The medium term and long run economic performance depends very much on the government’s ability to contain the fiscal deficit and bring the future deficits to more acceptable levels. Economic stabilization is very much dependant on the containment of the fiscal deficit and is a prerequisite for rapid economic growth. This is why we have repeatedly stressed the need for fiscal consolidation. This is a position that has been accepted by the government, the Central Bank and the Institute of Policy Studies, the foremost economic think tank. The realization of this objective has however been a mirage. The Budget to be presented later this month would be a critical one in attempting this objective.
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However despite the end of the war there has not been any improvement in the fiscal outturn. Last year’s fiscal deficit of 8.9 per cent of GDP was in fact much higher than the target of 7 per cent. However the IMF is satisfied with the fiscal performance for this year. In its latest statement it showed satisfaction in the fiscal performance this year but indicated some concern in the government’s resolve to bring it down. The Budget 2011 will be of much interest to see whether there are significant attempts to bring down the deficit. No doubt containing of the fiscal deficit is a difficult task that requires a strong political resolve.
The International Monetary Fund (IMF) has expressed some satisfaction in this year’s fiscal performance. The IMF said that “The 2010 budget passed by parliament in June entails a deficit of 8 per cent, incorporating sizeable cuts in recurrent spending while allowing for significant spending on infrastructure and reconstruction. Fiscal performance in the first eight months of this year is in line with the full-year deficit target, with a recovery in budget revenues driven mainly by buoyant import-related taxes.”
Reading between the lines of an IMF statement has become mandatory to understand the more significant issues it brings out under its veneer of international diplomatic language. It must be noted that the improvement in fiscal performance has been mostly due to “a recovery in budget revenues driven mainly by buoyant import-related taxes.” In other words the improvement has not been due to expenditure cuts of much significance or revenue from direct taxes. The drastic reduction in car and other import items has brought about a flood of such imports and therefore an increase in revenues. Whether this is a healthy development to an economy that has a very large trade deficit is open to question.
The IMF Executive Board Assessment is that: “While acknowledging the improvement in fiscal performance… (it) emphasized the need for forceful action to reduce the budget deficit and public debt. In addition to cuts in security-related expenditure, they encouraged the authorities to implement well-sequenced tax reform measures that would create fiscal space for social spending and for the much needed reconstruction and infrastructure investment. Directors stressed that the 2011 budget would be a key step in embarking on a credible reform strategy, aimed at broadening the tax base, simplifying the tax and tariff systems, and improving tax administration….. Continued efforts to achieve full cost recovery of energy services are also important for fiscal sustainability.”
This statement gives both, the reasons for reducing the fiscal deficit and how it may be achieved. The reduction of the fiscal deficit requires a two pronged strategy: a reduction in expenditure and an increase in revenue collection. Reduction in public expenditure has proved difficult. The large debt servicing costs, huge expenditure on public service salaries and pensions, big losses in public enterprises, a large defence expenditure (that has been increased after the war), wasteful conspicuous state consumption and expenditure on subsidies and welfare, inevitably result in a large fiscal deficit. Many of these expenditures have rigidity and are difficult to reduce. However these large expenditures have to be reduced for overall government expenditure to be reduced.
There should be a cut back in defence expenditure. Despite the end of the war defence expenditure has risen. The explanation for this is the need to meet obligations, such as differed payments on armament purchases that were incurred in the past. At present military hardware expenditure could be brought down to a minimum. New recruitment of personnel should be avoided, though committed expenditure on salaries and pensions would continue to increase. Reduction of expenditure on defence can bring down its burden on the public finances.
The losses incurred by public enterprises like the CEB, CPC and the Railway are huge. 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.
Salaries of public servants and pensions cannot be reduced. On the contrary the salaries bill may once again increase due to both a salary rise and further recruitment. Increasing unemployment among the educated youth would probably result in another wave of public service recruitment.
The other area of fiscal consolidation is in increasing government 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. 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.”
Increasing of revenue, the reduction of losses in public enterprises, restriction of defence expenditure and the curtailment of wasteful expenditure are vital for reducing the fiscal deficit. Reform of public institutions and pragmatic economic strategies are also needed to ensure a reduction in the fiscal deficit. |
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