Fiscal position still weak, worsens economic volatility

Treasury Secretary Dr. P. B. Jayasundera speaking at the Sri Lanka Economic Summit yesterday (10) said the government must be given credit for bringing down its fiscal deficit and reducing the debt-to-GDP ratio in recent years but International Monetary Fund (IMF) Sri Lanka Resident Rep Dr. Koshy Mathai said Sri Lanka’s fiscal position remained weak and exacerbated macroeconomic volatility.

The first session was on ‘Rebalancing Fiscal Performance’ and Jayasundera said the government was committed to reducing the budget deficit to 5.8 percent of GDP this year, down from 6.4 percent the previous year, and below 5 percent by 2015 and reduce the debt-to-GDP ratio down to 70 percent of GDP by 2015 from 79.1 percent last year, and to 60 percent by 2015.

"The government’s fiscal commitments are very encouraging but there is a lot that needs to be done," Dr. Mathai said after Dr. Jayasundera had spoken for more than an hour on the economy’s progress.

Dr. Mathai said fiscal discipline was critical for macroeconomic stability and Sri Lanka’s fiscal position was still weak and exacerbated economic volatility.

After the global financial crisis broke out in 2007/8 the IMF had asked many governments to increase their spending in order to stimulate their economies. "But when we came to Sri Lanka we had to tell the government to cut back its spending because it made matters worse," he said.

"During the past seven to eight years the government has made an effort to reduce the fiscal deficit and bring down the debt-to-GDP ratio. But this is not the end of the story, there is room to improve," Dr. Mathai said.

Comparing Sri Lanka’s performance with other economies, Dr. Mathai said Sri Lanka’s loose fiscal position led to higher inflation and higher interest rates. A high level of public debt has also stunted growth compared with many other economies, including Sri Lanka’s peers, and put pressure on the banks.

Sri Lanka’s share of banking sector credit to the government was also on the high side and had a crowding out effect on the private sector. As previously reported in these pages, around 85 percent of new loans generated by domestic banks this year went to the government.

"There is one good piece of news however," Dr. Mathai said. "Sri Lanka is blessed with good debt dynamics. This is a gift and it is a blessing because this allows the government to bring down the debt-to-GDP ratio without much fiscal effort."

Explaining why this was so, Dr. Mathai said much of Sri Lanka’s outstanding debt was concessionary loans and grants. "But, we need to strike while the iron is hot. As time goes by there will be more debt on commercial terms and interest rates would be high and Sri Lanka would lose the benefit it now enjoys."

Compared with other economies, Sri Lanka’s government expenditure was not that high, but its revenue was low, particularly from income taxes.

"We are not talking about increasing tax rates, but broadening the tax net and administrative reforms especially to tax collection which is not efficient," Dr. Mathai said.

He said the defence expenditure was still too high with plenty of scope to increase expenditure to health and education. "There is scope for rebalancing government expenditure," he said.

A Harvard economist Jeff Frankels studying data of many economies over the last 50 years has shown that when governments increase spending during an economic boom, and cut back expenditure during a bust, it increased macroeconomic volatility and gave government’s little space to manoeuvre during downturns or shocks and made matters worse. This is called pro-cyclicality, a trade mark of poor and emerging economies, and the OECD economies did the exact opposite.

"During the last 10 years Frankels has shown that many countries have moved away from pro-cyclicality. But Sri Lanka, has moved further towards pro-cyclicality," Dr. Mathai said.

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