It is heartening to find that the Treasury is intent on keeping the fiscal deficit to the original target of 6.2 per cent of GDP this year despite the challenging circumstances it faces. This resolve is a healthy sign for the management of fiscal affairs and the economy. Even if the fiscal deficit exceeds this [...]


Politics and good fiscal management


It is heartening to find that the Treasury is intent on keeping the fiscal deficit to the original target of 6.2 per cent of GDP this year despite the challenging circumstances it faces. This resolve is a healthy sign for the management of fiscal affairs and the economy.

Even if the fiscal deficit exceeds this target marginally this year, if this resolve leads to meaningful actions to curb the deficit next year, then it would indeed be an achievement for economic management and an important step in good financial governance.

What is important is not the precise statistic of the fiscal deficit, but the movement towards good fiscal management by increasing revenue collection and spending government revenue prudently and sensibly according to a set of economic and social priorities. A strong political understanding of the need to manage public finances in an accountable manner; to contain the fiscal deficit to manageable proportions; and to ensure that fiscal management leads to economic stability and economic growth, are indeed vital to achieve fiscal consolidation and good management of public finances.

The fiscal operations of the government are the centrepiece of government policy around which the economy revolves. It has wide ramifications on the country’s economic performance and social attainments. An understanding of this by the political leadership and a determination to achieve fiscal consolidation are needed to contain fiscal deficits. This has been the weakness for many years. The ballooning public debt and high debt servicing costs are the consequences. These, in turn, have been responsible for the country’s fundamental economic weaknesses.


Containing the fiscal deficit to the original target of 6.2 per cent of GDP is a daunting task as the economy is slowing down and the off target fiscal performance in the first half of the year makes it particularly difficult to contain expenditure and catch up on revenue. Treasury Secretary P.B. Jayasundera has himself reduced the expected economic growth this year to 6.5 per cent.
The Standard Chartered Bank’s (SCB) research suggests that Sri Lanka’s economy would grow 6.8 per cent this year but recover to 7.5 per cent in 2013. It expects the budget deficit to reach 7 per cent of GDP this year, missing the 6.2 per cent target set by the government. It also says there is limited scope for the Central Bank to ease its monetary policy stance this year, while the rupee is expected to stabilise at around Rs. 130 against the dollar.

Difficult task

The slowing down of the economy implies that revenue too would fall. Besides this, the attainment of a low fiscal deficit as a proportion of GDP is made difficult when the ratio has to be obtained on a lower GDP figure, which is the denominator. The scope to reduce government expenditure in the next quarter is limited. Nevertheless the Treasury expects to cut expenditure by rolling over this year’s budgeted expenditure to next year. The capacity to reduce expenditure is not entirely in the hands of the Treasury, as ministers could steamroll the bureaucracy to increase their spending. This has been a frequent occurrence and one cannot see a difference in the next few months.

Treasury Secretary Jayasundera has maintained that non-essential expenditure would be rolled over to the next fiscal year with cuts possible in some farm programmes that were expected to be undertaken under more normal weather conditions. These, he said, would not be implemented because of the weather conditions. It is this sort of adjustment that the Treasury will make.
Dr. Jayasundera insisted that there would be certain cuts in expenditure and that other than the most important committed expenditure everything else will spill to the next year on a rollover basis. Furthermore, he pointed out that rising costs for imported fuel and higher interest rates put pressure on finances at the start of the year, but lower outgoings and back-loaded revenue would help keep the budget on track to achieve the 6.2 per cent deficit. We must hope that such expenditure cuts will bring down the deficit.

There are two areas by which revenue may be increased and budget expenditure reduced during the rest of the year. New taxation measures could raise revenue. Already some fresh taxation measures have been introduced. It is likely that revenue would be buttressed by further taxation. It is also likely that some expenditures would be made off budget so as to achieve the required statistic. Bank lending to meet some Government expenditures, like losses in public enterprises, could reduce the expenditure figure for the year, although future commitments would be increased.

Fundamental issues

Fiscal consolidation requires fundamental issues to be addressed. One of the most important strategies is to reduce the large losses incurred by public enterprises. Reforms of these public enterprises to reduce public expenditure provide a significant means of reducing expenditure. The Government must take immediate steps to reform public enterprises. Furthermore it should not expand public ownership to incur further losses.

Expenditure on defence requires to be progressively curtailed. This is especially so with respect of military hardware and fresh recruitment of personnel. Infrastructure expenditure should be reviewed and more modest expenditure incurred. Government spending on unproductive activities require pruning.

Increasing government revenue is vital to reduce the deficit. The low revenue to GDP ratio of 14.3 per cent must be increased by reducing inefficiencies in the tax administration, tax avoidance and tax evasion. Tax reforms should increase revenue by realistic tax measures and improvements in the administrative capacity of the Department of Inland Revenue. These are measures that must be taken to improve revenue collection next year.


There is a conflict between economic imperatives and the political compulsions. This is the crux of the fiscal problem. While economists grapple with the issue of scarce resources of the government that has to be spent prudently in the most beneficial manner, politicians tend to think of Government resources as virtually unlimited and inexhaustible. In a sense it is true that there no limits to government expenditure as the government could expand its borrowing especially when it has a commanding majority in parliament. This is precisely what has happened. However such expansive expenditures much larger than the government’s revenue lead to inflationary pressures and an increase in public debt. In fact the persistent Government deficits over the years has been responsible to the large public debt and the huge debt servicing costs that requires a large proportion of current expenditure to be expended on debt servicing. This in turn increases the debt as well as distorts priorities in government expenditure.

The challenge facing the Government is one of reducing the fiscal deficit, while at the same time reorienting government expenditure towards a healthier prioritisation. This is a near impossible task in the current political milieu.

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