Budget 2019 themed “Enterprise Sri Lanka – Empowering the People and Nurturing the Poor” envisages to promote a new form of private sector free from the protectionist mindset that can operate efficiently in a rule-based system within a competitive market environment. Loan concessions and various other incentives are to be given to prospective entrepreneurs with a view to create an entrepreneurial society, particularly among the youth. Another programme highlighted in the Budget is the “Gamperaliya” scheme, which is meant for accelerating village development through infrastructure development. Increased allocations have been made for this scheme for 2019. The Budget also contains a series of proposals covering a host of other areas including livelihood development, social welfare, knowledge-driven skilled society, smart cities and sustainable environment.
The government seems to have tended to provide a variety of such concessions and incentives to different segments of the society in view of the upcoming elections, although budget cuts are inevitable, given the enormous revenue constraints and public debt sustainability risks. As in the previous budgets, no attempt has been made to cut down extravagant and wasteful expenditure.
Unmanageable recurrent expenditure
The recurrent expenditure is expected to account for three fourths total government expenditure (15.5 percent of GDP) in 2019 leaving the balance 25 percent for public investment (4.8 percent of GDP). There are 194 new expenditure proposals in the Budget that would raise recurrent expenditure by 11 percent this year.
As in the previous years, the bulk of the recurrent expenditure for this year will go to interest payments, salaries and wages, subsidies and transfers. The interest payments on public debt will be Rs. 913 billion in 2019. Welfare subsidies to households and transfers to loss-making state-owned enterprises amount to Rs. 546 billion. The populist concessions introduced in successive budgets have contributed to augment the subsidies and transfers continuously.
Bloating public sector
The wage bill of the public sector is estimated to rise by 12 percent to Rs. 778 billion this year. It has continuously gone up over the years due to expansion of public sector employment and salary increases effected in almost every Budget. Currently, there are more than 1.4 million employees in the public sector constituting around one sixth of total employment in the country. In other words, one person out of every 15 persons of the country’s population is a government employee. They include employees in Ministries, Departments, District Secretariats, Divisional Secretariats, Provincial Councils and Semi Government institutions. Low productivity in the public sector is a well-known fact. Increasing the salaries in this sector without taking any drastic steps to raise its productivity offsets any economic growth effects emanating from productivity gains in the private sector.
Politicized social safety nets
While allocating a sum of Rs. 50 billion for the country’s apex social welfare scheme, Samurdhi, the Finance Minister himself admits in the Budget Speech that it is politicized to such an extent that Samurdhi officials are affiliated to a certain political party. As such, this has resulted in the deserving, not benefitting from this scheme, while those who do not deserve, mostly card-carrying members of a particular political party, continue to enjoy these free subsidies for merely supporting the politics of the day, resulting in the “poor remaining poor”, says the Minister. However, no policy measures are suggested in the Budget to rectify such flaws in the Samurdhi scheme by limiting its coverage to the deserving poor.
The Budget also contains a series of other populist concessions including free milk for school children, salary subsidies for recruitment of disabled employees in the private sector and allowances for armed forces.
Economic returns from capital allocations ambiguous
Given the increasing recurrent expenditure, the leeway available to raise public investment in the Budget is rather limited, and it has dampening effects on economic growth. By and large, even the limited public investment programs are based on the expected short-term political gains rather than on criterial linked with long-term economic returns.
Additional capital expenditure is allocated in the Budget for a wide range of projects, and it is questionable whether appropriate cost-benefit analyses are conducted in launching such projects. As much as Rs. 10 billion is to be spent for “Ran Mawath” rural roads maintenance and construction programme. Considering the past track records of corruption and poor quality of construction involved in such projects, the economic benefits of these programmes remain ambiguous.
It is also proposed to allocate a sum of Rs. 2 billion as capital expenditure for “Nangwamu Lanka” Micro and Small Enterprise Development Programme. This would be useful to promote micro and small enterprises. But it is essential to encourage such enterprises to engage in high-tech and high value added production processes, instead of confining to traditional low productivity activities.
The Budget contains certain proposals that reverses previous policy decisions. For example, it is proposed to establish a Fund under the Central Bank of Sri Lanka (CBSL) to provide guarantees to the SME Sector, for which necessary allocations will be made. This somewhat contradicts with the policy decision taken years back to phase out the refinance and credit guarantee schemes operated by Central Bank so as to foster a market-based financial system.
Education reforms for a knowledge-driven society lacking
The government’s effort to gear the education sector towards building up a knowledge-driven society by means of infrastructure development and curricular revision is a welcome feature. A sum of Rs. 32 billion is allocated in the Budget to improve the laboratories, class rooms, libraries, sanitary & water facilities, teachers’ quarters, etc.
These are commendable moves considering the inadequate application of technology and innovation in production activities that has led to stagnate Sri Lanka’s economic growth at a low ebb of around 3 percent a year in recent times. Economic growth is currently driven by inputs of labour and capital, and the contribution of technology in productivity improvement is minimal. The deficiencies in the education sector are a major cause for limited technological applications and lack of innovations. In contrast, the fast-growing East Asian economies, particularly the four Asian Tigers – Hong Kong, Singapore, South Korea and Taiwan – prioritized fostering knowledge-based economic environment in the last several decades enabling to achieve advanced economic status.
Sri Lanka has a different story with annual budgets aiming at capturing the electorate by offering popular handouts year after year neglecting science and technology priorities. The present Budget is no exception except for a few casual remarks on the buzz word, knowledge-driven economy. This kind of economy cannot simply be built by making certain improvements in the school system as mentioned in the Budget speech. It needs radical transformation of the education system to nurture young generations of critical thinkers and innovators. The present school education loaded with heavy syllabuses, text books and tuition classes does not allow children to think beyond the given subject material. They continue the same learning styles after entering the university. In the absence of pathbreaking education reforms coupled with R&D, achieving a knowledge-driven economy would be a myth.
Revenue sources limited
Against the backdrop of increasing expenditure, the government has limited choice in raising its revenue. In 2018, the total revenue realized was only Rs. 2,013 billion, and it was much lower than the amount of Rs. 2,316 billion anticipated in the Budget 2018. Revenue shortfalls in income tax as well as taxes on goods and services were evident last year.
In the Budget 2019, the total revenue is expected to increase by 21 percent to Rs. 2,451 billion this year. Tax revenue contributes four fifths of the total revenue. Indirect taxes – taxes on goods and services and taxes on external trade – account for 82 percent of the total tax revenue. Such excessive dependence on indirect taxes for revenue generation makes the tax system more regressive hurting the poor and further widening income inequality. Inflationary effects of indirect taxes and the consequent repercussions on the poor also cannot be underestimated. As soon as this government came into power it was announced that the income tax component of taxes will be raised to 40 percent, and thus, indirect tax revenue component was expected to fall to 60 percent. But income taxes still account for only 18 percent of the total tax revenue reflecting the failure to effect personal and corporate income tax laws effectively.
In the present Budget, revenue generating proposals are limited only to indirect tax sources, and no attempt has been made to raise direct taxes. Accordingly, the bulk of the additional revenue is to be realized from the typical sources such as excise duties on vehicles and luxury vehicle taxes, excise and customs duties on liquor and tobacco, customs duties on other selected goods.
Widening budget deficits and debt accumulation are the end results
In the context of rising expenditure and revenue constraints, the fiscal deficit continues to widen compelling the government to rely heavily on borrowing from local and foreign sources. Ironically, there is no discussion in Budget 2019 regarding the problem of how the fiscal deficit is going to be financed. The budget deficit is expected to decline from Rs. 761 billion (5.3 percent of GDP) in 2018 to Rs. 685 billion in 2019 (4.4 percent of GDP). However, such performance depends on the mobilization of tax revenue as expected and the government’s ability to keep expenditure programmes intact. Both seem to be unrealistic, given the adverse track records.
In the past, the projected tax revenues were not materialized due to economic slowdown and administrative shortcomings, and the expenditure targets got derailed with frequent supplementary estimates. This led to overshooting the budget deficit over and above the original estimates indicated in the annual budget speeches. For instance, the projected budget deficit in Budget 2018 for the year 2018 was 4.8 percent of GDP, but the actual deficit went up to 5.3 percent for that year due to revenue shortfalls and expenditure hikes.
The achievement of a primary surplus of Rs. 91 billion last year and the projected surplus of Rs. 228 billion for this year, as boasted in the Budget speech, is merely a cosmetic exercise. This number is derived by deducting interest payments from the budget deficit. It is a superfluous indicator, as one cannot assume a fiscal deficit without making provisions for interest payments.
In financing this year’s budget deficit, net foreign borrowings are expected to contribute marginally as the bulk of foreign borrowings, mainly from commercial sources, are to be utilized for repayments to the tune of Rs. 665 billion. The resulting accumulated foreign debt will cause burden on future budgets as well. Domestically, the government depends on non-market borrowings, Treasury-Bond and Treasury-Bill markets and bank borrowings.
The widening fiscal deficits have compelled successive governments to rely on extensive domestic borrowings and foreign commercial borrowings augmenting the debt service burden to unsustainable levels. In view of the upcoming elections and the continuing political fragility, little emphasis is given in Budget 2019 to overcome such problems by fiscal consolidation. This causes adverse repercussions for economic stability and growth in years to come.