Although the most severe obstacle to economic progress during the last three decades has been removed, rapid economic development cannot be achieved over the next decade without appropriate economic policies. Even though peace is an indispensable condition, it is not a sufficient condition.
Among the other essential requirements is fiscal consolidation or the containment of the large fiscal deficits. This is undoubtedly very difficult to achieve in the current fiscal context, yet a fundamental condition for economic stabilization and economic growth. Reform of public institutions and pragmatic economic, diplomatic and political strategies are also needed. The road to the realization of the post war economic expectations is not an easy one.
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Fiscal consolidation is difficult for many reasons. With a limited revenue base of only 15 per cent of GDP, large debt servicing costs, huge expenditure on public service salaries and pensions, big losses in public enterprises, a large defence expenditure, wasteful conspicuous state consumption and expenditure on subsidies and welfare, a large fiscal deficit is inevitable. Many of these expenditures have rigidity and are difficult to reduce. Paradoxically, it is these large expenditures that provide the opportunities for reductions that would trim down overall government expenditure.
The cumulative fiscal deficits have resulted in the accumulation of a large public debt comprising both foreign and domestic borrowing. This in turn has led to a massive debt servicing burden. Current revenue is inadequate to even meet the costs of servicing this debt. In 2009 the debt servicing cost was 114 per cent of revenue. In this context the government resorts to further borrowing to meet its recurrent as well as capital expenditure. This results in further increases in debt servicing costs. The country is caught up in this vicious cycle of a debt trap.
The very difficulties in bringing down the fiscal deficit are pointers to where the resolution of the problem lies. Now that the war is over there should be a curtailment of defence expenditure. There has been much criticism that in spite of the end of the war defence expenditure has risen. This is partly owing to the need to meet obligations, such as differed payments on armament purchases that were incurred in the past. Now military hardware expenditure should be brought down to a trickle and there is no need for fresh recruitment of personnel, though committed expenditure on salaries and pensions would continue to grow. If the expenditure on defence can be brought down then its burden on the public finances could be relieved somewhat.
The other item of huge expenditure is the losses incurred by public enterprises like the CEB, CPC and the Railway. Without reforms of these public enterprises an important means of expenditure cuts would be unavailable. In the past the privatization of loss making enterprises, such as the management of estates, provided both relief to public expenditure as well as revenue from the privatization proceeds to offset the deficit to some extent. This option is no longer available due to the ideological position of the government that it will not sell public enterprises.
This ideological position was once described charmingly by former President Chandrika Kumaratunga as “selling the family silver”. She however went on to privatize some of the most important public enterprises. Such pragmatism is not to be expected. In fact the danger is that the government will not only not reform public enterprises but expand public ownership to incur further losses, such as in Sri Lankan airlines, Mihin Air and the Shell take over.
Many of the other public expenditures such as salaries of public servants and pensions, subsidies such as for fertilizer and Samurdhi payments are not likely to be reduced. In fact the salaries bill may once again increase due to both a salary rise and further recruitment that the government has so far held back owing to the fiscal constraints. Increasing unemployment among the educated youth would probably result in another wave of public service recruitment. The government is resisting both these due to the fiscal stringency and the need to keep government expenditure down.
The other area of fiscal consolidation is in increasing government revenue. Much is expected in this direction from tax reforms in the next budget. The revenue to GDP ratio of 15 per cent is below the levels of countries with Sri Lanka’s per capita income. Tax avoidance and tax evasion are important reasons for this shortfall in revenue. The IMF is hopeful of tax reforms that would yield higher revenues. It has said that, “Despite the weaker-than-programmed 2009 fiscal performance, the government’s 2010 budget proposal if carried out, would significantly address past fiscal slippages, mainly through comprehensive tax reforms and sizeable cuts in recurrent spending.”
The IMF is perhaps aware of the recommendations of the Tax Commission that is expected to release their report shortly. Much is expected in revenue collection in the next budget. The IMF says that, “The authorities’ efforts to reform trade and excise taxes and the Board of Investment’s tax concession regime are a signal that they recognize the importance of a broader tax base and higher revenue in achieving the programme’s original goals of fundamental and sustainable reduction of the deficit and the public debt. These efforts should be followed by important steps to permanently reform tax concessions and broaden the VAT and income tax bases to be introduced as part of the 2011 budget.”
The increasing of revenue depends very much on the realistic nature of the tax reforms and the administrative capacity of the tax gatherers. Both these have been rather weak in the past and high expectations on increasing revenue may be misplaced optimism. In any event there is a need to increase revenue as well as curtail wasteful expenditure. There have been no signs in the government of fiscal prudence so far. Reducing the fiscal deficit to 7.5 per cent of GDP from 8.9 per cent is no easy task. It requires a strong resolve on the part of the government to undertake reforms and to spend public money carefully. Without such an effort the economy’s growth will be unsustainable. |
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