Expect austere budget, economists say


Central Bank earlier cautioned govt on the need to
contain high deficits


The government is presenting its ‘mini’ budget for 2010 tomorrow and while public expectations are high, there are real concerns as to how successful the government would be in taking steps to curtail its day-to-day administrative expenses, as ballooning budget deficits threatens to erode investments on much needed infrastructure development and put pressure on inflation which in turn exerts pressure on the cost of living and interest rates.


By Devan Daniel

The government is presenting the 2010 budget tomorrow and leading economists said they hoped the government would take steps to bring down high deficits, which increased to 9.8 percent of GDP in 2009 from a targeted 7 percent, promote infrastructure development and establish an investment friendly tax regime. They said conditions to bring down the budget deficit to 5 percent of GDP by 2012 as laid out in the US$ 2.6 billion standby facility arrangement with IMF would also have an impact on the budget.


"We could expect austerity in the 2010 budget because the government has to bring down the budget deficit quite significantly this year. The deficit for the quarter of this year is about 2.23 percent of GDP and this must be reduced to lower levels during the next quarters if the government is going to maintain a deficit of around 8 percent," Prof. ADV de S Indraratna, Emeritus Professor of Economics, University of Colombo and President Sri Lanka Economic Association told The Island Financial Review.

2009 was a difficult year for Sri Lanka’s economy. The last stages of the war which was fought during the first half of the year and the global financial crisis led to an expansion in spending and a contraction in revenue which widened the deficit to 9.8 percent of GDP which resulted in the IMF holding back a US$ 326 million tranche.

According to the appropriation bill, expenditure for this year is estimated at Rs. 974.7 billion, but the revenue estimates would only be announced tomorrow (June 29).

The government presented a Vote on Account for the first four months of this year, with estimated expenditures amounting to Rs. 362.7 billion. By March, Rs. 305.6 billion had been spent.

Officials have always argued that Sri Lanka tended to overestimate revenues and underestimate spending.

In the 2009 budget, presented to parliament in November 2008, the government estimated revenue at Rs. 854.9 billion. Expenditure was estimated at Rs. 1,191 billion. These were later revised. Revenue was brought down to Rs. 725.7 billion and expenditure was revised down to Rs. 1,091 billion.

However, by the year end, actual revenue was Rs. 702.6 billion and expenditure was Rs. 1,201 billion.

Earlier this year the Central Bank cautioned the government to contain high budget deficits and refrain from reckless spending as increased borrowings could threaten medium to long term economic stability. This would make it difficult for the government to concentrate resources to priority areas, crowd-out the private sector and put pressure on inflation as domestic borrowings increase.

"The government is expected to contain its administrative expenditure (recurrent expenditure) while capital expenditure on infrastructure projects should be maintained or even increased if we the economy is to grow at rate of seven to eight percent this year. It is hoped that the budget would be development oriented but austere," Prof Indraratna said.

"We could also expect to see some tax increases. Direct taxes are unlikely to be increased but indirect levies could be increased because the government has to raise its revenues," he said.

Senior Economics Lecturer of the University of Colombo, Dr. Sirimal Abeyratne, said the IMF would have an influence on the budget to be announced tomorrow. "The government would have to introduce certain policy measures that would ensure high deficits are contained so that the IMF programme could continue," he said.

"But the most important thing right now is for the government to establish an investor friendly environment. Policy predictability has been severely undermined in Sri Lanka due to various ad hoc policy measures introduced from time to time and this makes it difficult for investors to plan-out their investment," Dr. Abeyratne told The Island Financial Review.

A vicious cycle...

High budget deficits leads to higher borrowings and Sri Lanka must be carful that its debt stock does not spiral out of control.

In 1950, Sri Lanka’s debt stock stood at Rs. 0.8 billion (16.9 percent of GDP) and has grown to Rs. 4,161.4 billion or 86.4 percent of GDP by end 2009. The debt stock almost doubled from Rs. 1,219 billion since 2000. As at end March 2010, the outstanding debt stock increased 2 percent from end 2009 levels to Rs. 4,246.5 billion.

According to the Central Bank the doubling of the public debt stock over the past nine years was a result of continuously high budget deficits and the depression of the rupee.

When governments run high budget deficits more needs to be borrowed to finance the deficit and an appreciation of the currency makes it more expensive to payback foreign debts.

High budget deficits had a 69 percent share in the increase of the debt stock from Rs. 1,219 billion in 2000 to Rs. 4,161.4 billion in 2009 where as the depression of the rupee had an 18 percent share in the increase of the debt stock..

Of the Rs. 4,161.4 billion, or Rs. 4.16 trillion, debt stock, domestic debt accounted for 58 percent while foreign debt accounted 42 percent and Sri Lanka would continue to service a high level of debt.

For this year, Sri Lanka has to service debts amounting to Rs. 801.1 billion of which 44 percent is interest.

According to the Central Bank, bringing down the budget deficit to sustainable levels would ensure that inflation and interest rates are maintained at low levels which is necessary to spur growth.

Persistently high budget deficits puts pressure on domestic funding sources and drives up interest rates, this is in turn drives up inflation and the cost of living. More debts result in higher repayment obligations leading to higher deficits, a vicious cycle.

"Each time the budget deficit increases by 1 percent, the net borrowing requirement of the government increases by Rs. 54 billion and the debt stock increases by this same amount. If interest rates increase by 1 percent, the government’s expenditure on interest payments would increase by Rs. 10 billion and if the rupee depreciates by 1 percent it would cost the government Rs. 9 billion," a recent study by the Central Bank showed.

The bank believes better coordination between fiscal policy and monetary policy is necessary if inflation is to be sustained at low levels in the long term.

The budget that would be announced tomorrow is an interim budget and the first complete budget in Sri Lanka’s post-war economy would be presented later this year for the 2011 fiscal year.


Expectations are high as the government presents its mini budget for 2010 tomorrow. The Island Financial Review spoke to some business personalities to gauge their expectations and concerns.

Tough 2010-11 as deficit takes centre stage

A tax expert says the 2010 budget is expected to focus on containing high budget deficits but taxation reforms would probably come into force when the budget for the 2011 fiscal year is announced this November.

"2010 and 2011 is going to be challenging years for us as Sri Lanka emerges as a post-war economy. This is a mini-budget and serious revenue proposals and recommendations of the Presidential Tax Committee are not likely to feature in a big way. These could be expected in the 2011 budget," N. R. Gajendran, Partner Gajma and Company, told The Island Financial Review.

"There is bound to be a focus on reducing the budget deficit, but public sector wages and interest payments would continue to be high," he said.

The budget for 2010 should have been announced last November, but a Vote on Account was submitted instead due to elections in the first quarter of this year.

Budget should be export oriented with GSP on the line

Exporters hope the 2010 budget would be exporter oriented and not burden the industry with GSP Plus concessions to be withdrawn later this year.

"The budget should be export oriented and support Sri Lanka’s export industry. We already see authorities taking steps to prevent the rupee from appreciating further but steps must be taken to assist the export sector just as much as the focus would be to improve infrastructure," Colombo Dockyard Managing Director Mangala Yapa said.

"We would expect to see a strong focus on infrastructure developments, such as the expansion of the Colombo Port and construction of a port in Hambantota. But this is not enough. Tax reforms must come though. As it is the tax regime is so complicated with various taxes, duties and levies. It must be made simpler and easier," he said.

Create level playing field for rural economies, HR development a must

Sri Lanka should focus on attracting investments to rural areas and plan early to bridge an already widening skilled-labour deficit, a regional businessman said.

Business for Peace Alliance Chairman Suresh De Mel said the budget should make it easier for investors to enter rural areas.

"The further you go from Colombo the more difficult it becomes for investors. There has to be level playing field for businesses in rural Sri Lanka. There is also a skilled labour and middle management deficit in the country and there has to be strong emphasis for human resource development in future budgets," De Mel said.

"There are expectations for the North and East to develop rapidly, it is the same for the South, but do we have an employable labour force? It is also so hard to find mid-range managers. The government could introduce a scheme whereby they would subsidise training costs for available jobs. This is already done for those seeking employment overseas, so why not here?"

Simplify taxes, support capital formulation

Industrialists would like to see a simplified tax regime and government support to raise capital to invest in newer technologies.

"The focus of the 2010 budget would be on containing the government’s administration costs which would allow the government to focus much more on infrastructure development activities. While the government has already reduced duties on raw materials we hope the budget would further strengthen industrialists," Newton Wickramasuriya, Chairman Ceylon National Chamber of Industries said.

"Taxes also need to be user-friendly. We are not suggesting that taxes be reduced but hope they would be simplified. Industrialists are also finding it difficult to upgrade technologies and an capital allowance payable in four to five years would go along way in ensuring that Sri Lankan industrialists remain competitive," he said.

Link wage increments to productivity

Exporters would like to see productivity linked wage increments while domestic utility costs are brought down to more manageable levels.

"The 2010 budget is going to be focused on development but we also hope the government would consider a performance based formula for wage increments because the haphazard way it happens now, it is too much of a burden on exporters," Former President of the National Chamber of Exporters, Rohan Fernando, said.

"Uninterrupted electricity at reasonable rates could take the export sector a long way and if Sri Lanka is to reach the export earnings target of US$ 20 billion by 2010, then the government would have to do all this and also simplify the tax system," Fernando said.

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