SL overshoots budget deficit as pandemic puts strain on state revenue

• Budget deficit as a share of GDP hits 11.1% in 2020, up from 9.6% in 2019 and 7.9% deficit target
• State revenues as a percentage of GDP declined to 9.1%, from 12.6% between 2020 and 2019
• Govt. expenditure at 20.3% of GDP in 2020, compared to 22.2% in 2019
• Capital expenditure fell sharply to 3.3% of GDP, from 6.1 % in 2019.

Sri Lanka’s fiscal deficit for 2020 exceeded both the deficit target for the year and the deficit in 2019, as the pandemic-induced economic disruptions put a strain on revenues, while the tax cuts failed to produce their desired economic resurgence.

Further, the contraction in gross domestic product (GDP) by 3.6 percent in 2020 also played a notable role in expanding the fiscal deficit, which is typically measured as a share of GDP. The fiscal deficit, as a share of GDP, reached 11.1 percent in 2020, up from 9.6 percent in 2019 and 7.9 percent targeted for the year. 

Sri Lanka aims to gradually narrow its budget deficit towards 4.0 percent by 2025, under its more practical fiscal consolidation path, as both the government and Central Bank indicated that they stand ready to end the current stimuli, once the economy finds its equilibrium to sustain on its own. 

The state revenues as a percentage of GDP declined to 9.1 percent, from 12.6 percent between 2020 and 2019, reflecting a sharp decline in tax collection, as the pandemic-induced disruptions to broader economic activities hindered tax revenue generation. 

While business and consumption inducing tax cuts played a part in deepening the revenue hole in 2020, those stood as necessary fiscal stimuli to support business and consumption to recover fast from the pandemic, as reflected by the record corporate earnings in the third and fourth quarters of 2020.

This was clearly seen from the near 2019 level tax incomes in August and September last year, which was possible due to the quick ‘V-shaped’ recovery in the economy since the virus-related restrictions were disbanded. 

“The effects of the pandemic caused the key fiscal balances to deteriorate notably in 2020,” the Central Bank said presenting the full picture of how the government’s fiscal sector performed in 2020, as typically the Finance Ministry’s data is either not forthcoming or lagging beyond a justifiable time. 

Meanwhile, the government’s expenditure was recorded at 20.3 percent of GDP in 2020, compared to 22.2 percent in 2019, largely due to the adjustment made by the Finance Ministry by shifting the payment of Rs.422.6 billion made on account of arrears for 2019 to 2020. State budgets are typically made on cash basis. 

The recurrent expenditure rose to 17 percent of GDP in 2020, from 16.1 percent in 2019, “mainly on account of an increase in salaries and wages, subsidies and transfers and interest payments”, the Central Bank said. 

However, the government cut enormously from its capital expenditure budget in 2020, to contain the overall budget deficit, as such expenditure fell sharply to 3.3 percent of GDP, from 6.1 percent in 2019. 

The higher fiscal deficit expanded the outstanding government debt stock to 101 percent of GDP in 2020, from Rs.86.8 percent in 2019, caused by the dual effects of increase in debt stock and the GDP contraction.

However, the government succeeded in reducing its reliance on foreign debt to 40 percent by end-2020, from 47.6 percent in 2019, as it consciously skewed heavily towards domestic sources to finance the deficit.