Reducing fiscal deficit and reviving economic growth formidable challenges in 2020

The economic challenges facing the country are many and formidable. Reducing the fiscal deficit, bringing down the accumulated domestic and foreign debt, enhancing exports and foreign direct investment and reviving the economy are foremost challenges for the government/A strong resolve is needed to mitigate the fundamental weaknesses of the economy and develop an enabling investment climate to propel the

economy to a much higher trajectory of economic growth in 2020 onwards. However, this being another election year is a serious constraint to adopting the needed economic policies for economic stabilisation and growth. Much cannot be expected this year except to improve some of the macroeconomic fundamentals to foster a higher economic growth from 2021.

Economic objectives

The government has announced that it expects to reduce the fiscal deficit to 5.5 percent of GDP and achieve an economic growth of 5.5 percent this year. Given the low economic performance and fiscal slippage of last year (2019), and the parliamentary elections this year, these are difficult to achieve. It would be more realistic to achieve these goals in 2021.

Electoral constraints

In as much as the Presidential elections last year derailed the economy, this year’s preoccupation with the forthcoming parliamentary elections and the consequent political compulsions of the government, are not likely to help in fiscal consolidation though it is an economic imperative for economic stability, growth and development.

Fiscal deficit

Last year’s fiscal deficit is estimated at between 5.5 to 6.5 percent of GDP. Reducing the fiscal deficit to 5.5 percent of GDP in 2020 through difficult, must be achieved. It is difficult as the reduction in several taxes last year is likely to decrease government revenue and, on the other hand, government expenditure is likely to increase.

Nevertheless the government requires to find ways of increasing revenue and cutting expenditure to ensure that the fiscal deficit is contained. The crunch is that the reduction of the fiscal deficit this year is considerably difficult, in the current political context. It would be to the credit of the government if these objectives are progressively attained in the next 3 to 5 years.

Root cause

The recurring high fiscal deficits have been a root cause of the country’s economic problems. Last year’s estimated fiscal deficit of above 6 percent of GDP is far above the target of 3.5 percent of GDP set for 2020. The government’s intent and objective of reducing it to 5.5 percent of GDP by end 2020 requires bold measures to increase revenue and reduce expenditure.

Fiscal consolidation

The government expects to reduce the fiscal deficit to 5.5 percent of GDP this year from the estimated 6 percent or more of GDP for last year. This is not an easy target to achieve after the changes to taxes that reduced government revenue and the likely increases on new expenditures. It is imperative that ways and means are found that

would increase revenue, while containing government expenditure. Since the latter is difficult in an election year, much of the onus of reducing the fiscal deficit must be on enhancing revenue.

The process of fiscal consolidation that was initiated in 2016 was derailed from 2018 onwards owing to imprudent expenditure to gain popularity at the last elections. Another programme of fiscal consolidation must be resuscitated to progressively lower fiscal deficits in 2020-2025. It must attempt to achieve the fiscal deficit target of 3.5 percent of GDP that was set for 2020, by 2025. A new fiscal consolidation programme must progressively achieve a fiscal deficit of less than 4 percent of GDP by 2024. This has to be achieved

mainly by enhanced revenue, as there are likely to be increased government expenditure. The country’s revenue to GDP ratio should be increased to about 17 percent of GDP through a system of progressive direct taxation.

Way forward

The path to fiscal consolidation has to be mostly by the enhancement of government revenue although it must also find ways and means of reducing as much as possible wasteful and unproductive expenditure. However, the possibility of reducing government expenditure is limited as there are political pressures for increasing government expenditure.

Reducing the massive losses of state owned enterprises is one means of reducing government expenditure. The government has eschewed the privatisation of any state enterprise. Privatisation of state enterprises would have reduced expenditure on loss making state enterprises as well as increased revenue. Structural and management

reforms should try to reduce losses of most state owned enterprises. This has not proved a success in the past.

Revenue enhancement

The process of fiscal consolidation must be by the enhancement of government revenue as Sri Lanka had one of the lowest tax to GDP ratios of 13 percent of GDP until the previous government began a programme of fiscal consolidation that was based on revenue enhancement.

This fiscal consolidation programme raised the tax to GDP ratio to about 16 percent of GDP in 2018. However in 2019 a fiscal slippage occurred owing to increased government relief measures and increased public expenditure and this year’s fiscal deficit is likely to be 6 percent of GDP or more.

The increase in government expenditure of the previous regime and the present government’s tax reliefs are likely to increase the fiscal deficit and undermine macroeconomic fundamentals this year too as it is not a propitious year for containment of expenditure owing to it being an election year.

Enhance revenue

The government’s tax reliefs are likely to reduce the tax revenue to GDP ratio. Therefore new taxation measures are needed to ensure that government revenue does not fall. The government must come up with a programme of fiscal consolidation based on its economic strategy and priorities in public spending. It must necessarily be one based on a revenue enhancement programme. The measures to enhance government

revenues must necessarily come from mostly direct taxes like higher property taxes, stamp duties and wealth taxes and some progressive indirect taxes on luxury imported items. However as these have a high elasticity of demand, their scope of revenue enhancement is limited.

Tax evasion

One of the difficulties in increasing revenue is the large scale tax avoidance and tax evasion and inefficient and corrupt tax administration. Tax avoidance and tax evasion have to be drastically reduced to not only increase revenues, but make taxation more

equitable, as very rich persons and high income earning professionals are avoiding taxes. This is a most difficult task due to the innovative methods used by professionals to avoid and evade taxes and the inefficiency and corruption in the tax administration. In spite of these difficulties, innovative methods of direct and indirect taxation must be devised to reduce tax evasion

Economic growth

Reviving the economy to achieve a growth of 5.5 percent from its current below 4 percent is a medium term prospect. It requires the building up of investor confidence, much higher foreign direct investments, strengthening the agricultural economy, especially export agriculture and restoring international confidence that the country is safe to revive tourism.

Conclusion

The government’s goal of reducing the fiscal deficit to 5.5 percent of GDP this year is difficult owing to the likely fall in tax revenues and increased government expenditure this year. The political environment and political compulsions will not make it possible reduce public expenditure. Nevertheless every effort must be made to enhance

revenue and curtail expenditure in order to reduce the fiscal deficit to 5.5 percent of GDP. Reviving the economy to achieve a 5 percent or more growth is possible only after the macroeconomic fundamentals are stabilised and investor confidence restored.