(Nation) Last year’s fiscal deficit reached a record 9.7 percent of GDP. This was not merely much higher than the IMF requirement of containing it to 7 percent of GDP, but too high by any standard of good fiscal management. Such a high fiscal deficit would lead to an increase in borrowing, higher debt service costs, inflationary pressures and economic destabilisation. Therefore, one of the priorities this year should be to contain the deficit to around 7 percent of GDP. The preliminary estimates place the expected deficit this year to be 7.5 percent of GDP.
Last year’s total revenue is estimated at Rs.702 billion or 14.6 percent of GDP. Of this revenue, tax revenue is Rs.620 billion or 12.9 percent of GDP. Total expenditure is estimated at Rs.1,197 billion or 24.8 percent of GDP. Consequently the fiscal deficit of Rs.470 billion is 9.7 percent of GDP. Last year’s deficit is much higher than in the previous year, as well as higher than the IMF requirement of containing the deficit at 7 percent of GDP. From these statistics it can be seen that last year was one of the worst in terms of managing the public finances. The fact that it was an election year has considerable bearing on the deterioration in fiscal management.
Fiscal consolidation
Fiscal consolidation has been the most serious economic challenge for many years. Containing the fiscal deficit to manageable proportions is a fundamental requirement for economic stabilisation and growth. This is well recognised. There has been not only lip service to this but Parliament has even enacted legislation requiring the deficit to be maintained at below 7 percent and brought down to 5 percent of GDP. The Fiscal Management Responsibility Act of 2002 (FMRA) required the government to bring down the deficit to 5 percent by 2006. This has been observed in the breach and even the IMF condition has not been conformed with. It is noteworthy that the FMRA requirement was a more stringent condition than what was laid down as a condition by the IMF for the stand-by arrangement of US 2.6 billion granted last year.
Despite this, fiscal deficits have risen sharply above this and it reached a near 10 percent of GDP last year. This high fiscal deficit has been looked upon mainly as a non-compliance with the IMF condition of keeping it to 7 percent of GDP last year and brought down further to 5 percent by 2011. To view it in those terms is a narrow perspective for the containment of the deficit is vital for economic development. High fiscal deficits lead to high inflationary pressures that affect the living standards of the poor, require depreciation of the currency and lead to loss of export competitiveness. In turn, these lead to unemployment and aggravation of poverty. The distortions that are brought about are unsatisfactory for investment and growth. Foreign investors too look to moderate fiscal deficits as a sign of good economic policies.
Remedial actions
There are difficult decisions that a government must make to ensure that the deficit is contained. Electoral politics is certainly not conducive to such decision making. Last year and the beginning of this year was not at all conducive to cutting expenditure or increasing revenues. In fact, what happened last year was that while expenditure increased by leaps and bounds, revenue declined partly due to the reduction of tariffs. Reducing expenditure on a number of items was inconceivable and in fact, what we witnessed was an increase in government expenditure.
Once a new government is formed, the fact that elections are six years ahead should give the incumbent government the courage to take unpopular decisions to cut down expenditure. One fortunate development is that defence expenditure need not continue to escalate. In the last two decades, one of the key areas of increasing expenditure had been that of defence. There was no way that this expenditure could be cut in the midst of a waging a war. May be some of the expenditure was excessive; may be there was a lack of accountability in military expenditure; may be the sources of supply were not the least costly. Whatsoever be the reasons, defence expenditure was a high cost to the government and could not be contained. Now the government has the opportunity to curtail defence expenditure, especially the vast sums spent on expensive hardware. The government must attempt to reduce expenditure by about 2 percent of GDP. This alone will bring down expenditure significantly and the deficit to around 8 percent of GDP.
There must be a serious attempt to reduce wasteful government expenditure that was claimed to be essential in the political context. The budget should curtail such expenditure to save about 1 percent of GDP. Then there is the serious and difficult area of reducing losses in public enterprises. The government has taken a decision that these loss making enterprises would not be privatised. Given that decision there must be ways and means to reform these to make them far more cost-effective. Substantial savings in expenditure could be made if these were done at least within a two to three year period.
Increasing revenue
The revenue side is probably more problematic. The Taxation Commission that is currently sitting is expected to come up with proposals to increase revenue. Simplification of the tax system, closing of loop holes and tax exemptions are being talked of as possible ways of increasing revenues. Unfortunately past efforts in this direction have not borne much fruit. Deficiencies and corruption in the tax administration have led to considerable losses in direct and indirect taxes. The loss of VAT revenues is a glaring example of this.
The fact is that revenue collection in the country falls far short of what it should be. Tax revenues must be raised from its current 13 percent of GDP to at least 15 percent initially and then aim towards 17 to 18 percent of GDP. This is about the norm for a country at Sri Lanka’s level of per capita income. It is vital that the new measures of taxation to be proposed by the commission are realistic and administratively feasible.
Conclusion
There can be no doubt that the fiscal deficit should be brought down to much lower levels this year. Most of the fiscal consolidation this year would have to be through the pruning of government expenditure. This has to be complemented with increasing revenues. This is a strategy that must be vigorously begun this year so that revenues would increase from next year onwards. The reduction of the fiscal deficit must be a cornerstone of the next budget.
