The Sunday Times Economic Analysis                 By the Economist  

Can the budget control expenditure?
Will the Budget for 2003 to be presented next week address the central fiscal concerns? Most unlikely. The political situation is such that once again the government would not be ready and willing to take the political risks associated with the required decisions to correct the fundamental weaknesses of government finances. The fundamental weakness of the country's fiscal situation is the large budget deficit. Current expenditure exceeds revenue. Unproductive and committed expenditures on defence, debt servicing, welfare salaries and pensions absorb the entirety of revenues. The consequent large overall budget deficit requires the government to borrow heavily.

The simple fact is that successive governments have been spending far more than the revenues they could muster. Consequently the public debt has reached huge proportions and in turn the servicing of the public debt has become a huge cost and the largest component of expenditure. In such a situation bold decisions are needed to cut expenditure on the one hand and increase revenue on the other.

However a government that requires retaining popularity cannot take the unpalatable decisions that would correct the fundamental problems especially when the government's political horizon is short.

Admittedly the restructuring of the public finances is a difficult task. The difficulties arise out of the magnitude of the problem, on the one hand, and the political repercussions, on the other. The large deficit both overall and on the current account requires to be reduced. Budgets have stated that they were cutting down the deficit but the final out turn has been a large deficit. In booth 2000 and 2001 the government ran budget deficits of about 10 per cent or more. The Budget of 2002 once again announced that it would bring down the deficit to 8.5 per cent of GDP.

Analysts pointed out, even at the time of the presentation of the budget, that it was most unlikely that the government could contain the budget deficit. This was because current account expenditures were unrealistically low and the revenue expectations were too high. Now it is rather clear that the deficit for this year too would be about 10 per cent of GDP. Will this happen again to the Budget of 2003?

One of the fiscal difficulties is the large debt servicing costs that has been accumulated over the years. Today the public debt is larger than the current GDP. This large chunk of the revenue each year going for servicing the debt is one of the severest constraints to an improvement in the public finances. Both the amounts of the debt and the interest costs have been increasing.

The budget for 2003 expends Rs. 130 billion on interest payments alone. The amortization payments for 2003 are a massive Rs.197 billion. These two amount to nearly the expected revenue for 2003 of Rs.339 billion. In fact this year interest and amortization costs are expected to exceed government revenue. The more the government has to borrow the higher the rates of interest it would have to pay.

The large government borrowing implies rather unsatisfactory consequences to the private sector, which too has to pay the higher interest costs of the market. The government borrowing also means a lesser amount of finances available to private enterprise.

The lesser amount of finances available to the private sector and the higher cost of credit dampen economic investment. This effect known as the "crowding out" effect is an important factor for lower economic growth. The first manner to reduce the budget deficit is to reduce expenditure.

There are three key areas of public expenditure that the government has shown an intention to control expenditure.

These are the curtailment of defence expenditures, the costs of the public service and welfare expenditure. The on going peace process has enabled the government to restrain the annual escalation of defence expenditure. Although the defence expenditure is high it has been maintained at just Rs. 1 billion more than this year's expenditure. The government has also attempted to reduce expenditure on the public service. The bill on salaries and wages has been reduced next year.

The staffing in many departments is very large in relation to the functions they perform. Given modern techniques and management practices, it would be possible to operate more efficiently with a lesser staff.

Unfortunately, the public services have been considered a means of providing employment without consideration of the productivity of the employees or the cost to the Treasury. A significant reduction in the wage costs of the public services can give relief. Otherwise these costs are likely to escalate and make the fiscal problem more acute.

Whether the budget cut could be achieved is questionable. The other area of concern has been the Samurdhi programme. Studies have revealed that much of this expenditure does not reach the intended beneficiaries although the expenditure has been large.

This is very clear from the fact that over 50 per cent of households obtain Samurdhi benefits-an extraordinarily large proportion for any country in the world. Studies have also shown that as much as 44 per cent of the beneficiaries are in the top 30 per cent of income households. The government expects to cut these expenditures too. The Budget for 2003 is lined with these good intentions.

It hopes to reduce the deficit to 7.6 per cent of GDP. The unstable political situation and the possibility of an election are likely to increase expenditure and reduce revenue from those projected in the Budget.

If so we may be back in the same situation as in years past. If these expenditures were allowed to continue their up-trend, then the fundamental weaknesses of fiscal policy would grow rather than diminish. Future budgets would have even a lesser capacity to be a device for stimulating economic growth. Fiscal reform on the lines of this budget is imperative. Is it politically practical?

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