Fiscal dangers 

Monday, 7 September 2020 00:00 -     - {{hitsCtrl.values.hits}}

Hit by a significant Rs. 1.3 trillion in revenue losses, the Treasury has warned that relief measures anticipated in the upcoming Budget will have to be pruned to deal with it. This is hardly a surprise but it underscores the perilous nature of Government finances and the need to set up serious contingency plans for fiscal consolidation and debt repayments. 

A report over the weekend said the biggest chunk of the loss, Rs. 490 billion, was due to tax concessions given immediately after the Presidential Election in November, last year when the Government announced sweeping tax concessions. This unwise move was exacerbated by COVID-19, which hit import and export taxes, remittances and tourism. 

But Sri Lanka has been living beyond its means for decades, and successive governments are responsible. Eminent economists have argued that Sri Lanka’s less-than-ideal track record has brought huge challenges, as the country grapples with how it can meet debt repayments next year, which are expected to be around $4 billion. 

Once the conflict was over, the Government borrowed extensively for infrastructure projects, but failed to jumpstart investment and broaden exports. Sri Lanka will meet its debt repayments this year, but unless the COVID-19 situation improves significantly next year, allowing the country to return to international financial markets, its ability to raise funds to repay debt due in 2021 while keeping the rupee at its current levels will be tough. 

Until 2023, the Government has to repay an estimated $ 13 billion, which is mostly going to have to come through more debt. This, together with low growth, means Sri Lanka will remain on the knife edge economically for the better part of this decade. Sri Lanka can join international calls for assistance, but it will be just another short-term solution. If the Government is serious about turning around the economy, it will have to initiate difficult reforms that have been kicked down the road by successive governments. Struggling with low public revenue, the Government had started slowly rolling back tax concessions it gave in December, but COVID-19 forced a change of tactics with a refinancing facility. Public revenue needs to grow to about 15% of GDP for Sri Lanka to sustainably fund education, healthcare, housing, and other welfare support needed for as much as 40% of the population. Without taxes, there is simply no other revenue source to achieve this.  Another tough but crucial step will be reforming State-owned enterprises (SOEs). The Government cannot keep funding its losses, but trimming the public sector will be deeply unpopular. Slashing defence allocations, which have remained the highest component of the budget despite the war ending over a decade ago, and rationalising other expenditure is also important. Strongly connected to this is effectively fighting corruption and proactively promoting transparency, which have received scant attention so far. 

Persistent issues, such as the relatively low ranking in the Doing Business Index, high utility costs compared to regional peers, high costs of land acquisition, and rigidity in labour laws and Government procedures remain the main impediments in terms of attracting FDIs to the country. Sri Lanka needs investment and exports to build reserves and repay debt without relying on more borrowings. So far the signs are that international assistance will be limited, making reforms the only realistic path for the Government, should it choose to take the responsible route.

Spurring domestic industries is a positive move, but it will need to be underpinned by a wider set of policies that will give confidence to international markets. Only then will the economy be on a truly sustainable path, and Sri Lanka’s fiscal woes will be addressed.