Columns - The Sunday Times Economic Analysis

Budget 2009: Not different to the rest

By the Economist

Not much was expected from the budget presented by President Mahinda Rajapaksa on Thursday. The Deputy Minister of Finance said when presenting the estimates in October that this budget was being presented at a time of enormous difficulties challenging the Sri Lankan economy.

The President reiterated this when presenting the Budget. Yet the facts and figures in the Budget did not reflect much of this outlook. There were no “blood sweat and tears”, but a promise of the country flowing with milk and honey when the war was soon over. A few popular expectations were realised. Public servants’ salaries and pensions were increased and petrol, diesel and kerosene prices reduced. The reduction in fuel prices is expected to result in a decrease in transport costs by 25 percent and electricity tariffs are expected to be reduced. Personal income tax rates are lower and the withholding tax on interest income is also lower.

The reduction in transportation costs of goods is expected to result in a downward revision of other prices such as those of vegetables. Whether this would materialise is left to be seen. On the other hand, some of the new duties such as on milk powder and the expected depreciation of the currency will increase prices on imported commodities.

Though the impact of the Budget on incomes and costs of living are the popular concerns, in fact, it is the underlying figures of revenue and expenditure that would have the biggest impact on the costs of living and medium term economic performance. As was the case in previous budgets of this government, and previous governments as well, expenditure increases much above revenue. Much worse is the fact that during the course of the year expenditure overshoots the budgeted amounts, while shortfalls in revenue have been endemic. In 2007 revenue was expected to be nearly Rs.600 billion but turned out to be only Rs. 585 billion. According to the figures presented in the Budget, government revenue that was expected to be Rs. 785 billion is estimated to be only Rs. 709 billion. Revenue for 2009 is expected to jump by about 20 percent from Rs. 709 billion to Rs. 855 billion. As in the past, revenue shortfalls are most likely, especially with an expected downturn in the economy owing to the global recession that would slow down the country’s production that would in turn result in lesser tax revenues.

Government expenditure current and capital is estimated to rise to Rs.1678.5 billion, resulting in an overall deficit of Rs. 336 billion. The 2009 expenditure is bound to overshoot what was presented in parliament, while revenue collection would be much less than expected. Consequently the fiscal deficit is likely to be much higher than stated in the budget. The final outturn is unlikely to be the one presented in parliament.

Pride of place has been given to defence expenditure totalling Rs. 200 billion, an increase of about 16 percent over that of the previous budget. In fact this defence expenditure is vastly underestimated as in previous years.

The 2008 defence expenditure in the budget was Rs.166 billion. However, in fact it increased by a further 28 billion to Rs. 194 billion. Perhaps the final figure may be still higher. In 2009 the government plans to spend Rs.200 billion. This is a comparatively low estimate Additional security spending is most likely next year too. It will probably increase to over Rs. 225 billion. Given the intensity of the war and increases in the costs of fighting, this is a more likely figure.Defence expenditure is considered a priority and such expenditure is considered untouchable.

Therefore discussion of defence expenditure and any disagreement on it is not considered patriotic. There can be no doubt that the security of a nation is its priority and the foremost responsibility of the state. This does not necessarily mean that such expenditure should not be scrutinised. Large expenditures, as in the case of defence hardware procurement, lead to corruption and consequently wasteful use of public funds that often also result in poor equipment being purchased. This does not serve either defence needs or prudent management of public finances. From an economic point of view defence expenditure is especially inflationary, as they are large and spent on services that do not lead to commensurate increases in the production of goods and services that could be consumed by the public. Consequently high defence expenditure is inflationary and is a primary reason for the mounting public debt and debt servicing costs.

The implication of this for fiscal policy is that if defence expenditures cannot be pruned down due to security priorities, then we must turn to a curtailment of other expenditures in order to reduce the inflationary impact of this expenditure. Unfortunately the capacity to cut other expenditures too is very limited. Most of the other expenditure is committed expenditures, such as salaries and pensions for government servants, recurrent expenditure on health and education, servicing of the public debt, welfare expenditure and subsidies to loss making public enterprises. Many of these are what economists call unproductive expenditure. Therefore it is not only the fact that the country has been incurring large fiscal deficits that is the problem, but that these deficits are mostly caused by expenditures that put money into the economy without resulting in commensurate goods and services being produced. Large expenditure for “non productive” purposes is distinctly an important reason for the inflationary pressures generated in the Sri Lankan economy for quite some time now. This is one of the key reasons why Sri Lanka’s economy has had much higher rates of inflation than our neighbours.

This government through last year’s Budget and this year’s expenditure on infrastructure has addressed the underdeveloped nature of infrastructure in the country. The deterioration of the country’s infrastructure was self-evident. The poor state of infrastructure, especially economic infrastructure like roads, railways and energy were considered a serious bottleneck for economic growth. The expenditure on infrastructure has been increased in recent budgets and it could be considered a move in the right direction. There can be no doubt that this expenditure is vital for the country’s development. Yet the harsh economic fact is that while such expenditure is vital and necessary, their returns are over a long gestation period and indirect. In the long run these could yield returns by way of increasing the productivity of the economy, yet the investments in infrastructure are inflationary during the current period. Furthermore, to the extent that these expenditures have high import content, they lead to an increase in imports that could be a strain on the balance of payments as well.

This year’s fiscal deficit is expected to be over 8 percent though the Budget expects it to be 7.2 percent. As usual the budget predicts a lower deficit of 6.5 percent next year. This is a mirage that is never realised. The high fiscal deficits have been at the bottom of the inflationary pressures in the economy for quite some time. The inability of the present government to cut wasteful expenditure has been the underlying reason for much of the country’s high fiscal deficits. No doubt the increasing defence expenditure has been at the root of this problem. This is so not merely because the expenditure is very large but also due to such expenditure not generating commensurate goods and services for consumption. Nothing much in the way of fiscal discipline was expected and nothing much was realised. This has been so in previous years as well..

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