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Stabilisation and structural reform programs
During the late 1980s and throughout 1990s in particular, this economy went through structural reforms in many areas covering trade and payments arrangements, liberalisation of the exchange rate regime, having moved to full convertibility of current account transactions in 1993 and subsequent reforms towards a free float in 2000, privatisation of State-owned manufacturing and trading enterprises, hotels, plantations, livestock and agriculture farms, telecommunication, the airline, mines, sugar plantations and manufacturing, the deregulation of banking and finance, trade, transport, etc.
Failed attempts were also made in areas of public sector restructuring, labour market reforms and in the area of taxation at that time. It is private sector now managing these activities and not the Government.
As we all know, the country has gone through a number of IMF and the World Bank supported stabilisation and structural reform programs, although in most instances the full program could not be gone through. In early 2000, further attempts were made to carry forward these initiatives through the privatisation of insurance, bunkering, deregulation of land and property and public sector restructuring with the support of the Fund and the Bank.
Even throughout these periods, the average fiscal deficit remained over 8% of GDP and the debt to GDP ratio touched 105%. External deficits were large and the exchange rates were unstable, while depreciating continuously. Export to GDP as well as tax to GDP deteriorated from 29% and 20% respectively in 1980 to 17% and 14% respectively in 2005.
Unemployment, inflation and poverty ratios were double digit. Regional and income distributions remained stubbornly high. These indictors that show that there has been no good balance in comparison to corresponding trend indicators of the past seven years. The 2009-11 Stand-by Arrangement was the only program that completed the full cycle, having satisfied all program targets. If so, to what level and against which benchmark do we rebalance now?
Global economy
I wonder whether this theme is selected in the context of the present state of the global economy, in which many countries are struggling to put their own houses in order by addressing their own fiscal imbalances, by improving system stability issues in banking and financial institutions, by addressing structural issues in their agriculture and manufacturing businesses and by making adjustments in view of competitive challenges from emerging economies to traditionally advanced economies – in a bid to re-balance Sri Lanka to such changes.
In that context, let us update what is happening around the world. According to an IMF analysis, challenges faced by member countries of the European Union are far more complex and span beyond their current focus on fiscal deficits and sovereign debt. What is suggested is that many of these countries have structural growth weakness brought about by weak competitiveness. The debate is not over as to how a political consensus can be reached in favour of a wide range of reforms involving factor markets, financial systems, governance and fiscal monetary imbalances.
The long term success of the Euro Zone at this stage seems uncertain with uncertain fiscal adjustments in those countries. The structural challenges confronted by the US are far beyond its deficit reduction. Its fiscal capacity to fine tune business cycles by adjusting its federal tax and spending policies seems to have reached limits and the fiscal policy role played during the great depression has strayed off-track. There is a new concern following the recent down grading of the US Government bond rating by Standard and Poor’s while Moody’s placing the US on a “negative watch” status.
If Japan and China demand high interest rates on US bonds, the world may see a situation similar to the 1980s where the average mortgage rate rose above 15% while the 30-year Government bond rates were 10.56 in comparison to around 3% as of now. The World Bank has expressed the view that only a little progress has been made by the US in setting its fiscal policy on a sustainable path. Japan has taken a ‘U’ turn in its macroeconomic policy stance to create inflation and an exchange rate depreciation and the World Bank has expressed the view that Japan represents a source of risk for the Global economy as Japan seems to be making very little progress seems towards reducing large Government debt, to a sustainable level.
The World Bank has also stated that finding the optimal balance between macroeconomic policies to stimulate the domestic demand in the short term and structural reforms to enable faster growth over the longer terms, remain the main challenges for the Latin American economies as supply side constraints have become apparent in many of these countries, where output was above the potential during the recovery phase of post 2009/10 economic crisis, contributing to a deterioration of the current account balance. The bank has expressed the view that as external financial conditions are likely to become tighter, the high financing cost could reduce investment spending and growth and also expose unsustainable positions in that region.
China is in a process of balancing pressure against exchange rate appreciation and credit expansion in the banking system, while addressing remaining dimensions of supply barriers. The IMF has highlighted that notable supply bottlenecks and policy uncertainties have caused significant structural challenges in India. As such, the road to development seems bumpy all over and I don’t know what we ought to rebalance as no easy benchmark could be establishedelsewhere other than by using National Accounting Identities or typical financial programming exercises to find out our own standing. I will leave that to experts to establish the extent of rebalancing even using such exercises. However, we all must understand balancing or rebalancing is real and hence workable.
Government progress
In this background, permit me to deliver my speech framing on the theme that the Government has made good progress so far, namely 
‘Managing the Fiscal Deficit towards Securing Stability and Development’. The Central Bank of Sri Lanka has been working on the theme of ‘Stability and Growth’ in recent years giving more focus to its mandate on price stability having made impressive progress in fiscal monetary coordination towards realising its policy goals, while the Government has broaden the theme to ‘Stability and Development’ since the President does not believe that growth alone is capable in delivering economically and socially desirable outcomes.
The Ministry of Finance and Planning has provided substantial material in support of this theme in its Annual Reports of 2011 and 2012 which are issued in accordance with country’s Fiscal Management (Responsibility) Act of 2003, that provides a framework to law makers, the general public, the business community and the Government, to develop their capacity to address concerns in the area of public finance and also to ensure responsible travel as per the road map.
As we all know, we are in a 10 year development framework based on the ‘Mahinda Chinthana’ under which the country has entered into a second five year plan for 2011-15 having completed the first five year plan period from 2006-10. This strategy which has facilitated a paradigm shift from 1977–2005 the policy regime has recognised the need of public investments for human resources and infrastructure development, blending market strengths with the explicit role of the Government, channelling resources for regional and rural centric development initiatives, improving fiscal monetary policy coordination towards greater macroeconomic stability, strengthening peace and security and private sector investment and production.
The planned opportunity creation within this policy framework includes livelihood development at household level, agricultural revival for food production and primary commodities towards a full scale value chain economy, availability of greater resources for private sector activities, development of a globally competitive skilled and employable work force, placing the country within a well-connected shipping and aviation network and opportunities for long term investments in a predictable and secured environment.
Outcome-focused strategy
The development strategy is outcome focused. Consolidating the economy as an upper middle income economy with US$ 4,000 per capita income, free of poverty, remains the national goal. Lowering inflation, unemployment and poverty to a middle single digit level is an equally important outcome targeted by 2015. Reducing the fiscal deficit to below 5% of GDP and debt to GDP to near 70% by 2015 and towards 60% by 2020 have been explicitly stated. Therefore, I think I should pursue this audience to get onto this theme and work on a common national economic agenda for few more years to claim together a turnaround of the economy in Asia, since talking on managing the fiscal deficit in isolation would have very little relevance in reality.
After all, our country is packed with opportunities in the backdrop of restored security, peace and stability to exploit all what we have lost due to experimenting policy strategies – shifting from one extreme to another during post-independence and what we lost over a costly 30 year terrorist led conflict during the post 1977 open economy period. All what we need to do is to improve on what we have built over the last seven years within a policy framework that recognised the role of the State and the private sector, and move ahead. Therefore, let me run through the road we have travelled so far to define where we are as a country today in 2013 and thereafter turn to outline the road ahead of us that we’ve got to travel together in the next seven years, with several new generation reforms capable of taking the economy forward.
Post-conflict Sri Lanka
Ladies and gentlemen, post-conflict Sri Lanka has already entered a middle income country journey. One major challenge was managing the transition and entering the post conflict development environment as the brutal terrorist conflict has ended. That was indeed a priority. In a short time span of three years, almost 95% of mined lands have been cleared. The post 2006 IDPs have been settled and placed on livelihood development opportunities supported with housing, education and health care advancement initiatives to improve their living conditions. Major infrastructure facilities providing access to electricity, water and irrigation, roads, highways and railways, market outlets, and transportation are being restored.
The administrative and civil service delivery facilities, courthouses and police stations are being re-established. Misguided youth and ex-child soldiers are being rehabilitated. National reconciliation initiatives and recommendations of the LLRC are being implemented and much awaited elections for the establishment of Provincial Council has been declared. All these have a fiscal cost as there is no free lunch, after all.
All such expenditure is in the Budget and financed through domestic and external finances mobilised through taxation and borrowings. The progress we have made during a short time-span of three years reflects a country that is a role model in the management of post conflict challenges in comparison to a similar situation elsewhere, considering the complexities that were associated, the resource constraints and short term capacity limits, while on the other hand the Government itself was engaged in fiscal management towards lowering the deficit, annually.
Infrastructure deficits
Sri Lanka suffered severe infrastructure deficits by 2005 particularly in power supply, port and airport facilities and in terms of the road network. We lacked them not simply because we didn’t have the required resources, but moreover since we lacked a long term vision, and the determination and the boldness required in taking decisions. The first was the commitment to maintain a high public investment of around 6% of GDP on a sustainable basis without compromising fiscal adjustments towards lower deficits.
The Government recognised that compromising public investment is equivalent to compromising development and is an opportunity denial to the private sector. This enabled the Government to accommodate a comprehensive infrastructure program consisting of developing power generation and distribution, ports and airports, multi-purpose irrigation schemes, water supply and waste management, urban development, highway network, educational and health facilities in the national budget. Having gone through all these development initiatives since 2006, Sri Lanka has ensured the availability of uninterrupted supply of power not only for commercial and industrial purposes but also to almost 95% of households. The power generation mix has being oriented towards least cost technology along with a reduction in transmission losses to 11% – which is very close to standards that are internationally accepted.
The Port and Airport capacity development, which was lagging behind due to which the country was getting marginalised in transhipment trade and travel. These areas have now reached new levels. The development of the Hambantota port and a second international airport which were in the development agenda of every successive government, the development of the Colombo South Port which is one of the largest private public partnerships, and the transformation of the Katunayake Airport have created new capacity to position the country in external trade and travel.
In fact a new legislation that enables converting them as free port provides investment opportunities for foreign and domestic investments focusing exports. The completion of the southern expressway along with the construction of the airport expressway would be ready by next month. This has enabled to offer the Northern expressway construction by foreign direct investments exceeding US$ 1,500 m. The Government hopes to have this expressway connecting Kandy, Kurunegala, Dambulla to North and East by 2016. This expressway network which aims at connecting all ports and the two airports in the country is conducive to promote regional growth centres targeting agriculture, manufacturing, tourism resources and financial services towards creating an export economy with high value creation in the domestic economy to transform a one-time primary commodity producing export economy to a modern economy.
Irrigation, water management, the provision of drinking water and waste management has not had a long term development strategy after completing of accelerated Mahaveli Development program which was substantially scaled down in mid 1980s following the fiscal crisis at that time as part of IMF supported stabilisation program. Preoccupation of front loaded Mahaweli development initiatives also had a cost in the sense that it sacrificed the development and maintenance of small and medium irrigation systems and their downstream infrastructure.
A renewed interest has been placed in the water sector since 2006 by reactivating abandoned Moragakanda-Kaluganga irrigation system to take water to the East, North Central and North Western and Northern Provinces to support un-irrigated land development as well as drinking water requirements of those areas including to the greater Jaffna area through the ongoing development of the Jaffna/Kilinochchi water supply schemes and Uma Oya water management system to divert water to the dry zone areas in the South.
Restoration of dam safety and head work systems in 30 major irrigation reservoirs, development of several new irrigation systems through the diversion of several rivers and river basin development initiatives and drinking water supply schemes in all major townships take priority in public investments. The recent multi tranche credit facility to reduce Non Revenue Water ratio in Colombo to 20% by 2016 with a projected investment of US$ 400 m is another milestone in public investment in water management in recent years.
The annual investments which is now around US$ 1,000 million is also meant to address challenges in food security, bio diversity and access to safe drinking water to the population as well as creating investment opportunities in food agriculture which has a huge import substitution scope particularly in the conflict affected areas in the country.
Transformation of the urban landscape
The transformation of the urban landscape here in Colombo as well as in many major townships is a success story in itself and in improving investment climate. Relocation of government establishments has released land for large scale flagship investments while making it a good source of capital formation to relocation and development of modern settlements. Restoration of archeologically important buildings has given space for private sector for new investment avenues.
Investments in flood protection and “clean green city” concept has improved business outlook in cities and living environment in urban settlements. Firm investment commitments of so far recognised investments under Strategic Investment Law now exceed US $ 2,000 m in additions to investments under normal tax law of around US $ 500 m. This shows the multiple extent of private investment through public investments in urban development. Foreign exchange regime has been liberalised to further facilitate banking and private sector fund raising initiatives through foreign sources and look beyond domestic capital and debt market to ensure undue pressure on the Balance of Payments due to associated import content of such investments.
Poverty reduction strategies
Traditional poverty reduction strategies in Sri Lanka were heavily influenced by the distribution of handouts and cash transfers. However, the present government has reoriented these strategies through the provision of basic rural infrastructure, improvements in public service delivery mechanism and livelihood development initiatives to create gainful income generating opportunities. Annual budget has accommodated such expenditure while protecting cash transfers to vulnerable groups. The recent initiatives to convert cash transfers to low income groups through the issuance of stamps to be en-cashed against commodities at Co-operative system to direct transfers to their saving accounts enable low income families to build investable funds.
Community centric approach now being pursued keeping in line with long standing working arrangements in rural agrarian economy in Sri Lanka supported with expanded micro finance arrangements by both the Government and private sector have gathered momentum in rural development. The sustained reduction in poverty levels in recent years to around 6.5% with the reduction in dispersion to a range of 2.4 to 7.5% between rural, urban and plantation sectors must be viewed alone with these changes and improvement in rural livelihood activities.
Fiscal reforms
Fiscal reforms which is at the centre of the reform matrix in the context of stable public investment levels has not only addressed deficit reduction through moderation of current expenditure which is supported by a gradual reduction in defence expenditure, but has also implemented long overdue tax reforms with a view to move away from relying on liberal tax concessions and has restored a regionally competitive rate structure with a wide tax base.
The initial phase is costly to the extent that it involves revenue losses and is also confronted with other challenges such as the erosion in the import base, has resulted in weakening the buoyancy in the traditional excise tax and caused transitional challenges in administering taxation in an emerging service economy. However, the concessions having being explicitly incorporated in Income Tax Laws, the introduction of the Strategic Investments Law to govern large investments, institutionalising the Tax Appeal Commission and Tax Interpretation Committee along with the transition towards an IT based tax administration by end of 2014 and a further rationalisation of exemptions in the various tax statutes, the country should see a progressive improvement in tax to GDP ratio.
The compliance improvements and strict enforcement of tax laws, the further consolidation of retail level VAT introduced this year and the private sector moving away from relying on tax concessions as has been the traditional practice through the BOI in the past which made a narrow tax base, are essential steps in this reform process.
As shown in the first half year data, income and VAT sources from domestic activities have taken an upturn while import base indirect taxes have continued to suffer as imports of largely motor vehicles haven’t returned to stable levels yet. Of course first half of 2012 reflect without adjustments whereas the first half corresponds to a period of adjustments in the exchange rate, credit restrictions and high taxes on motor vehicles to stabilise imports. There is a trade-off between Government revenue and imports. However, the Government has refrained from introducing ad hoc measures to balance this trade off as it is expected to be statistical and a short term phenomena.
Nevertheless the Finance Ministry is confident that there will be improvements in the second half of this year over the contraction witnessed during the second half of last year, together with continued moderation in recurrent expenditure, the deficit set for this year at 5.8% is realisable. The Government remains committed to the deficit reduction path seen in the post conflict period is continued to reach further progress in 2014 and 2015 to bring the deficit to below 5% which seems to be consistent in accommodating available long term financing at relatively at low rates from foreign development partners and domestic sources while creating an increased space for private borrowing.
This level of deficits over the 2013-15 medium term fiscal framework within which the Government formulates its fiscal strategy is conducive to provide greater freedom to the Central Bank to conduct its monetary policy towards amid-single digit inflation. The analytical work undertaken by the Department of Fiscal Policy also indicates that an economic growth in excess of 6% with a fiscal deficit reduction towards 5% from the current level is conducive to bring the debt to GDP level down to 70% by 2015 and to below 60% by 2020.
The Government’s fiscal strategy also aims at addressing the loss reduction in state owned business enterprises. As the Finance Ministry in its 2012 Annual Report has shown, Sri Lanka has 54 State-owned business enterprises of which 10 own an asset base well in excess of the market capitalisation of all listed companies in the country. They include state enterprises such as Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lanka Port Authority, Airport Authority Water Supply and Drainage Board, Sri Lankan Airlines, the three large State banks and Sri Lanka Insurance.
The oil shock has hit CPC, CEB and Sri Lankan performance significantly in recent years. However, the Government has moved towards cost reflective pricing particularly in petroleum products and the electricity supply. Still CEB subsidises private industries and services in addition to the lower segment of electricity consumers. Prices of diesel too remain below costs. While recent adjustments are expected to reduce losses of these two enterprises significantly this year adjustments are also necessary to phase out their existing debt through further capitalisation by converting debt into equity and transfer interest into profit, reducing fuel base power generation, and price rebalancing initiatives. The cost reflective price rebalancing is necessary to compel private sector to adopt their own energy efficient production processes, gradually.
The Water Supply Board is being strengthened through the ongoing investments to reduce Non Revenue Water to 20% and its pricing strategy already in place. Sri Lanka Port Authority and Airport Authority have improved considerably. SriLankan Airlines is under a restructuring plan and the Board of Directors has been collectively assigned management responsibilities to various aspects of its operations.
Accelerating development
Let me now turn to spell out the road we need to travel together to consolidate the gains so far reaped and accelerate our development while managing the fiscal deficit reduction path and their vulnerabilities to secure further stability.
Let us first try to quantify the planned deficit reduction towards 4% by 2015. In fact that was the deficit Sri Lanka seemed to have maintained in 1950. Given that the 2013 deficit target of 5.8% remains a firm commitment of the Government to ensure a continuity for the fourth year in such a downward direction is noted, we need a further two percentage points or about a Rs. 250 billion reduction over the next two years in our efforts to raise revenue or allow recurrent expenditure growth to moderate by that amount or a combination of both.
Since feasibility improves with a proper distribution between revenue and current expenditure the required adjustments appear manageable due to several reasons. First, the effects of the moratorium on tax holiday extensions should bring the balance 40 percent out of total commercially functional BOI enterprises of 1962 at the end of 2012 to the tax system over the next two to three years that is of about 330 commercial operations.
Second, full operations of VAT at retail level commenced this year with a further rationalisation of the exemptions list together with intensified tax audits of large and corporate tax payers including SVAT arrangement now in place to simplify the application of VAT to zero rated category should improve tax elasticity of the VAT system. Third, the normalisation of imports following the sharp adjustments made to bring imports in line with normal trends should reflect recovery in revenue collected at the point of imports though applicable taxes which have been simplified recently depending on the purpose for such taxes and administrative convenience.
Out of about 6,000 line items, 179 items remain free of any tax and 570 are subject to only a Special Commodity Levy (SCL) due to the nature of such imports and easy administration for both importers as well as tax administration. A further 425 high value branded products are liable only to the Port Levy and Nation Building Tax. They remain a buoyant source of revenue in the background of the expansion of tourism and high income growth effects of such commodities in the domestic economy.
According to our classification, only 2,033 items are liable to PAL, NBT and VAT while 1,811 line items are liable to the Port Levy, NBT, VAT, Excise taxation and Customs duties. Only 3, 628 line items come under import duties as Free Trade and other simplifications made to Customs tariffs have reduced the reliance on Customs duties. Since we have a four band tariff structure of 0, 5, 15 and 30% we may need further rationalisation of customs tariffs having regards to keep exports free of taxes, maintain local industry safeguards and in view of revenue considerations.
All concessional import facilities on motor vehicles extended to public servants are also subject to taxes ranging from 20% to 100% and no one is exempted from PAL, NBT and VAT, bringing them to a minimum 20%. Investments approved under the Strategic Investment Law are subject these three taxes and applicable Customs duty from the day they come to commercial operation. These are substantial improvements over the past tax regimes which allowed unlimited concessions at the cost of government revenue.
Fourth, the Government has also rationalised land and property taxes to improve the value of land use for foreign and domestic land transfer transactions. Profit and Income taxation for exports, tourism, constructions, SMEs and agriculture has been reduced to 12% and the rest to 28% justifying the redundancy of tax holidays anymore. Wage income and interest income have been subjected to tax at source and compliance is expected from employers and banking and financial institutions in both private and public sectors as public sector too has been brought under taxation for the first time after 1978. So the responsibility of the private sector is to protect the low rate and wide base tax regime, through better compliance.
Last but not least, taxation of income from other sources and from income of professional service providers remain to be a challenge but considering the fact the average tax rate has been reduced to about 17% and professionals are expected to adhere to best practices and professional ethics, I suppose this sources should become elastic revenue over the medium term when the country begins to see a rapid expansion in this sector as well. Tax administrative reforms are being directed to improve compliance and enforcement as well.
Revenue efforts
The Government’s revenue efforts are also being made through improvements in profits and dividend in State-owned business enterprises in addition to applicable income taxes to raise non tax revenue of the Government. Towards this end, the importance of adopting a cost reflective flexible pricing policy has been recognised instead of rigid administered pricing arrangements for key state owned business enterprises, capitalisation and balance sheet restructuring to place them on a commercial footing, engagement of competent managerial staff and the adoption of modern procurement and financing practices are in progress.
The SOBEs are also encouraged to move away from their reliance on the national budget for capital investments and financing of operational losses. This will enable financial institutions and rating agencies to interact with SOBEs on the basis of doing business more on commercial considerations rather than on Treasury protection. However, these changes take time as they are essentially of a structural nature involving legal, administrative and political challenges but progress so far is encouraging.
The ultimate improvement of revenue performance requires a sustained growth in the economy and in particular in the formal economic activities. The growth in income taxation requires income growth generating not only a reduction of people below poverty income level but also a population that is earning a well above tax free threshold income, currently in Sri Lanka stands at Rs. 50,000 per month.
The growth in economic activities in IT, logistic services, professional services, tourism, value change in manufacturing and construction industries, banking and financial services etc. have the potential to keep their work force in such levels of income. In this regard, the reorientation of skills education and university education to suit such a human resource pool has become a priority in that sector.
The skills development must be linked to productivity enhancement of the labour force and private sector must move in this direction at firm level operations to double current rate of productivity growth of around 2-3%. Similarly, the development of the health sector which has made considerable openings in the private sector alone with the development in country’s public health services. The mutually beneficial expansion in both private and public sector involvement in selected activities in education and health sector developments seems to have produced complementary benefits to each other and has set the stage for the growth of professional services, significantly.
Trade account
The country’s trade account is another area that shows potential growth opportunities in both import substitution and exports. In addition to consolidating in Western markets as a high quality exporter, the government is looking for new markets for exports in the large economies in Asia namely, India, China and Japan where rebalancing trade certainly relevant. The recent trade talks have centred around large trade deficits with these countries and have made good progress to secure unrestricted market access to country’s main export products such as high value garments, tea, rubber products, etc. to these countries.
I am sure in the near future Sri Lanka will have a Free Trade Arrangement with China and Japan, the world’s second and third largest economies in addition to further expansion in Free Trade Arrangement with India and Pakistan. Similarly, the changing comparative advantage in favour of Sri Lanka in renewable energy products, food, pharmaceutical, light engineering products, etc. have opened new areas of investments for exports from Sri Lanka. It is encouraging that the country already has graduated to export solar panel to Japan. The export oriented growth emphasis therefore will also be supportive to create a progressive growth in Government revenue on a sustainable basis.
On the expenditure side, we don’t see pressure from social security and the prevailing welfare support payments to low income groups in the context that the economy sustains over 6% growth, single digit inflation and continuous reduction in unemployment and poverty. In fact the current level provides sufficient space to improve such shames as numbers are declining to a manageable level to provide a social security system to protect the vulnerable groups in society.
Social responsibility programs
The 2013 Budget Proposals encourage the private sector to commit themselves with social responsibility expenditure being directed towards addressing remaining facets of poverty in the country along with Government initiatives to achieve a poverty free status and to go beyond Millennium Development Goals by 2015 must be welcome by the private sector. This kind of PPP is needed in poverty reduction strategies as the private sector itself has the responsibility and capacity to undertake such initiatives in the country and project their own positive role in development. In view of the end of the conflict, development of infrastructure and the substantial progress that can be seen in reducing transaction costs and the ease of doing business in the country have helped them well. We think that this effort should be tripartite in the sense that all development partners and international development agencies, the private sector including reputed NGOs and the Government must work together by pooling their resources in a transparent manner to mobilise such grant aid and contributions through a commonly worked out poverty reduction strategy to make Sri Lanka a role model in tackling poverty. My estimate is that the country could easily mobilise well over US$ 200 million per annum towards the betterment of the needy through this collective effort.
After all social responsibility programs must be country owned, in the same spirit of development strategies to make them beneficial to the country. We already have the Government UNDP development framework for 2014 -16 medium term upon which we could improve further. All funds directly spent – sometimes by all of you – could increase the value addition in this process. Such expenditure could be disclosed to Parliament and the public under the reporting arrangements in terms of the Fiscal Management (Responsibility) Act of Sri Lanka.
Salary expenditure
The salary expenditure which is incurred for public services with a total civil cadre of about 700,000 of which nearly 400,000 on the provision of education and health services and a further 200,000 on agriculture and rural centric service deliveries, have been managed responsibly. The salary and service expansions have been carried out without making it is unaffordable. All such expenditure in relation to GDP has been maintained having regard to affordability in the fiscal deficit reduction framework. This is evident in the way we have managed the primary deficit which has declined from 2% of GDP in 2006 to 1.1% in 2012 underscoring substantial adjustments in non interest expenditure and the reduced debt creation tendency.
A primary surplus is targeted in 2015 further underscoring the acceleration of debt reduction strategy. Labour relations have improved and have helped country’s stable progress largely because of the wide consultation process the President himself is engaged in the process of fiscal policy formulation and management. The appointment of the new Pay Commission as announced in the 2013 Budget is expected soon to address salary and associated reforms in the public sector.
External financing
The approach to mobilise external financing of the budget is also being re-engineered to support our development effort. As you probably know, Sri Lanka has a larger development partner community far beyond its two traditional multilateral lending agencies and Japan which one time dominated over 90% of foreign financing in the budget, but now accounts to only one third, in view of the involvement of India, China, South Korea, the middle east development funds, European countries, the US and also banks and capital market. Of course, most of these country funds are from EX-IM Banks and export credit agencies have become strong partners.
Multilateral agencies are also phasing out concessional funding due to our own success of becoming a middle income country. However, new resources available for all sources are useful for both sides as in any case the Government needs to finance its import content of its public investment program to contain its Balance Payments implications. Such lending is also beneficial to lenders as it supports lender exports and creates a win-win situation, provided that such funds are used for asset creation and to support private sector development for growth. The Government of course favours long terms funds at least in excess of 15 years with a three to five year grace period and at much lower rates of interest depending on the nature of projects.
The approach with multilateral lending agencies is also being directed towards budget support and front loaded commitments for the full program recognised in the national budget so that there are no separate and isolated projects for development agencies, as in the past. A major achievement in this regard has been made by the Asian Development Bank through budget support assistance of US$ 200 million for education and US$ 300 million for NRW reduction strategy. A similar initiative is being worked out with the World Bank to mobilise US$ 200 million for health sector developments. Further the public investment budget is being designed to promote PPP based investments like the Colombo South Port, or joint investments cum PPPs like the Sampur power plant or BOOs or BOTs like the Northern Expressway. All these changes will enable the fiscal management more development oriented.
Challenges
Despite all these, fiscal management towards securing stability and development is not free from risks and vulnerabilities. One such major challenge is the risks of the budget to extreme fluctuations in weather conditions that we have begun to experience increasingly in recent years. This aspect is a subject interest of the World Bank, which has already deployed a mission to study options to insulate the budget from such pressures. I will also not underestimate the resistance for cost reflective price adjustments to be progress as the private sector still lives on subsidies on electricity and fuel. They need to move away, allowing us to target them only to the needy segments of the population and SMEs. Tax dodging through evasion, avoidance and the use of so called tax planning may undermine the envisaged improvements in taxation.
Work and work harder
Let me conclude. Sri Lanka today has the lowest fiscal deficit since 1977 and in fact the nearest comparison is 1975. However, that was in a close economy and different local and global settings. It exploited taxation of import up to 5% of GDP and primary commodity exports of a further 3-5%, the use of multiple rates of turnover tax and around 70% profit tax. Despite a very high revenue GDP ratio of 20%, public investment too was low. Besides, development model didn’t have much room for a private sector role. So let us not think of rebalancing that way.
Let us not re-think but work and work harder. Think only about work and how to work harder. The deficit today is credibly low though much progress needs to be made. Credible and feasible adjustments are sensible than undeliverable ambitions in relation to fiscal management. So let us not be academic and over-dramatise these either. Management of the fiscal deficit is real and we have to do it in a very complex economic environment. The silver lining however, is the relatively low defence expenditure and the much stronger security that is prevailing in the country which make fiscal policy management much easier than what I have experienced before from the same position that I have the privilege to address this summit today, which has evolved a much more promising outlook for the country to secure stability and development.
Thank you.
