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The 2019 budget to be presented on February 5 would have far reaching impacts on the country’s economic stability and development. The central issue is whether the government’s foremost interest would be its popularity in the run-up to elections or ensuring economic stability and long-term economic development. Reconciling these two objectives is a tough task.

Objectives

Finance Minister Mangala Samaraweera has said the forthcoming budget would ensure that the fiscal deficit would be contained at 4 percent of GDP and the debt to GDP ratio would be 70 percent of GDP.

These are essential objectives in the long-term interests of the economy.

However, achieving them would not be an easy task in an election year when there would be pressures to increase public expenditure and reduce taxes.

Fiscal consolidation

It is commendable that the Government has committed itself to a programme of fiscal consolidation. The fiscal deficit was brought down to 4.8 percent in 2016, 4.5 percent in 2017 and is expected to be contained at 4 percent of GDP in 2018 and 3.5 percent in 2019.

This process of fiscal consolidation is indeed a significant achievement. It has far reaching benefits for the economy. Unfortunately, the need for fiscal consolidation is neither understood nor appreciated by most lawmakers and the general public.

Need for fiscal consolidation

Large fiscal deficits affect every facet of an economy just as high blood sugar affects every organ of the body. Therefore, the containment of the fiscal deficit is an essential prerequisite for economic stabilisation and growth.

This paramount importance of reducing the fiscal deficit is not generally understood, though much of an economy’s stability and performance rests on containing the fiscal deficit. Containing the fiscal deficit is vital as a large deficit generates inflationary pressures, increases the public debt, distorts public expenditure, reduces export competitiveness and increases the trade deficit.

Inflation

Fiscal deficits create inflationary pressures which, in turn, increase the cost of living and causes severe hardships, especially to the lower end of wage earners. This in turn leads to higher wages that in turn increases the costs of production and erodes the country’s competitiveness in international markets.

The depreciation of the rupee is then necessary to remain competitive with other countries. Otherwise the lesser export earnings would increase the trade deficit that would be a strain on the balance of payments. Reduced export earnings imply loss of employment and lower incomes.

If the rupee is not depreciated to remain competitive with other countries’ lower rates of inflation, the lesser export earnings would increase the trade deficit and strain the balance of payments. Reduced export earnings imply loss of employment and lower incomes to workers in export industries, such as garments, rubber goods and ceramics. On the other hand, the depreciation of the currency would ensure the competitiveness of exports but lead to further inflation and increased hardships to people.

Public debt

Large fiscal deficits impair the economy by increasing the public debt. Fiscal deficits lead to borrowing and in turn to huge debt servicing costs. The large accumulated debt of the country is the result of persistent deficits over the years. Debt servicing costs have risen to mammoth proportions that require the Government to borrow to repay debt.

The massive public debt and crippling debt servicing costs distort public expenditure priorities and hamper economic development. Owing to the large debt servicing costs, the Government is starved of funds for investment and social infrastructure development. Consequently economic development is severely hampered.

The crucial importance of containing the fiscal deficit for economic stability must now be clear.

Political context

An election year is a severe constraint to fiscal consolidation that is crucial for economic stability and economic growth. Political compulsions could increase public expenditure on populist measures and drive the country to the brink of a fiscal cliff. Salary increases, increased public employment, enhanced welfare measures and reduction of taxes on consumer items and other items that could gain popularity could result in overruns in expenditure and reduction in revenues. These would derail the budget balance.

Cautious expectations

Fiscal discipline is difficult to expect in the current political context. The budget is likely to be a populist one with proposals for subsidies, populist programmes and salary increases. The large expenditure on these populist measures would increase the fiscal deficit unless there are countervailing expenditure controls and new taxation measures. There is also the possibility of some measures of tax relief that would expand the fiscal deficit by decreasing revenue. Furthermore, the depreciation of the rupee is increasing the rupee cost of debt servicing that would also impact adversely on the fiscal outturn.

Hopefully, the government would restrain such increased expenditures that would expand budgeted expenditure and increase the fiscal deficit.

Choice

The budget can, on the one hand, ensure that the essential ongoing process of fiscal consolidation is continued by prudent expenditure. On the other hand, it can destabilise the long-term interests of the economy by pandering to the electorate by populist expenditure programmes that would increase public expenditure, expand the fiscal deficit and derail the progress of fiscal consolidation. It is of crucial importance that the expenditure estimates presented in the budget are not subsequently increased by supplementary estimates.

Key to fiscal consolidation

The key to fiscal success is in ensuring that there are no cost overruns from the budgeted figures and that the revenue target of 17 percent of GDP announced by the Minister is achieved. In the event that political pressures dictate new expenditures, these should be met by commensurate reductions in other budgeted expenditures.

In conclusion

Attaining this fiscal deficit target would be significant for economic stability and development. Fiscal policy must also keep an eye on its impact on the trade balance and balance of payments.

The paramount issue is whether government expenditure could be contained to achieve the fiscal deficit target this year. One can only hope that the government would be concerned about economic stabilisation and long-term economic growth and have a strong resolve to achieve the target.