Finance Minister's tough task
By the Economist
Despite the next budget being scheduled for November, the new Finance Minister will find himself in a difficult situation to manage the finances of the country. This is mainly due to the government's fresh expenditure proposals; the failure of the previous government to obtain the necessary revenue through its proposals; and the poor administration of the revenue gathering mechanisms.

On the one hand, there are the new expenditures on fertiliser subsidy and proposed increased expenditure on health and other social services such as Samurdhi. On the other hand, the Finance Minister has announced new policies and articulated certain new approaches that may also pose difficulties. For instance, he has said that he is not obsessed with the fiscal deficit. These policies have inevitable financial consequences on the economy that he would have to cope with.

The fertiliser subsidy is expected to cost an additional 1 billion rupees. In fact it may cost more were international fertiliser prices to rise further. There are likely additional increases in expenditure owing to higher prices in crude oil imports and the effect of this on the cost of thermal generation of electricity. These costs are likely to be material increases in government expenditure. The reluctance to pass on the higher costs to the consumer, owing to their impact on the cost of living, that would contravene election promises to reduce it implies burdens on the budget.

Increase in Samurdhi benefits, promised at election time would mean an increase in expenditure on this poorly targeted highly politicised programme. Then there are the promised changes in social policy to increase expenditure on health and other social services that may be justified in terms of the poor service that the poor have received in recent times, but the increased costs are likely to be heavy.

All these measures mean that public expenditure would rise, initially this year and then flow on to an increase in expenditure in 2005. The already announced approaches to increase taxation on casinos, gambling and the like are unlikely to breach the deficit.

The Finance Minister's statement that he would not be obsessed with the budget deficit is an interesting one. It rings correct as there was such an obsession and fixation on the deficit that this seemed the most important element of fiscal policy rather than the quality and composition of public expenditure. This was owing to the high dependence on the advice and assistance of the multilateral agencies that are obsessed with the magnitude of the budget deficit. In fact all previous governments have announced their intentions to cut the deficit, though the final outcomes have been very different.

Nevertheless, the government must be mindful of the need to keep the deficit within acceptable margins as a large budget deficit would inevitably lead to inflationary pressure, high interest rates and inadequate supply of credit to the private sector. All these would result in lower economic growth.

The new approach that the Finance Minister should adopt is not that of being unconcerned with the budget deficit, but maintain it at a reasonable level, without neglecting the much-needed social expenditures. This requires a two-fold strategy that is needed to achieve reasonable fiscal balance.

One is to prioritise expenditure and reduce wasteful expenditure. This means essentially the diversion of current expenditure on certain items to others. The other inevitable strategy is to increase revenue. The failure of the previous government to meet its revenue proposals was indeed one its most serious weaknesses.

Additional sources of revenue are needed. Errant taxpayers must be brought into the tax net and the indirect tax proposals have to be re-examined and implemented to ensure higher revenue to the government.

In all these tax measures it would be most important that they are carefully designed not to have disincentives on investment and productivity. The Finance Minister must be cautious to ensure that he does not pluck the feathers in a manner that kills the geese that lay the golden eggs.

His task is more arduous than he may realise at the first bidding. On the expenditure side, the pressures for increased expenditure would be very strong owing to political imperatives. These he may find difficult to rein in owing to the election promises, the composition of the government and its instability. Much of such expenditure may be wasteful rather than productive. Recent years have witnessed a reduction in tax revenues in terms of the value of goods and services produced.

Fundamental changes in taxation and tax administration are needed to change this trend. Several sources of revenue that previous governments, including the PA government of 1994-2000, tapped are not available. The privatisation proceeds of the large public enterprises, such as Telecom, plantations and the National Development Bank brought on significant resources to the budget. Given the announced policies of the government, privatisation proceeds would not be available.

Since it is also likely that the several policies of the new government would not find favour with the multilateral agencies, foreign assistance could be much less. The instability of the government and uncertainty about the peace process, are further reasons for international aid being unpredictable. All these reasons make the tasks of the Finance Minister an onerous one. Meanwhile long-term fiscal consolidation is most unlikely.

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