The country’s most serious economic problem is the large fiscal deficits over the years. Inflationary pressures result in cost of living increases that cause 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 that would ease competitiveness of exporters, but would lead to further inflation and increased hardships to the people.
A large deficit results in inflationary pressures which in turn increases the costs of production and erodes the country’s competitiveness in international markets. This necessitates the depreciation of the Rupee in order to remain competitive with other countries that have lower rates of inflation. Otherwise lesser export earnings would increase 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 by lower exports. Large deficits lead to borrowing and in turn to huge debt servicing costs. The accumulated debt is a result of persistent deficits over the years. In 2008 the public debt was over 80 percent of GDP. In 2009 it had risen to 86.2 percent of GDP owing to the large foreign and domestic borrowing. The massive public debt and crippling debt servicing costs distort public expenditure priorities and hamper economic development.
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Last year the country failed to comply with the IMF condition of achieving a fiscal deficit of 7 percent of GDP. It overshot the mark by nearly 40 percent to reach one of the highest fiscal deficits in recent years of 9.8 percent of GDP. The Central Bank Annual Report for 2009 recognizes this very clearly. In the words of the Central Bank in the press release issued as a summary of the Annual Report, it states that “the budget deficit widened to 9.8 per cent of GDP in 2009 compared to the revised target of 7.0 per cent leading to an increase in the borrowing requirement.” The Central Bank attributes this widening fiscal deficit to say: “The impact of the challenging domestic and global environment resulted in an overall setback in fiscal operations in 2009.” More specifically it points to the reasons being that “Despite several revenue measures introduced during the year, there was a significant shortfall in revenue due to the slowdown in economic activities and the contraction in imports. In addition, government expenditure increased due to higher security related spending during the decisive phase of the conflict and continued urgent rebuilding activities in the second half of the year, as well as increased salaries and wages, interest payments and expenditure on continuing public investment projects.”
In brief, the fiscal deficit was a result of both a shortfall in revenue and increases in expenditure. The reasons for extra expenditure are not that accurate or detailed but the end result was a large public expenditure. No doubt the election was an underlying cause for the various measures that increased government expenditure. The slow growth in the economy accounted for revenue to fall far short of expectations. During the previous week the Representative of the IMF in Sri Lanka Dr. Koshy Mathai gave a public lecture at the Central Bank on “Fiscal Sustainability for Out Time.” In his lecture he said that the main reason for the high deficit was the huge expenditure in the budget to service the high public debt. There can be no controversy on this. In 2008 the amount spent on servicing the debt absorbed 90.5 percent of revenue and therefore was a reason for the high borrowing that in turn increased the annual costs of servicing the debt. Last year this figure would have risen as the debt had risen and there were higher costs of servicing the debt owing to commercial borrowing. Besides this there was a shortfall in revenue collection that would have increased the proportion of revenue that had to be spent on servicing the debt.
The high debt servicing cost has been due to the accumulation of debt over a long period owing to recurring high fiscal deficits. No doubt one of the important reasons for the accumulation of debt has been the high costs of defence from especially the mid eighties. Yet it would be misleading to think that the high public debt was entirely due to defence costs. When there are high defence costs in a country, prudent fiscal policy measures are adopted. These include the tightening of the tax system and new and higher taxes. In spite of many new taxes and a very untidy system of taxation in the country, tax revenues hardly increased over time. On the side of expenditure, there was no commensurate curtailment of expenditure to cope with the additional high expenditure on defence. In fact public expenditure on several items that have been dubbed as “wasteful expenditure” (as these do not increase production), increased significantly. Notable items are the huge increases in the costs of public administration, large recruitment to the public services and salary increases, the burden of indefensible large Cabinets and perquisites. Among the other noteworthy items of high expenditure are the losses of public enterprises.
Fiscal discipline is an essential prerequisite for economic stabilization and growth. Containing the fiscal deficit is vital for the country’s economy to achieve the desired high rates of growth to resolve the problems of unemployment and poverty. However, the containment of the fiscal deficit has eluded successive governments. This year offers a new opportunity to improve the management of the public finances. This year offers an opportunity to rein in the deficit to manageable proportions and begin a trend of declining fiscal deficits.
The end of the war and elections are two of the favourable developments for fiscal consolidation through lower expenditure on unproductive activities. The prospect of economic revival also provides opportunities for increased government revenue. Defence costs could be brought down by reducing costs of hardware and other non-combatant expenditure. The promise of reducing the Cabinet is another step in the reduction in costs. There should be a curtailment of costs that do not increase the country’s production. Losses in public enterprises should be brought down by both reforms in their management and pricing policies. A better system of taxation and tax administration could increase revenue. There must be a strong resolve to reduce the deficit this year and reduce it progressively in the next years of the decade.
If public expenditure is not reduced in line with government revenue to achieve a lower deficit, the cycle of a large deficit leading to borrowing that in turn leads to deficits will continue to cripple economic growth and development. Until now defence expenditure was blamed for much of the fiscal deficit. The end of the war and curtailment of defence expenditure offers an opportunity to reduce the deficit. Yet this alone would be inadequate. Wasteful and unproductive expenditure, losses in public enterprises and other prudent financial measures are needed. Government revenue too has to be increased with a better taxation system and administration. There is an opportunity to begin a process of fiscal consolidation this year that would provide a foundation for rapid economic growth and development. |
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