By Ananda Jayawickrama –
The Budget of the Government of Sri Lanka for the year 2023 was presented to the Parliament on 14th November and is now under the discussion in the Parliament and in various forums. The Budget 2023 was presented in a historically challenging environment as the economy is suffering from a worst ever crisis admits the country’s first ever foreign debt default. Though the Budget speech of the Finance Minister was silent on many vital information of the budget making, the Fiscal Management Report 2022 issued on 14th November 2022 identifies key challenges of the economy.
These challenges can be summarized as follows: (i) a simultaneous twin-deficits-a chronic current account deficit in the Balance of Payment and a continuous and widening fiscal deficit; (ii) low government revenue due to extra ordinary tax cuts given in 2019; (iii) high an excessive monetary financing of fiscal deficits; (iv) several exogenous shocks such as Covid-19 pandemic, Ukraine Russia war, low tourism earnings and low worker remittances; (v) rapid depletion of usable foreign reserves; (vi) historically high inflation, (vii) sharp depreciation of rupee in terms of USD; (viii) high adverse impact on poor and vulnerable; (ix) severely affected government cash flow; (x) surging borrowing and debt making debt unsustainable; (x) foreign debt crisis and local financial sector crisis; (xi) long-neglected economic reforms; (xii) tightening global monetary policy due to high global inflation; (xiii) slowing down of Chinese economy; and (xiv) slowing down of global economy.
The Finance Minister’s above analysis of the state and challenges of the economy deliberately ignores the following points:
Of above all challenges, what are the challenges and issues beyond our control and what are the challenges and issues that were created by the government of Sri Lanka in general and the Gotabhaya Rajapaksha (GR) Regime and its second phase Ranil Wickremesinghe-Rajapaksa (RWR) Regime in particular. Issues like global pandemic, Ukrain-Rusia war are beyond our control. Though the government highlights the slowing down of the global economy and the Chinese economy as major challenges, it remains question as to what extend the slowing down of the global economy affects the Sri Lankan economy. The historical growth rate of the global economy is around 3% and as IMF predicts (in October 2022) the growth of world GDP in 2022 and 2023 would be 3.2% and 2.7% respectively. But as it is at present, the gloomy picture of the global economy is not serious as of Sri Lanka. The IMF predicts that Sri Lanka’s economic growth rate will around -8.7% in 2022 and -3.0% in 2023 which may be downward revised further in next few months.
In my view, the economic crisis and all short of financial problems occurred in Sri Lanka are mostly having nothing to do with the global economy. To begin with, the mis-handling and mismanagement of the pandemic control process led to severe disturbances to the economy and therefore exaggerating the impact of the pandemic. The GR regime’s wrong policies, policy inconsistency and policy uncertainty and irrational decisions and mismanagement of the economy led to an absolute destruction to the economy, examples public finances, agriculture, foreign reserve crisis, exchange rate collapse, debt default, etc.
- The misuse of tax and revenue generation and subsidy and exemption policies largely to provide extra advantage and benefits to politically attached business cronies badly affected the general cash flow of the Treasury leading the Central Bank to print money excessively hiding behind the non-applicable modern monetary theory. This irresponsible monetary policy directly and indirectly results in near three-digit level inflation making all economic activities highly uncertain and now for high nominal interest rates to facilitate the controlling of inflation.
- The wrong exchange rate policy to fix the exchange rate around Rs 202 per dollar wasted much needed and limited foreign reserves. Lack of proper planning in debt repayment and failure to seek international bilateral and multilateral support at the right time to face worst ever foreign exchange shortage has fueled the economic crisis and led to import controls and bans and ultimate collapse of importing essential goods such as fuel, gas and other energy sources, drugs, food, material, investment goods, etc.
- The GR and the RWR regimes failed and fail to protect the poor and the vulnerable in the face of pandemic and man-made economic crisis. UNICEF has reported that more than 5.7 million people including 2.7million children in Sri Lanka need humanitarian assistance to cop up with ongoing economic crisis and loss of livelihood. In September 2022, the World Food Program reported that an estimated 6.3 million people face moderate to severe acute food insecurity which will be getting worse in early 2023 if there is no adequate life-saving assistance and livelihood support assistance from the government. Expected poor harvest of staple foods such as rice, vegetable, fish, milk, meat and other nutritional foods in 2023 will further deteriorates the status of the malnutrition of the country. Food assistance and subsidy schemes such as school meals, nutritional food package for mothers, Thriposha program for undernourished children, etc. will also be less effective due to unprecedently high inflation rates like near 94% food inflation and above 60% average inflation. UNICEF also reports that about 15.7% of children under 5 years of age (1.9 million children) are suffering from malnutrition in 2022. The country’s position in terms of malnutrition and food insecurity is severe both in absolute and relative terms. This food insecurity and child malnutrition triggered mainly by a man-made economic disaster will last for generations even if we solve the economic crisis in a relatively shorter period of time from now onwards.
- The failure of the ex-President Gotabaya Rajapaksa and the incumbent President Ranil Wickremesinghe to protect basic economic political and social rights of people has led to a very weak public confidence on the government. Therefore, people in the country and migrants have low and weak faith on the credibility of the government creating a situation in which government policies and programs become ineffective or less effective.
- It is in these conditions that the RWR regime proposed the new budget but in nutshell the budget has no vision to create a platform to resolve debt crisis, resolve foreign exchange shortage, to contain skyrocketing prices, to revive the collapsing economy and livelihood, to eradicate food insecurity, to bring children and poor out of hunger and malnutrition, and so on.
Assumptions of budget making and target macroeconomic outcomes
As per the Fiscal Management Report 2022, the government uses the following information in making the budget 2023: (i) economy will contract by 3% in 2023; (ii) unemployment rate is expected to be below 5% in 2023 but economic recovery will generate new employment opportunities; (ii) trade deficit is expected be narrowed down in 2023 with the revival of exports and reduced imports; (iii) certain import restrictions will be lifted to cater to the demand for investment and intermediate goods; (iv) tourists arrivals and remittances are expected pick up in 2023; (v) structural reforms will help FDI rebound; (vi) exchange rate will remain high and stable; (vii) inflation will be reduced to a single digit level thus interest rates can be kept down through less tightened monetary measures; (viii) money supply will be maintained at desirable levels; (ix) net credit to the government will be gradually reduced; and (x) private sector investment will be promoted.
Under these 10 assumptions, the Minister of Finance highlighted the following five major macroeconomic targets as outcomes of this budget: (i) high economic growth rate around 7% -8%; (ii) increasing the international trade to GDP share to 100% or above; (iii) an annual increase of export income by USD 3000mn (3 bn) through new exports from 2023 to 2032; (iv) an annual FDI inflow of USD 3000mn (3 bn) in next ten years (2023-2032) and (v) creation of high skilled and internationally competitive labour force in next 10 years (2023-2032)
I reckon that the assumptions used to prepare the budget 2023 are just some general facts or arbitrary thoughts without proper assessment of the economy except the first assumption which predicts a negative 3% growth rate of the economy in 2023. The -3% growth rate is the predicted growth rate by institutions like IMF and the World Bank based on present information. Other information presented in the budget is not sufficient to make rational revenue, expenditure and financing estimates. Further, the expected outcomes of the budget are not for the immediate year of the budget 2023 and the following year (2024) but for 2025. This prediction is strange and it will not help assessing revenue and expenditure targets in 2023 and will lead to accounting and audit issues in general. Most of the expected outcomes of the budget are gorgeous but hard or impossible to come by.
For example, achieving 7%-8% growth rate under present economic conditions is really unlikely in near future and the budget 2023 does not lay any foundation for the target, no additionally required investment on real sector of the economy. Sri Lanka’s present international trade (= imports + exports) to GDP ratio is around 43-45%. The budget 2023 expects to increase it above 100%. Raising the trade share of GDP from 45% to 100% or above requires an increase in the volume of international trade by more than 4 times. Raising trade share will be beneficial for the country only if exports to GDP share increases substantially. At present Sri Lanka’s exports to GDP ratio remains around 18%. Pushing it up to 60% or more requires exports to increase more than six times from its current value, which is impossible in near future without a dedicated and time targeted program and a plan. Budget 2023 is ambitiously expecting new (additional) annual exports of USD 3000 mn (3 bn) in 2023 and afterwards. Given that Sri Lanka’s annual exports value is USD 12,500mn (in 2021), the Finance Minister must elaborate the road map of increasing annual export volume by another USD 3000mn.
Not only that, the government is expecting annual Foreign Direct Investment (FDI) receipt of USD 3000 mn (3bn) from 2023 onwards. This high hope of the Minister of Finance can be questioned by looking at the amount of FDI received by Sri Lanka in 2021, it was a mere 598mn US dollars. But compared to FDI receipts of Bangladesh USD 2896mn, Ghana USD 2614mn, Vietnam USD 15,660mn, Singapore USD 99,099mn in the same year to attract USD 3000mn a year the Finance Minister must come up with a solid plan. But Budget 2023 does not have any thing tangible to reach the target thus it will remain as a target which be never materialized as it lacks proper planning and ground work.
Macro level public finance targets:
The President cum the Finance Minister highlighted the following macro level public finance targets of the Budget 2023: (i) increasing government revenue to GDP ratio from 8.3% in 2021 to 15% by 2025; (ii) achieving a primary balance surplus of 2% of GDP or above in 2025 and more thereafter; (iii) decreasing public debt to GDP ratio from 110% in 2021 to below 100% in medium term; (iv) bringing rate of inflation down to a mid-single digit in medium term; (v) pushing the interest rates down gradually to reach a middle point value with inflation controlling measures; (vi) reducing the pressure on exchange rate through foreign reserves rebuild-up once macroeconomic confidence is established; and (vii) raising economic growth rate to reach 5% with the introduction of series of economic reforms targeted for high economic growth.
Feasibility of Revenue target
The government is targeting to revise its revenue generation mechanism to reach a threshold of 15% of government revenue to GDP ratio by 2015. This requires revenue GDP share to increase by 6.2 percentage points in a two-year period of time. The budget estimates 2023 show that revenue to GDP ratio will be around 11.3% of GDP in 2023, a 2.5 percentage point higher than 8.8% in 2022. The Budget does not explain how the government going to raise this additional revenue. Given the nominal GDP and revenue are Rs 23,795 Bn and 2094 Bn respectively in 2022 and the estimated nominal GDP and revenue of Rs 30,221 Bn and 3415 Bn in 2023, reaching a revenue-GDP ratio of 11.3% requires revenue to be increased by 63% in nominal terms in next year. Given that the nominal GDP will increase only by 27% in 2023, most of the increase in next year’s government revenue will at the cost of real GDP of the country, which means that tax burden on purchasing power of consumers and income earners will be higher. It indicates that the government’s revenue generation expectation takes a huge toll on the private real economy.
The government is planning to generate additional revenue (in excess of 2022 revenue) of Rs 1321 Bn in 2023. With new tax proposals and existing tax structure, it is estimated that that the government may generate additional revenue of Rs 550 Bn in a year. This amount of additional income will be generated as follows: personal income tax Rs 45Bn, Corporate income tax Rs 140 Bn, Capital gain tax Rs 100 Bn, Withholding tax Rs 40 Bn and VAT and other commodity taxes Rs 225 Bn. With increase in non-tax revenue due to rate adjustments of fees and charges, the government will be able to generate about 600-650 Bn rupees. Then, nearly about another Rs 700 bn should be generated to reach the revenue target in 2023. Given the negative growth rate of the economy it is not clear how the government generates Rs 3514 bn rupees of revenue in 2023. If the government fails to generate the estimated revenue as experienced traditionally, all other fiscal targets are non-achievable.
High dependency on commodity taxes
Further, the new tax proposals would not help lowering the high dependency on the indirect taxes or taxes on commodities. Taxes on locally produced and imported goods will remain high as Rs 2218 bn in 2023 which is still 71% of total tax revenue of the government. As per the revised estimates, the share will be 70% in 2022. By reducing the VAT registration tax base (annual business turnover) to Rs 120mn from Rs 300mn, a large part of business turnover which was not subjected to the VAT tax will be taxed and therefore the compound effect of VAT on prices will be higher. The increase of general VAT rate from 8% to 12% and then up to 15% will increase its impact on prices exponentially. Further, upward revision of CESS tax by large amount and introduction of surcharge taxes on fuel will further increase the prices of goods. Thus, the tax burden will be laid more on the poor, therefore tax system will remain as a regressive system.
Discouraging income earning
Though income tax hikes can be and should be justified on equity grounds, the government’s continuous attempts to squeeze regular and reported income earners will badly affect the economic activity as it discourages work effort, saving, investment and risk-taking habits of individuals. The proposed personal income tax changes will tax incomes of individuals in several means. The government has proposed to increase current marginal tax rate of 4-tier scheme from 0%-18% each with 6 percentage point difference to another 7-tier scheme from 0%-36% each with 6 percentage point difference. Further, the extra ordinary tax cuts of the GR regime increased the tax-free annual income up to Rs 3,000,000 and the new proposal is to bring it down to Rs. 1,200,000. Further, the income level tax under each tax brackets has brought down to Rs 500,000 so that the amount of income tax at the higher and the highest rate will be maximized at the new tax proposals.
The calculation given in the table shows that the proposed tax system to be laid an un-tolerable burden on income earners and therefore such a tax system would be highly discouraging economic activities and income generation. For example, an employee who earns Rs 300,000 income per month (annual income of Rs 3.6mn) pays only Rs 36,000 annual tax payment on his/her income under the existing tax system. The Ranil Wickramasinghe’s proposed tax system will make the person paying Rs 420,000 annual income tax which is about 12 times higher than the current tax. The new tax system will also place much bigger burden on the income earner than the 2018/19 tax system in all categories of personal income tax brackets. Considering the high inflation conditions and increased taxes on commodities I propose the government to implement 2018/19 tax rates and schedule on the income of employees. That will help the government generating sufficient revenue without disturbing the private economy too much.
Further the government imposes a 5% withholding tax on professional income earnings exceeding Rs 100,000 per month. Thus, the actual tax rate on personal income at the time of income generation should be 5 percentage points higher at all marginal income tax rates. The withholding tax will impose by 5% on interest income, 15% on dividends and 10% on rental income which exceeds Rs 100,000 per month. The taxing of personal income in various fronts and very high rates may discourage income earning and work effort or it may enhance tax evasion and avoidance. Though income taxes to be raised to generate sufficient revenue for the government and to create less income disparity among different groups of income earners, taxing personal income in this nature of exploitation is not suitable with the current economic conditions in which the economy of individuals and the country were hard hit by the galloping inflation and reduced income due to the crisis. The government should follow a system of gradual increase in taxes in line with the economic recovery process and the expansion of income earning opportunities and such an approach will help the government achieving revenue based fiscal consolidation through the protection and promotion of individuals economy. The proposed bandit queen type tax policy is targeting to protect highly inefficient government along with its all waste, corruption, malpractices and impotence by squeezing the private economy to the maximum.
Unfair taxing of corporations
The government is also proposing significant changes into the corporate income tax as well. It is proposed to increase the standard corporate income tax rate from its current value of 24% to 30%, a six percentage higher, on profits and income of companies. A unified tax system may help and improve tax administration by removing complications and ambiguities. However, the nature of the business sector is such that some companies are small and vulnerable and some are large and well-established in the market. The companies which are small and vulnerable needs more investment funds to expand their operation in terms of quality and quantity. Taxing profits of small and large companies and new and established companies at the same rate is in a way unfair for small and new companies as they ended up with less resources to finance their after-tax investment.
Further, the government has raised the concessionary corporate tax rate (14%) to 30% prevailed for some sectors including small and medium enterprises, trading of goods for foreign exchange, non-importing offshore business to the local market, re-exports, stores and warehouse business, construction services, activities of tourism promotion, educational and health services, supply of renewable energy to national grid, are few to name. Further, new corporate income tax proposals will remove tax free provision given to some sectors and tax profits of those sectors at 30% rate too. These sectors and businesses include trading of recycled construction material, construction of telecommunication towers, new renewable energy projects, manufacturing of ships and boats, export or reexport of gem and jewelry, IT services and professional education services. These concessionary and free tax provisions definitely have a toll on the potential tax revenue of the country. But we need to be clear about why these tax-free provisions and concessionary rates were granted. It is indeed need to check the objective of having a concessionary corporate tax rate and granting tax free provisions for these sectors and then determine whether the policy was/is successful or unsuccessful achieving the objectives and therefore the policy is lifted now. It will make the policy makers and policy implementing authorities accountable and responsible for the said policy outcome and will help devising proper policies in future. But, the present budget is quiet on doing any assessment on the outcomes of tax-free provisions and concessionary rates granted for companies in selected sectors.
The total outlays of the government including recurrent expenditure, public investment expenditure and repayment of debt in 2023 is estimated to be Rs 7879 bn. Out of this total expenditure, 58.5% (about Rs 4609 bn) is for recurrent expenditure, 15.5% (about Rs 1221 bn) is for investment spending and 26% (about Rs 2048 bn) is for repayment of debt, mainly the domestic debt. The total expenditure will be higher in 2023 by about 27% in nominal terms compared to the revised estimate expenditure in 2022. The government reported inflation in October 2022 is 68%. With this high inflation the real value of government expenditure of Rs 7879 bn will come down significantly by 12% in 2023. The real value of the recurrent expenditure will be lower by 21% compared to that of year 2022. This indicates that Rs 4609 bn allocated for recurrent expenditure in 2023 will not be sufficient to purchase the amount of goods and services purchased by government in 2022 using Rs 3583 bn. Though money value of the recurrent expenditure is high in 2023, the government agencies and public institutions may suffer heavily in the provision of their services and functions, both in terms of quantity and quality, as goods and materials used will be in severe shortage. This will lead the already inefficient public service delivery such as health services, educational services, welfare services, public administration, etc. into chaos.
The nominal value of the public investment spending of Rs 1225 bn in 2023 is 13% higher than the estimated public investment spending of Rs 1084 bn in 2022. However, the rapid inflation will bring down the real value of public investment in 2023 by 32%. This indicates that only 0.67 share of investment goods the government purchased in 2022 of Rs 1084 bn can be purchased in 2023 by using Rs 1225 bn. The quantity and the quality of the investment expenditure and work done by the government will be less or lower in 2023 even though more money is spent. Therefore, expenditure incidence of the economy will be less as the real value of expenditure is falling down sharply. Further, what we observe from Sri Lanka’s high and unnecessary government expenditure programs and poor revenue generation policy have always taken a big toll in investment expenditures on infrastructure and development projects. High interest payments on accumulated debt put the pressure on government to reduce deficits by reducing vital investment expenditure.
New expenditure proposals
In 2023 budget, the government has proposed new spending proposals worth Rs 49,280 mn. These new spending proposals can be classified into following groups: social safety net program; other subsidies and relief, agriculture related proposals, tourism related proposals, road development and infrastructure, education and skill development, productivity enhancement targeted proposals. In 2022 Budget estimate, the government allocated Rs 54,156 mn for new proposals. However, the Minister of Finance has not given details on progress of implementing 2022 new budget proposals.
Social safety nets
In 2022 budget new expenditure proposals, allocation for social safety net program was Rs. 46,600 mn and allocation for other subsidies and relief was Rs 5,000 mn. In 2023 budget, the government allocates new expenditure of Rs. 43,000 mn for social safety net program and Rs 850 mn for the following welfare/relief measures- Strengthening of elders/disable/low income widows as household entrepreneurs Rs 250 mn (new proposal), improvement of child nutrition Rs. 500 mn and sanitary facilities for prisoners, Rs 100mn.
In 2022 budget estimate, Rs 1450 mn were allocated to new proposals on agricultural sector development. These allocations were made on the following proposals: supply of seeds and planting material Rs 400 mn, payments for crop damage Rs 350 mn, establishment of youth agricultural companies Rs 250 mn, railway facilities for vegetable and fruit transportation Rs 200 mn, youth entrepreneurship for agriculture and animal production Rs 50 mn, and promotion of domestic diary production Rs 200 mn. One would like to ask the following questions: What was the progress of the above projects? Whether the government was able to supply farmers seeds and planting materials?, how much have been paid for crop damage created by Rajapaksha’s foolish policy on fertilizer and agro-chemicals?, how many youth agricultural companies have been established in 2022?, where are the railway lines and facilities for the transportation of vegetable and fruits? what was the progress of creating youth entrepreneurship for agriculture and animal production?, how many additional liters of milk were produced in 2022?. These questions to be raised answered and clarified before one would introduce agriculture related new proposals in 2023. It is essential to know whether these projects are extending to the 2023 fiscal year as well.
Without having any word on these policy proposals and their progress, the Finance Minister put forwarded the following new proposals in Budget 2023: establishment of 10 agro entrepreneur villages Rs 250 mn, reducing post harvesting crop losses Rs 150 mn, retaining youth in agriculture Rs 120 mn, establishment of a separate department for cinnamon industry Rs 200 mn, increasing domestic milk production through enhanced breeding Rs 100 mn. In many of these proposals, objectives, method of implementation and outcome are not clear. For example, Rs 120 mn was allocated to retain youth in agriculture, but the way that the government is going to implement it is not clear and stated. Is it through giving them subsidies or incentives or baring them entering into other sectors? Is that the money allocated to conduct some seminars and workshops? Some expenditures are having no clear objectives or need: for example, what is the objective of establishing 10-agro entrepreneur villages? No answer in the budget.
In 2022 budget, Rs 300mn were allocated to the promotion of tourism industry and we did not see implementing new and novel activities under the ministry of tourism to promote tourism. In 2023 budget a new proposal is brought to promote marine tourism and is allocated Rs 50 mn. Sites and areas of marine tourism are located along the coastal areas of Sri Lanka. Even if few locations were selected for the promotion, the project needs huge amount of resources to promote marine tourism. Very expensive equipment and gears including ships and boats, infrastructure and service of trained guiders and lifesavers are needed to implement the proposal. While allocating Rs 200 mn for a separate department on cinnamon which is currently looked after by the existing system and allocating Rs 50 mn to study history which is currently done by Departments of History established in all most all universities in Sri Lanka a massive project and high potential revenue projects such as marine tourism is allocated only Rs 50 mn. This Rs 50 mn will be wasted on travelling costs, payments for henchmen and entertainment expenses and nothing tangible will be done to promote marine tourism.
In 2023 budget the government proposed to establish a Road Maintenance Fund (RMF) and allocated Rs 100 mn for the purpose. The current annual vehicle registration charges and highway fees are a kind of fees for the use of road and infrastructure facilities. The government should use proceeds of vehicle registration which are credited to consolidated fund to the maintenance of roads. The establishment of RMF may be an attempt to introduce a Road Maintenance Fee to be charged from users.
Skill based jobs and educational needs
In 2022 budget the government has allocated Rs 200mn for a budget proposal on facilitating new skill-based jobs. However, the progress of the implementation of the proposal was not given in 2023 budget, no discussion is on new skill-based jobs and it seems that new skill-based job project of the government is over. But what the government wants to do is enhancing postgraduate education for doctors (Rs 60 mn), setting up a quality assurance accreditation board (Rs 100mn), establishing an international university for climate change (Rs 100 mn) and establishing an institution to study History of Sri Lanka (Rs 50 mn). First question one may raise by looking at these proposals is whether this Rs 100m is enough to establish an international university on climate change. Secondly what is the need of establishing an international university on climate change in Sri Lanka while departments of geography and climatology sections of universities and research institutions of the country and international universities and research institutes cater to the need. It is also questionable to allocate Rs 50mn to set up a separate institute to study History while all state universities have history departments to study history.
Given that the country is facing its biggest financial and economic crisis, whether these spending on climate change university and institution to study History would help the immediate recovery of the country from the crisis. Further, one would also ask whether the allocation of Rs 60mn to enhance postgraduate education of doctors and to establish separate medicine faculties is sufficient. Some of the monies, may Rs 10-20 mn, will be used to start the operations of postgraduate institute in medical sciences at the University of Peradeniya which already established institutionally. Then, is the rest good enough to establish a medical faculty in Monaragala district? It is not clear for what purpose Rs 100 mn is allocated to establish Quality assurance and accreditation board while a quality assurance system is already in place under the UGC. What the government should do is strengthen the existing framework with minimum amount of additional resources. The government has allocated additional Rs 200mn to improve facilities in rural schools. While reckoning it as not sufficient (each rural school will get only Rs 100,000) to overcome drinking water and sanitary facilities of rural schools, the proposal is welcome as education facilities for rural population is a serious issue for decades.
There were few new proposals to enhance production and productivity in 2022 budget proposals. They are: research and development activities Rs 100mn, establishment of national agency for public private partnerships Rs 250 mn and promotion of local packaging products Rs. 250 mn. Altogether Rs 600 mn were allocated for these new proposals, it is again a question how much money has been spent and what is the progress of the activity. The budget 2023 also contains some proposals targeting productivity enhancement: Loan scheme to encourage young women entrepreneurs Rs 250 mn, Training of youth for foreign employment Rs 50mn, Establishing Agency for External Trade and Investment Rs 100mn, New economic zone program for attracting foreign investment Rs 300 mn, Establishing a National Productivity Commission Rs 100mn, Creating a more business friendly environment Rs 200mn, Promotion of electronic payment systems for payment Rs 200mn, development of inland fisheries Rs 100 mn and Establishing a laboratory under the excise department Rs 100mn.
Of these expenditure proposals, the proposals worth Rs 1120 mn could have been avoided or postponed in this economic crisis situation. These expenditures include costs on establishing 10 agro entrepreneur villages, retaining youth in agriculture industry, establishing a separate Department for the Development of Cinnamon industry, establishing a Road Maintenance Fund, setting up a Quality Assurance and Accreditation Board, establishing an International University for Climate Change, establishing an institution to study History in Sri Lanka and establishing a National Productivity Commission. The government should make arrangement to fulfil the tasks of proposed new institutions through the existing institutional framework and to remove corruption and waste of public funds. That will save a significant amount of resources that can be used to revive business and production sectors and/or for programs targeting the eradicating of child malnutrition, hunger and various other social welfare issues. The government needs to understand that the fiscal consolidation can be and should be achieved through expenditure-based measures as well.
Financing the Deficits
In 2023, the total estimated budget deficit is Rs 2404 bn which is 7.9% of the GDP. Compared to 2021 and 2022 deficits (about 11% and 9.8% of GDP), the 2023 expected budget deficit is relatively low. The estimated primary deficit of the budget, the difference between government revenue minus non-interest payment government expenditure, is Rs 211 bn and it is around 0.7% of GDP. The primary deficit/ surplus is a key indicator of gauging fiscal confidence and fiscal sustainability. A surplus in primary balance indicates that the government borrowing is needed only to pay interest on past debt and thus the speed of accumulation of debt is slower. Compared to 2022 estimates, -5.7% in initial estimates and -4.0% in revised estimates as a % of GDP, if the government is able to achieve a -0.7% of GDP primary deficit in 2023 that will help the government reducing the growth rate of debt. However, as observed consistently in historical data, the actual deficits are much higher than the estimated deficits as the governments ended up collecting less revenue than the estimated and spending more money than the estimated. If that happens in 2023 too, the government may not be able to achieve -0.7% primary deficit and -7.9% of GDP of overall deficit making the debt accumulating at a higher rate and thus making the issue of fiscal unsustainability serious.
The total borrowing requirement of the government in 2023 is Rs 4979 bn in which Rs 2404bn is needed to finance the deficit and Rs 2025bn is needed for repayment of debt, mainly domestic debt. Given that the country has defaulted its foreign debt and non-access to further foreign borrowing, the government might have to resort to borrow heavily from domestic sources, mainly through Treasury bills and bonds and printing money. As at present the government is borrowing through open market operation at exceptionally high annual interest rates, above 30%. This would increase the cost of public expenditure projects and government activities making them less effective in terms of cost benefit analysis. As the private sector prefers to invest in risk-free assets such as T Bills (now government financial securities in Sri Lanka is highly risky and that is another reason to increase interest rates by large margin), the private economy is shrinking rapidly. Running the government at the cost of private economy is not a rational and wise policy option.
Debt restructuring is a must for fiscal consolidation and economic recovery of the country at present. The discussions are underway at policy circles on how to restructure the existing debt stock, especially foreign debt to qualify for IMF’s extended fund facility and borrowing from other sources. While plans are being made to restructure the existing debt stock, the long-term planning is required to restructure debt stock from commercial debt securities and international sovereign bonds (ISBs) and other market instruments to loan-term loans and from highly rent-seeking Chinese and Indian borrowings to Western country borrowings. In 1981, 96% of Sri Lanka’s foreign debt was from bilateral and multilateral sources and only 4% of debt obtained from the financial market. This composition of Sri Lanka’s foreign debt was remained mainly stable until 2005 in which bilateral and multilateral debt was around 93% and financial market debt was 7% (see Figure 1). But the country’s debt composition has changed significantly during the one and half decade period starting from 2006 to 2021 towards more financial market borrowing: by 2021 only about 26% of Sri Lanka’s foreign debt was from bilateral and multilateral sources and the share of financial market debt has risen to 54% of total foreign debt.
Going back to Western Financing
In addition, the ownership of debt has also been changed since 1981 significantly. Of total foreign debt of 1981, United States (US) accounted for 21%, Japan accounted for 12%, Germany accounted for 8%, Canada accounted for 7%, Netherlands accounted for 5%, France accounted for 3%, China accounted for 3% and India accounted for 2%. Above top 5 Western lenders, US, Canada, Germany, Netherlands and France, owed 43% of Sri Lanka’s foreign debt which are mainly highly concessionary long-term loans. The share has later changed as follows: by 2005 top 5 Western countries 13%, Japan 28%, China 0.5% and India 1.1% and; by 2021, top 5 Western countries 1.6%, Japan 10%, China 1.8%, India 2.2% and Export and Import Bank of China 8.5% and ISBs 34.6%. Of total foreign debt of the country in 2021, US owed 0.3%, Canada owed 0.1%, France owed 0.7%, Germany owed 0.6% and Netherlands owed 0.0%. Chinese government and the ExIm Bank of China together owned 10.3% of Sri Lanka’s foreign debt in 2021. This indicates the high reliance on Chinese borrowing in recent years and less reliance on Western country borrowings. There is evidence that Western country borrowings are more productivity and task oriented and well monitored in all stages of the assistance and are tied with human rights, democratic norms and freedom. The governments since 2006 faced difficulties in borrowing from Western lender countries. Instead, governments especially since 2006 preferred to borrow more from China and the financial market and from India recently. With downgrading of financial market ratings and China’s reluctance to lend more, the government borrowed heavily from India over the last several months. These Chinese and Indian borrowing may directly or indirectly be tied up with some other extra conditionalities in which these countries may compete for the purchase/access the country’s vital physical assets such as Hambanthota harbor, Eastern terminal of Colombo port, Trincomalee oil tanks, etc. in return for debt.
Therefore, foreign debt restructuring does not only mean restructuring of current foreign debt and it includes restructuring of future borrowing too. External financing of budget deficits needs a policy of less borrowing from financial markets, less borrowing from India and China, less borrowing in terms of ISBs, other bonds and debt securities, and more borrowing in terms of long-term loans and more borrowing from Western bilateral sources such as US, Canada, UK and the European Union countries. If the country may ensure human right protection, rule of law and the freedom of citizens with corruption and waste free environment, it will help the government re-approaching Western lenders and funding sources enabling the country to have a diversified debt structure until a point that the government is self-sufficient in managing and financing its business.
*Ananda Jayawickrama is a Professor in Economics at the University of Peradeniya. Currently, he serves as the President of the Intellectual Forum for People (Janathavadi Buddhi Mandapaya), a forum of university academics, researchers and experts. He is available for any clarification at firstname.lastname@example.org.