One key factor which has led to weak fiscal performance in Sri Lanka is the continuous decline in government revenue as a proportion of GDP over the years. The current revenue collection of only 13 per cent of GDP in 2015 is far below the average of countries with the same GDP as Sri Lanka. Meanwhile, government expenditure, accounting for about 21 per cent of GDP in 2015 exceeds revenue collection, leading to an overall budget deficit of 7.4 per cent in 2015.
Sri Lanka’s debt/GDP ratio of 76 per cent in 2015 is high. The country’s budget deficit and debt/GDP ratio in 2010 – 2015 given below discloses the country’s fiscal weaknesses.
This weakening of public finances along with the deterioration of foreign reserves have downgraded the country’s Fitch ratings and according to Moody’s, Sri Lanka’s debt burden and debt/GDP ratio would rise further this year and in the following years.
Out of the overall revenue received by the government in 2015, tax revenue accounted for about 96 per cent, while non–tax revenue accounted for 7.3 per cent. The former could be increased by a further increase in tax rates (the VAT increase was discussed in my previous article), but this in turn is a disincentive for investments. Instead of tax rate hikes, some other measures the government could look at are: expanding the tax base, rationalizing tax exemptions, increasing other sources of revenue such as direct investments by government in profitable sectors, and minimizing tax evasion and avoidance. The reform of state-owned enterprises and selling of some enterprises are also likely to bring in revenue.
Recurrent expenditure far outweighed capital expenditure in 2015. Recurrent expenditure accounted for approximately Rs. 1702 billion and capital expenditure for Rs. 588 billion The reduction of the latter is also with the aim of reducing the budget deficit. However to contain the deficit, wasteful expenses too need to be reduced.
In Sri Lanka where people are so used to depend on the government for their vital expenses like education and health, it may not be realistic to cut down social expenditure. What is important is to rationalize public expenditure, which is currently lacking in Sri Lanka. Welfare expenses amounting to a quite high component in government expenditure, should be targeted to the most vulnerable.
Managing the deficit
Over the past, Sri Lanka has been tackling budget deficits by cutting down capital expenditure and by borrowing. Along with the cutting down of expenditure, government could dispose unproductive assets and reduce losses in state enterprises via necessary reforms. The deficit needs to be reduced by maintaining the required level of public investment. For this, private sector participation in the economy should be increased and Sri Lanka needs to attract more foreign investments in order to reduce the dependence on external borrowings. This is where governance plays a role.
Slow economic growth and structural weaknesses in tax administration would make fiscal consolidation difficult for Sri Lanka. This is further aggravated by the country’s high debt burden, less private sector participation in the economy and lack of expenditure rationalization. The latter two were also mentioned as government’s commitments in Budget 2016. Whether we have actually addressed the above, is something we have to reflect on.
Fiscal consolidation is essential for Sri Lanka’s macroeconomic stability and to build a favourable investor climate. Monetary policy should also be used in combination with fiscal policy, as low and stable interest rates are factors conducive for economic growth and investment. Lower budget deficits and increased revenues are imperative for Sri Lanka on her path towards fiscal consolidation. For this, reforms in revenue and expenditure aspects of public finances are essential. A more effective and an efficient tax administration than at present, and proper regulation to minimize loopholes are keys in meeting the above. Unless we have the required reforms and a proper fiscal framework, government’s fiscal targets may be too ambitious.