenditure, this, in spite of the fact that often capital expenditure was curtailed in order to reduce the fiscal deficit.
There are inherent difficulties in bringing down the deficit. Years of deficit financing has meant an accumulation of public debt. The public debt consists of both domestic debt and foreign debt. The total debt has been in the region of 85 to 100 percent of GDP. In absolute or nominal terms the debt has been increasing continuously, though as a percent of GDP it has fluctuated owing to changes in nominal current rupee terms.
Even more significant is the fact that the servicing costs of the debt was rising and absorbing a large proportion of government revenue. In some years as much as 90 percent of government revenue went towards servicing the debt. This in itself is a basic cause for the continuing debt. Since the current revenue is inadequate to meet even the recurrent expenditure of the government, it has to borrow. Such borrowing leads to an increase in debt and debt servicing costs. Therefore the country is caught up in a domestic debt trap. It is this that makes fiscal consolidation of utmost importance for good economic management.
Fortunately the foreign debt servicing costs of the foreign debt component is a manageable proportion. It is less than 20 percent of export earnings. Therefore Sri Lanka is not in a foreign debt trap that is a phenomenon of some African countries. The country is faced with a situation when the IMF has given the first tranche of the loan on condition that the subsequent tranches would be given only if the fiscal deficit is brought down to 7 percent this year and to 5 percent of GDP by 2011. This is a tough condition to meet, especially this year when there has been an overrun of expenditure and revenue collection has fallen from the levels of last year.
Yet it is imperative that we meet this condition as otherwise the withholding of the rest of the IMF loan would be a serious setback to the economy. It would without a doubt usher in an economic crisis from which it would be difficult to recover.Defaulting on these conditions implies that a loan facility at very low interest rate of one half of one percent that could help stabilise the economy would be forgone. The first tranche of the loan was only US$ 322 million dollars. It is the remaining US$ 2.2 billion that is of crucial importance. Besides this, defaulting on the conditions of the loan leading to the IMF withholding the rest of the loan would mean that the country’s credit rating would decline and any commercial borrowing even at considerably high rates would be difficult to obtain and would be at high costs. Therefore, however difficult it may be and whatever unpopular measures would have to be taken, we must not relent on the conditions of the loan.
As it has been repeatedly said, the conditions imposed by the IMF are essential for the economic recovery and long term growth of the economy. The bitter and unpopular measures have to be taken in the interests of the country’s economy. Conforming to the IMF conditions is imperative as the alternative scenario is an economic crisis of serious proportions. The government must have the political will to cut wasteful and unproductive expenditure, reform public enterprises to make them profitable and increase incomes by new taxation measures and by improving enforcement of tax measures. |
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