The essential prerequisite for economic stabilization and growth is fiscal discipline that brings down the fiscal deficit consolidation. This has been stressed ever so often in this column, accepted by the government, the Central Bank, the Institute of Policy Studies and the International agencies assisting Sri Lanka. It is a condition for the continuation of the remaining tranches of the IMF stand-by facility. There can be no doubt that reining in the fiscal deficit is vital for economic recovery and rapid economic growth. Yet it has proved to be an illusive target.
In December 2002 the Fiscal Management Responsibility Act (FMRA) was passed in parliament and it took effect from 2003. It made it mandatory for the government to take measures to ensure that the fiscal deficit is contained at certain specified levels. It stipulated that the fiscal deficit should be brought down to 5 percent of GDP in 2006 and kept at that level thereafter. In the event the fiscal deficit was 8 percent of GDP in that year. The fiscal deficit has averaged 8 percent of GDP in the last five years. In the last two years (2007 and 2008) they were 7.7 percent of GDP each year. Fiscal consolidation has been a delusion.
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Is there a possibility that this year’s deficit could be contained at 7percent of GDP? Expenditure for the first eight months of this year has surpassed revenue by Rs. 322.7 billion. The budget estimate of expenditure for the full year was Rs. 1191.7 b. The expenditure in the first 8 months at Rs.844.7 billion is 71 percent of it. It is most likely that expenditure for this year would exceed the budget figure.
On the other hand, revenue collection that fell short in the early part of the year has shown an improvement in revenue collection recently. There has been a revenue increase of 12.1 percent during the eight month period. However this increase is not likely to reduce the fiscal deficit by much as revenue is still only 61 percent of the amount expected (Rs.855 billion) for this year. Analysts expect the deficit to be around 9 percent of GDP. However both the Central Bank and the government are of the view that the deficit would be brought down to the required 7 percent of GDP. This as the IMF Representative in Sri Lanka observed is a “challenging task”. Will this target be met? That is the question. We will have to wait and see.
Quite apart from the IMF condition of containing the fiscal deficit, it is important for the country’s economy for several reasons. A large deficit means it would generate inflationary pressures. This in turn would increase the costs of production and erode the country’s competitiveness in international markets. This means an increase in the trade deficit that would be a strain on the balance of payments. Reduced export earnings imply loss of employment and lower incomes to workers in the industries affected, as was the case in respect to the garment industry when exports decreased owing to the global recession.
More directly the inflationary pressures mean that the cost of living, especially of the poor, increases and causes severe hardships especially to the lower end of wage earners and pensioners. This in turn leads to strikes with demands for higher wages and social unrest. The solution to the problem is the depreciation of the currency. Although this would ease the competitiveness of exporters, it would lead to further inflation and increase hardships to people.
There are other ways too by which large fiscal deficits harm the economy. Large fiscal deficits lead to borrowing and in turn to huge debt servicing costs. The country’s accumulated debt of Rs. 4023 billion as at the end of September this year is as a result of persistent deficits over the years. In 2008 the public debt was over 80 percent of GDP. It is likely that this year the public debt would be more than 90 percent of GDP owing to the large foreign and domestic borrowing. What is more serious is that debt servicing costs have risen to mammoth proportions. In 2008 the debt servicing costs absorbed as much has 90.5 percent of government revenue. This leaves only 9.5 percent of revenue for other uses. Consequently the government has to borrow and the problem continues. Large fiscal deficits increase public debt and in turn its servicing costs are a crushing burden.
The Institute of Policy studies as well as the Central bank has stressed the need for fiscal discipline to bring down the deficit to the targeted amounts. For instance the Institute of Policy Studies (IPS) in its report, The State of the Economy 2009 has stressed the importance of fiscal consolidation in responding to external shocks. “The constraints that weak public finances impose on the ability of governments to respond with appropriate policy flexibility to external shocks - such as the current global economic downturn - are clear from Sri Lanka's experience. The potential impact of the global recessionary conditions on Sri Lanka's own growth performance became clear from the fourth quarter of 2008. GDP growth dropped sharply to 4.3 per cent for the fourth quarter of 2008 and further to 1.5 per cent in the first quarter of 2009.”
The IPS assessment also warns about impending dangers arising from the fiscal outturn. “Sri Lanka's developing fiscal situation in 2009 looks fragile. The IMF funding will go a long way to easing external resource constraints, and thus help towards fiscal consolidation by easing the need to resort to costly short term commercial borrowing. Nonetheless, the magnitude of funding needed for the reconstruction process will be quite significant. For instance, the re-building of roads alone in the Northern and Eastern Provinces is estimated to cost US$ 750 million. In addition, the country is also likely to experience the general tendency towards some degree of fiscal slippage associated with electoral cycles. Presidential and General Elections are widely expected to be held by end-2009 or early 2010. Past experience in this regard highlights the risks; the 14-month Stand-By Arrangement entered into with the IMF in April 2001 fell apart before the General Elections of end 2001, before it was rescued once more by the incoming new government.”
The need for fiscal consolidation is well recognised. Yet governments have not had the political will, courage and determination to follow prudent fiscal policies to ensure that the problem does not reach the outlandish proportions it has reached. By not containing the fiscal deficit this year to the IMF’s requirement of 7 percent of GDP, the country could be on a dangerous economic course. |
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