Public debt continues to mount as a result of high budget deficits but a senior economist says the government has taken some steps in the right direction to contain fiscal deficits although the question remained as to how soon the government would be able to bring its fiscal position to more manageable levels.

Institute of Policy Studies Executive Director Dr. Saman Kelegama said Sri Lanka’s economy was poised to grow at around 6 percent this year after recording a 3.5 percent growth rate in 2009, a tough year for economies around the world because of the global financial crisis.

Sri Lanka’s economic growth was stagnant growing at a 5 percent average during the first two and a half decades under the open economy and averaged around 6 percent during 2005 to 2008 but this was because the global economy had grown and Sri Lanka was feeling the benefits of the trickle-down-effect.

"Economic growth will be somewhere close to 6 percent this year. If this growth is to be sustainable and move to a higher growth rate of 7 percent or more beyond 2011, Sri Lanka should bring down the budget deficit and create a stable macroeconomic environment while creating the necessary institutional and regulatory reforms to gear the economy to be more competitive to face the challenges of the modern world," Dr. Kelegama said.

He identified four major challenges facing Sri Lanka’s economy; containing the budget deficit to bring about macroeconomic stability, initiating the stalled economic reform agenda, removing barriers for doing business and creating a proper regulatory framework for private investments.

The budget deficit expanded to 9.8 percent of GDP in 2009, overshooting a 7 percent target and public debt increased to 86.2 percent of GDP from 81.4 percent of GDP the previous year, this was because the government expenditure far exceeded revenue during a year which saw an intensification of the war effort and more spending on subsequent rehabilitation and humanitarian activities. The global financial crisis affected growth resulting in low revenue.

The Central Bank last Wednesday warned that high budget deficits lead to more debts and could impede economic growth as inflation and interest rates come under pressure as the government borrows more to cover deficits while debt repayments and interest payments in turn expands the deficit further (see Island Financial Review of May 06, 2010).

Dr. Kelegama said that keeping inflation at single digit levels this year would be a challenge as international oil and food prices continue to rise and large budget deficit financing.

Speaking at the launch of the Economic and Social Survey of the United Nations Economic and Social Commission for Asia and the Pacific last morning, Dr. Kelegama said Sri Lanka no longer had the war or political instability which made it difficult for tough economic reforms to be implemented in the past and suggested several areas in which the government could cut expenditure.

The fertilizer subsidy amounted to Rs. 26.9 billion in 2009, or 0.6 percent of GDP which is too high according to Dr. Kelegama.

"The fertilizer subsidy can be trimmed as it accounts for only 5 percent of a famer’s costs. Likewise, the Samurdhi programme also needs to be streamlined as it is poorly targeted."

These expenditure cuts are expected to make welfare programmes more affective.

Dr. Kelegama said loss making state owned enterprises need to be turned into profit making enterprises as they continue to drain the public purse.

The Ceylon Electricity Board made a Rs. 7.4 billion loss in 2009. The Ceylon Petroleum Corporation, Sri Lanka Transport Board, Postal Service, Railways, SriLankan Airlines and Mihin Air all recorded losses amounting to Rs. 12.3 billion, Rs. 5.1 billion, Rs. 2.5 billion, Rs. 4.8 billion, Rs. 12.2 billion and Rs. 900 million respectively.

"These losses amount to a total of Rs. 45 billion which is close to 1 percent of GDP and this is a high amount. There are other state owned enterprises which are making losses as well, so the total loss exceeds 1 percent of GDP and this is too much," Dr. Kelegama said.

These are concerns the Central Bank and the Institute of Policy Studies and civil society groups have been voicing for years.

Dr. Kelegama said the government need not privatise these enterprises but could easily facilitate a turnaround through effective, transparent and regulated public-private partnerships.

"In this context, the Ministry of State Resources Management and Enterprise Development is a positive step taken by the government in the right direction and it is an indication that the government is committed to restructuring state owned enterprises. But the question is how fast the government would be able to carry out these reforms," Dr. Kelegama said.

The Public Utilities Commission and the Strategic Enterprises Management Agency would have crucial roles to play in the restructuring process.

Dr. Kelegama also said the formulation of the Economic Development Ministry was also a positive sign.

A presidential taxation commission will present its recommendations to President Mahinda Rajapaksa next month and Dr. Kelegama said he hoped the government would accept many of the recommendations as it would result in simplifying the tax system, broaden the tax base and increase government revenue without increasing tax rates, so that the tax environment would be pro-business.

Government revenue amounted to Rs. 14.6 percent of GDP in 2009, far below the potential of 20 percent of GDP and was exceeded by three recurrent expenditure items, subsidies, salaries and pensions and interest payments on debt.

He said Sri Lanka’s true potential growth rate was above 8 percent and could reach growth rates of 9 to 10 percent like India and China depending on how effective the government was in facing the economic challenges the country is faced with.