- Says Sri Lanka needs medium term budgetary framework to balance the contradictory objectives of fiscal stimulus in short-term and fiscal consolidation in medium-term
With the upcoming parliamentary elections in August, the government is urged to present a medium term budgetary framework balancing the contradictory objectives of an immediate need for counter-cyclical fiscal policy to bounce back from the COVID-19 infused economic downturn, and also with the compulsion to achieve fiscal consolidation over the medium term to improve the country’s deteriorating debt dynamics, a Colombo-based think tank recommended.
In presenting recommendations for Budget 2021, the Pathfinder Foundation (PF) suggested that the government could adopt a counter-cyclical stance, which responds to the contractionary pressure from the effects of the pandemic for the remainder of 2020 and 2021 with a medium-term framework focusing on fiscal consolidation beyond 2021.
“In the immediate term, priority should be attached to using some of the fiscal space available to support the poorest groups whose livelihoods have been severely affected by the pandemic. In addition, evidence has emerged that fiscal stimulus targeted at specific competitive sectors contribute more to recovery than generalized support,” the think tank noted.
However, it pointed out that the current high fiscal deficit, which increased to 6.8 percent of GDP in 2019 and which is projected to be 8.5 percent this year is not sustainable and it has led to extremely challenging debt dynamics, particularly external debt.
In addition to high fiscal deficit, Sri Lanka’s debt to GDP ratio also remains above 90 percent while the median for comparator countries is around 55 percent.
Hence, PF stressed that a high priority would need to be attached to backloading fiscal consolidation in the succeeding years to meet the government’s target of a fiscal deficit of 4 percent of GDP by 2023 to reinforce the creditworthiness of the country.
In particular, it emphasised on achieving a primary surplus in the budgetary outcomes, which has only been achieved three years since 1954.
“Progress cannot be made in addressing Sri Lanka’s onerous debt servicing without achieving a primary surplus,” it added.
PF also asserted that fiscal consolidation must be supplemented by structural reforms to ensure that growth is not stifled by learning from past lessons.
“Sri Lanka’s experience under the last two IMF programmes implemented by the two previous governments shows this very clearly, as progress made in containing the budget deficit was accompanied by a decline in economic growth,” it pointed out.
The think tank blamed Sri Lanka’s long-standing legacy of adverse deficit/debt dynamics for current limitation in fiscal space in responding to the pandemic.
“The new budget offers the government more room to manoeuvre in targeting assistance to protect the vulnerable and support key sectors of the economy. However, it is important to dampen expectations by recognizing that the scope to do this is constrained by a lack of fiscal space arising from many years of inadequate fiscal discipline,” it elaborated.
Further, the think tank proposed the government to prioritise redressing the regressive impact of the balance between receipts from direct and indirect taxes, which unfairly favours the rich.
“Receipts from indirect taxes account for over 80 percent of total tax revenue. This makes Sri Lanka’s tax system one of the most regressive in the world (in the case of indirect taxes the richest person in the country and the poorest person are subject to the same rate tax). A fairer system would involve a 60/40 balance between indirect and direct taxes: a goal to be achieved over time,” it elaborated.
The think tank also highlighted that best budgets are framed based on a set of priorities, which address short-term needs while creating a framework for inclusive (employment –generating) and sustainable growth while providing an effective safety net for the poor in the medium term.
Proposes partial credit guarantee scheme
The government must consider a partial credit guarantee scheme to share the credit risk with the financial sector complimenting the series of measures implemented by the Central Bank (CB), which aimed at facilitating the flow of credit to support firms and jobs in the post COVID-19 environment, the Pathfinder Foundation proposed.
Although, the CB has implemented range of measures to support the economy to bounce back from COVID-19 economic downturn, much of the businesses are yet to successfully obtain these facilities from the banking sector.
According to recent data, the banking sector asset quality measured by the gross non-performing loan (NPL) ratio edged up to 5.1 percent during the first three months of 2020, from 4.7 percent at end-2019.
Further, the rating agencies cautioned that although the reported NPLs could be lower due to restructuring of loans and moratoriums, those would only provide the sector a temporary respite, but the actual NPLs hidden inside that could be much higher.
Hence, PF proposed the government to consider a partial guarantee scheme to ensure credit flows to the COVID-19 crisis-hit businesses and individuals.
“These measures are all intended to create financial conditions which facilitate the flow of credit to support firms and jobs. The efficacy of these measures would be improved by a partial guarantee scheme which would serve to share credit risk,” it stated.