The Presidential election at the end of last year and the Parliamentary election of August this year have produced a strong government eliminating the political uncertainties that adversely affected Sri Lanka’s economic performance over 2015–2019.
The policy uncertainties that caused weak performance of the economy, are being addressed by the Government, in spite of various global and domestic disruptions caused by the Covid-19 pandemic. In this context, the Budget we are talking about came at a critical juncture and stands out as a policy document that has decisively addressed most of the uncertainties and ambiguities affecting our developmental prospects.
Declaring a whole new strategy of growth, development and social justice for Sri Lanka, it has the chances of becoming a significant watershed in the country’s socio-economic progress in modern times.
The vision which has guided the government in the formulation of the Budget for 2021 and its proposals has been expressed in a number of phrases which can be placed in two groups:
Group 1 consists of the following expressions:
* Technology- based entrepreneurial economy
* Techno-entrepreneur led economy
* Technology-driven economy
* Production-oriented economy moving away from trade-orientation
Group 2 includes the following:
* People-centric development
* Eco-sensitive sustainable development
* Inclusive growth and development
* Economy based on local farm products and agro-industrialisation
I venture to summarise the vision conveyed in these expressions as one of:
“Modern-technology-driven production economy combined with shared and environmentally sustainable patterns of development”
Facilities and incentives are provided in the Budget for producer elements to promote the former element in this dual objective function and many subsidies and other benefits to low income people to pursue the latter component.
To promote the dual objectives, the Budget has identified four promising activity areas in the economy for “directed encouragement” while the policy measures promulgated will have implications for economic activity areas on a broader basis. These four subject areas are chosen as they could serve the interests of “modern-technology-driven production economy” as well as “shared and environmentally sustainable patterns of development”. These sectors also have strong potential for growth and employment generation, promoting both import substitution and export-oriented production.
* Agricultural and fisheries
* Manufacturing activity
* Information technology related activities
* Construction
The focus as expressed is on (a) domestic private capital formation, or as this idea is sometimes presented in political economy literature, the promotion of a strong national bourgeoisie, (b) state capital formation (henceplans for productivity improvement and re-organisation of SOEs) and (c) investment of foreign private capital through FDIs.
The aspirations for the medium term macroeconomic path have been re-emphasised in the Budget. Maintaining inflation at around 5 per cent, reducing the fiscal deficit to 4 per cent and reducing the public debt to GDP ratio to 70 per cent by 2025, and accelerating economic growth to around 6 percent have been emphasised in the Budget.
According to the Budget speech, the way to achieve these is through “ensuring the economic freedom of the people with a production economy facilitated by a structural change within a framework of market economy”. The financial sector is expected to support this novel approach, and several enabling reforms are also proposed in the Budget.
This Budget deals with fiscal operations in a year that has been strongly affected by Covid-19 spread which came to attack the Sri Lankan economy and society in two devastating rounds. Naturally, the revenue that the government could collect was less than the potential.
There was also the revenue impact of policy action taken in January 2020 to lower taxation. Thus naturally, the expected budget deficit this year has been estimated at 7.9 percent of GDP. The Government expects to increase public investment from 2.6 per cent of GDP in 2020 to 6.1 per cent in 2021.
Resulting from this expected increase in public investment required to kickstart the stalled growth process, and the strategic shifts in policy I have noted, as well as various expenditures intended to help the poor, total expenditure of the government is expected to exceed its revenue by a large margin. The budget deficit in 2021 is expected to increase to 8.9 per cent, before returning to a consolidation path in the medium term.
Let me at this stage digress for a moment to remind ourselves that running a deficit budget, even one as big as 10% of GDP, is not wrong as a sovereign state is not like a household in terms of managing incomes and expenditures.
The sovereign has the right of currency issue to help it manage its deficit when it decides to run a deficit. Compensatory or discretionary finance, two other expressions used in literature to indicate deficit financing, has been seen by writers of alternative schools of economics as a necessary tool to get an economy up to its higher potential levels. The case for deficit financing has come up strongly during this year everywhere in the world because there was no other way for governments to address the devastating effects of the Covid-19 pandemic.
The Budget is also in line with the view of global thought leaders on near term fiscal deficits. The Covid-19 pandemic and policy actions needed to arrest its further spread have made fiscal consolidation in 2020-2021 a non-issue. It was impossible to achieve and undesirable.
The deficit financing strategy favours domestic financing, which is in line with the Government’s expectation of reducing the foreign debt share to below 35 percent in the medium term.Revenue collection will be low in 2020. But since 2021, the Budget-supported economic recovery strategy as well as the introduction of additional revenue measures such as the newly proposed special goods and services tax and improved revenue administration are expected to increase revenue to GDP ratio to 14.1 per cent in the medium term.
Expenditure management, particularly in terms of improving the efficiency in utilisation of foreign loans, public sector reforms, and also improving public enterprises performance are key proposals that will have significantly positive fiscal implications.
We believe that these expectations of the Budget and the proposals therein will help allay any fears on debt sustainability and external liquidity as well. On the ongoing, somewhat heated, debate on this topic, those who have raised concerns in this regard have argued that Sri Lanka’s fiscal deficits have been excessive and debt levels are at unmanageable levels. There is also a political debate on how and when debt levels, particularly foreign debt, escalated to current levels.
Without getting into political arguments, let me attempt to expand on this aspect in terms of alternative thinking in economic theory. Several countries including Japan, Singapore and the United States have debt levels far exceeding their GDP.
This shows that even such high levels of debt could be sustainable when domestic debt is predominant in the debt portfolio. As for foreign debt, one could think of alternative indicators that, in fact, show that even foreign debt in Sri Lanka today is indeed manageable.
The ratio of Government’s foreign non-concessional debt to GDP is around 23 per cent, and the remainder is either domestic debt which could be rolled over or long term foreign concessional financing. Annual foreign debt service payments as a percentage of export earnings and remittances are around 12 per cent in a normal year like 2018.
Given these indicators, and with the emphasis on domestic debt in financing the deficits, and the expected medium-term fiscal and debt consolidation path commencing 2021, we in the Central Bank believe that the widely expressed fears on debt sustainability are simply unfounded.
Along with the improvements expected in the domestic production economy through the Budget proposals, the Government has also made clear its stance on foreign trade and foreign economic relations. Overall, these new proposals, along with the ongoing developments, will result in a significant improvement in our external current account balance – the only way for the country to progress as an independent nation and address concerns such as the need to ensure debt sustainability in the medium term.
Thus far, in spite of extremely adverse speculation, Sri Lanka has done everything in its power to improve macroeconomic conditions and balance the aspirations of the investor community and the public. Prospects for foreign investments are high in the environment of incentives the government proposes and in particular the likelihood of the legal framework for the Port City Project implementation getting ready soon.
The impetus which export earnings received during July–September 2020 is likely to be seen again after the strength of the on-going second wave of Covid-19 subsides. The import restrictions on non-essential goods together with low oil prices will save US dollars 4.1 billion in import expenditure in 2020.
This saving almost coincides with the Government’s foreign currency debt service payments during the year. Unlike in many other countries where debt sustainability and external sector vulnerabilities have caused havoc in domestic financial markets, the proactive measures taken by the Government and the Central Bank have also resulted in maintaining the stability in the exchange rate with some improvement in external balances, while the Central Bank has also collected almost US dollars 500 million of foreign exchange on a gross basis from the domestic market from May onwards. With the external sector of the economy becoming stronger the exchange rate stability will be maintained at a higher level rupee value, pushing the rate towards USD1 = Rs. 180.
The ongoing Covid-19 second wave appears to have somewhat disrupted the positive momentum of the economy that was observed after the containment of the first wave by early June. However, the rebound of merchandise exports, increasing remittances, recovery of construction activity, and also the performance of the stock market since May have been quite impressive, and with the containment of the second wave, we hope, these positive trends will continue in the period ahead.
Against this backdrop, Budget 2021 was intended to showcase the economic agenda of the Government over the medium term, while overcoming any vulnerabilities stemming from local as well as global developments.
The Budget 2021 has laid a solid foundation for a fresh start for the economy battered by various structural weaknesses for decades, alongside the unprecedented circumstances surrounding the Covid-19 pandemic. Overall, the economy is poised to witness a structural shift of major macroeconomic variables thus consolidating the medium term macroeconomic framework of the country.
As the Government and the Central Bank have collectively responded thus far, to overcome the severity of the economic fallout of the pandemic by timely and prudent measures, the required policy coordination between the monetary and fiscal authorities will continue in the period ahead. With the help of the proposals presented in this development oriented Budget, achieving the envisaged 6 percent economic growth over the medium term would be plausible with the effects of the pandemic fading away and the country’s external economy recovering with the support of the extraordinary level of fiscal and monetary stimuli already in place.
Working with the Government, the Central Bank also remains committed to taking all possible measures to ensure economic and price stability, and financial system stability in the period ahead with a view to helping in the overall effort for shared development and employment growth.
The recognition by the Government, in this Budget itself, the need to maintain inflation at around 5 percent level per annum would certainly help foster fiscal and monetary policy coordination in the ensuing period.
The writer is the Governor of the Central Bank.