Sri Lanka plans 9.1 percent budget deficit in 2007

November 16, 2006 (LBO) – Sri Lanka is expecting a 9.1 percent budget deficit in 2007, with the revised budget deficit for 2006 being estimated at 8.7 percent of GDP. Sri Lanka’s Central Bank is estimating the debt to GDP ratio to fall to 91.5 percent from 93.9 percent by year end.

For the second year running, authorities made budget numbers opaque by separating a part of the expenditure as tsunami related, which had the effect of understating the budget deficit, capital expenditure, and the revenue deficit, depending on the breakdown of the expenditure.

The revised deficit in the current account of the budget (revenue deficit) without tsunami expenditure was 2.4 percent of GDP up from a targeted 0.9 percent.

In 2007 the government is projecting a surplus in the revenue account estimated at 0.1 of GDP, a feat not achieved for nearly two decades.

Though total revenue, at 17.4 percent of GDP fell short of the targeted 17.8 percent, it was a major improvement from the previous year’s 16.1 percent. In 2007 revenue is estimated at 18.5 percent of GDP.

Capital expenditure (without tsunami rebuilding) also rose to 5.9 percent from 5 percent of GDP. The government showed isolated tsunami related expenditure of a further 1.9 percent.

The deficit this year, which was partly financed from expansionary sources, has so far managed to generate 12-month inflation of 17.2 percent by October and annual average inflation of 11.8 percent.

President Mahinda Rajapakse who is also Finance Minister recalled a moment when he talked to members of the public at a foundation stone laying ceremony.

“When I said the cost of living was high, the spontaneous response from the crowd was that they would bare it, and that I should look after the country,” he told Parliamentarians.

“I believe that this is the view of the majority of our people. The message is that the majority is ready to make sacrifices in the interests of the country.”

The proposed budget for 2007, is designed to produce an average inflation of around 10 percent and GDP growth of 7.5 percent, the finance ministry said.

Critics say Sri Lanka’s inflation can be general and in 2006 in particular, which started to gallop from about the second quarter can be clearly traced to the over-dependence on banking sector financing, especially central bank credit (money printing) to finance the marginal 1-2 percent of the budget deficit.

However they also point out that inflation help fiscal authorities by expanding nominal GDP which brings the debt to GDP ratio down, and pushes up tax revenues in rupee terms, while imposing wage cuts on the public sector in real terms.

As expected, the budget did little to address the problem of the bloated public sector, which in 2007 is expected to cost 196.7 billion rupees in salaries and 68.2 billion in pensions.

Pushing 9 percent of GDP, the public service now eats up more than half the government revenue while taking home tax-free salaries.

Wimal Weerawanse of the nationalist-extremist Janatha Vimukthi Peramuna told journalists, that the budget did not meet peoples’ expectations.

The vocal party is a key driver of Sri Lanka’s unproductive subsidies, especially in fuel and fertilizer as well as using the public sector as a tool to reduce unemployment, all of which undermines national finances and contribute to inflation and balance of payments problems.

However, analysts say a ‘peoples’ budget, which announces new and unproductive subsidies, which are then financed with more central bank credit, taking away more from the poor through inflation than it gives through handouts is worse than a budget which raises taxes and has a promise of bringing economic stability.

Updated