Government promises better budget for Sri Lanka; opposition skeptical

November 16, 2006 (LBO) - The government says the upcoming budget would be growth oriented, with medium term objectives in view, while the opposition which is supporting the budget in parliament, warns that the poor would be hurt if fiscal weaknesses continue. Singapore and Hong Kong which have inflation of around two percent do not even have the institutional framework in the form of central banks with money printing powers, to fuel expansionary fiscal policy which ignite inflation and create balance of payments crises.

Sri Lanka’s governments have a well-earned reputation for presenting budgets with very high deficits around 8 or 9 percent of GDP which are then exceeded despite cuts in capital spending.

Capital Spending

But officials say capital expenditure is rising, though there was a compression from original targets.

“Last year budget capital expenditure is higher than the year before and is higher than previous years.

The capital expenditure now we are moving around 6 percent,” Treasury Secretary P B Jayasundera told journalists at pre-budget media briefing this week.

“Although we target 7 - 8 percent, sometimes implementation difficulties may not allow us to go to that extent. But the capital expenditure this year and last year are higher than the previous years.”

Sri Lanka has a current account deficit in the budget, indicating that its revenue is not enough to meet its day to expenses.

As a result most of its productive capital expenditure is funded through foreign aid.

Jayasundera says capital expenditure is almost fully financed from foreign sources.

“Quite a large number of capital expenditure is fully funded by foreign sources,” says Jayasundera.

“Norachcholai is a 455 million dollar project, which is 100 percent funded - for first time ever in Sri Lanka, an infrastructure project of this nature is fully funded.

Economists say Sri Lanka badly needs to divert resources away from unproductive subsidies, to high return capital projects.

Fiscal Consolidation

The government took a major step forward this year in scrapping fuel subsidies, which had undermined economic stability since 2004, by reducing tax revenues and also forcing the government to print money.

Analysts do not expect serious reforms in the country’s bloated public service, which is another key consumer of resources and a source of wage-spiral inflation.

The government service, which is paid tax free salaries, was stuffed with tens of thousands of unemployed graduates as recently as two years ago.

Vast amounts of resources are directed to salary increments by governments in Sri Lanka each year, to maintain its vote base.

Deputy Finance Minister Ranjith Siyambalapitiya was unusually reticent when questioned by journalists about this year’s public sector bonanza.

“In 2006 we have spent about 40 billion rupees to increase the salaries of government servants and pensioners,” Siyambalapitiya said.

"When we are going forward in a challenging economic environment, we would also like to ask what you think.”

The Jathika Hela Urumaya (JHU) a Buddhist-nationalist party, has suggested that the government re-introduce the Defence Levy, a cascading tax which yielded about two percent of Gross Domestic Product in revenue at the time it was scrapped three years ago.

A JHU official said the government should make sure the money was spent only for defense purposes, because the public was against paying other taxes in the belief that most of it just went to keep an unwieldy set of ministers in style.

Analysts say a broadening of the value added tax regime to include areas like wholesale and retail trade is a better move to strengthen government finances than imposing a new tax.

Siyambalapitiya says the government is looking to present a medium term economic plan moving towards sustainable growth.

“If we look ahead we can say we are moving towards a medium term economic plan. “We faced many challenges in 2006, as inflation went up due to oil price and other reasons,” Siyambalapitiya said

“Despite this economic growth moved above 7 percent which is the highest we have seen in 30 years.”

Inflation

Sri Lanka’s 12-month inflation rose in October to 17.2 percent, jumping 1.8 percent in 30 days, despite oil prices falling and retail fuel prices being cut three times during the period, as the government turned increasingly towards Central Bank credit or printed money to bridge the deficit.

This demolished an oft-repeated government excuse that inflation is caused by oil prices.

Jayasundera says the budget would contain measures to reduce demand pressure, but would not say whether it included putting limits on borrowings from the banking sector, saying it all depended on the level of inflation that authorities wanted to target.

"If you want to have four percent inflation, you can stop everything,” he said.

“Expenditure can be curtailed, to the extent how much you want to have a trade-off. You may get down the inflation to 5 percent but you may also get down the growth to 3 percent. It depends on what the level of demand that we consider is creating excess pressure.”

Meanwhile, Sri Lanka’s opposition United National Party which has pledged to support the budget says it does not endorse the economic plan of the government.

Better known as the Mahinda Chinthana the government’s strategy won the support of the public at the last election, while the UNP’s outward looking, small-government based strategy which promised low inflation was rejected by voters.

“How do we face the challenges of a global economy?,” UNP leader Ranil Wickremesinghe said at a ceremony where Bandula Gunewardene, a deputy finance minister in a former UNP administration released a book based on speeches made in parliamentary debates.

“We cannot solve it by building walls around us. Can we continue to think that we can bring the price of oil down, bring prices down and print money?

Or should we do like China, Vietnam, Japan and India and face the world?

Gunewardene addressing a group of academics and politicians who attended his book launch said he predicted that the Sri Lanka rupee would fall to 108 against the dollar and inflation and interest rates would rise, when the government presented its budget last year.

“When we were in power the US dollar was 94 rupees, when we pay 108 rupees to the dollar, we have to pay 14 rupees more for everything we import,” Gunewardene said. “We completely stopped printing money and re-payed borrowings from the banking system which brought inflation to less than 3 percent at that time.”

Biggest Sin

Harsha de Silva an economist says it is now evident that there is no direct link between Sri Lanka’s inflation and oil.

“Whatever anyone says, I can say without fear that the government is printing money. You can find the data in the Central Bank website,” de Silva said.

“During the last six months about 40 billion rupees had been printed.”

He says the biggest sin that a government can commit is the failure to arrest inflation.

“Even if there is growth what is the point if benefits are not going to the poor?” he asks.

Other economists say Sri Lanka is paying the price for the economic illiteracy of the post-independence rulers of Sri Lanka.

“We have to admit that in Sri Lanka’s political circles, the knowledge we have about economics is not adequate,” says Indrajith Aponsu.

“Korea and Malaysia were equal and we were ahead in some respects.
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After several decades when we look back, we have moved forward a little bit, but they have overtaken us and moved far ahead.”

Most East Asian nations have inflation below 3 percent, and growth around 8 percent or more.