and long-term economic growth
There are two publications those interested in
the economy must read: The Central Bank's Annual Report and the
Institute of Policy Studies' State of the Economy. The two reports
differ in style and content.
The Central Bank Annual Report is focused on the
developments of the past year and comment is mostly confined to
developments during the year. It focuses on the pressing problems
in mild and guarded ways, stresses on the healthy developments in
the economy and criticises some aspects of the economy in a muted
manner. Euphemisms downplay the less favourable developments of
the economy. There is often a glossing over of the fundamental problems.
Yet the facts are there and some critical comment is hidden in the
pages of this large volume. It is undoubtedly the best source of
data on the economy and essential reading.
|Fuel subsidies and heavy defence expenditure
are two areas that affect govt. expenditure
Those interested in a more interpretative account
must turn to the IPS report State of the Economy. This discusses
the most recent economic developments and gives a longer-term perspective.
Apart from this it selects several key issues in the economy for
in-depth analysis and comment. In fact State of the Economy 2006
has sections on agricultural reform, leading issues in the development
process and policy briefs on four issues. These sections of the
report constitute the bulk of the report and give an in-depth understanding
on these issues.
For sometime both reports have drawn attention
to the country's most serious economic problem: the imbalance in
the public finances. The Central Bank annual Report has pointed
out in its mild and discreet manner that there is a fiscal problem.
Yet the wording hardly brings out neither the gravity of the problem
or the urgency of it. Most readers dipping into the report are hardly
likely to be impressed by its prognosis. The Annual Report describes
the fiscal problem in these cautious words: "Though the debt
to GDP ratio declined in 2005, the relatively higher level of debt
poses a threat to long-term debt sustainability. Further improvements
are needed to lower public debt to a manageable level, contain the
primary deficit and the current account deficit and thereby generate
surpluses needed for debt sustainability, containing monetary expansion
and building up external reserves. The required strong and sustainable
fiscal adjustment process is implied in the medium-term targets
of the Fiscal Management (Responsibility) Act (FMRA)."
The most important and pertinent comment in the
Annual Report is that "Fiscal consolidation paves the way for
monetary policy to operate effectively in containing monetary expansion
and maintaining price stability." This is the most fundamental
issue in the public finances of the country that impacts on the
economy and produces inflation, reduces the supply and availability
of credit and increases its cost and prevents the state playing
its vital role of developing the country's economic and social infrastructure.
In contrast the IPS State of the Economy 2006
report is more interpretative and forthright on the fiscal problem.
It characterise the problem as a serious constraint to development
and points out that despite the rhetoric of attaining fiscal consolidation,
the performance has been in the opposite direction. The IPS Report
"While it has been encouraging that despite
political pressures, the government has not embarked on large populist
public spending schemes, the criticism is that budget policy is
doing too little to ensure sustained growth in the long term. The
deficit in 2005 was contained not by streamlining government spending
but primarily by reaping the extra revenue that comes with growth.
There were big rises in spending in some areas - adding workers
to the government pay-roll where payments on salaries and wages
increased from 5.2 per cent of GDP in 2004 to 5.9 per cent of GDP
in 2005 - that do little to strengthen long-term growth prospects.
Current transfers and subsidies over time have increased from 4
per cent of GDP in 2003 to 5.4 per cent of GDP in 2005. "
The country has got itself into a straitjacket
where government finances are concerned and redeeming itself from
it is indeed a formidable task. The capacity to reduce government
expenditure is extremely limited. As the IPS State of the Economy
"Most expenditure is hard to cut. The spending
goes largely on interest payments, defence, and public sector wages
and pensions, leaving little room for big capital investments. Given
the limited room for manoeuvre, curtailing expenditure in non-productive
areas is critical. But most importantly, if the government is going
to make a difference, it needs to raise more revenue."
The report then goes on to suggest some means
by which government revenue could be increased and also indicates
some measures that have been taken that may not augur well for good
fiscal management. It comments that "one of the most pressing
tasks here will be to raise tax revenues without discouraging investment.
Tax increases effected on an ad hoc basis - and with limited regard
for the overall structure and incentive implications of the tax
system - can prove counterproductive if it undermines the predictability
and consistency of the policy regime. Many 'temporary' taxes - such
as the imposition of excise duties on select 'luxury' goods and
cesses - introduced for short-term fiscal consolidation also tend
to become entrenched in the system over time." The Report also
focuses attention on what it calls "waste in the budget",
these relate to the "ill-directed fuel subsidies.” It
points out that "Fuel subsidies in theory are aimed at the
poor but benefit the rich disproportionately. The non-alignment
of fuel prices could heave further burdens on the government budget.
The report is emphatic in its unpalatable prescription. "Given
the steady upward rise in oil prices, overhauling energy policies
- cutting subsidies and raising domestic prices - are inevitable
to curb demand and allow government budgets to be maintained."
The fiscal problem remains unresolved. In fact
there has been little serious effort despite the ad infinitum budget
speech rhetoric that it must be reduced. The irony is that everyone
would agree with the views of the IPS State of the Economy observations
but little would be done to reduce the deficit. The fiscal problem
is likely to get worse this year owing to further unwarranted government
expenditure and the likely huge increase in defence expenditure.
We cannot but agree with the Institute of Policy
Studies observation that there has to be a qualitative improvement
in government expenditure. "The quality of fiscal consolidation
needs to be improved by re-orienting expenditures to priority and
growth enhancing areas. Given the strong growth performance of the
economy and the risk of a further widening of the external current
account deficit, the authorities should resist any temptation to
loosen the fiscal stance and use the additional revenues from higher
growth for debt reduction.
Fiscal consolidation would also reinforce monetary
policy in controlling inflation. The failure to rein in the fiscal
deficit saw the economy grappling with rising inflation in 2005.
And it goes on to state, "high inflation has a far higher cost
to the economy in terms of its potential to disrupt steady growth."
Unfortunately these observations are not likely
to be taken seriously enough to lead to any meaningful action, especially
on the side of government expenditure. The public debt is likely
to grow, the deficit in the current account would climb further
and the country would have to cope with the short-term impacts of
inflation and a credit squeeze and forego higher growth in the future.