Positive signs in fiscal management - IMF

By Gamini Warushamana

Positive signs can be seen in fiscal management of Sri Lanka, especially in deficit reduction, said IMF resident representative in Colombo, Koshi Mathai at the 14th Economic Summit of the Ceylon Chamber of Commerce in Colombo last week.

The Government has been successful in reducing the deficit and while overall deficit is declining, there is also a decline in the current account deficit. These are good signs. Although the deficit has declined the game is not over and there is room for improvement. In Sri Lanka, there has been high fiscal deficit from 1993 and a special feature is the high current account deficit. This means borrowing for present consumption, he said.

“What lessons we can learn from other countries regarding fiscal management?” he queried.

High fiscal deficit is a serious challenge in economic management. Government's have several options to manage huge deficits such as printing money, borrowing from domestic or foreign sources. Each option creates problems. Printing money leads to high inflation. Domestic borrowing leads to crowding out; high interest rates, low growth and high unemployment.

There is a strong correlationship between Debt to GDP ratio and inflation and if the government debt increases the ratio increases and it will put pressure on inflation and lead to slow growth.In Sri Lanka this ratio is still high compared to other countries but it is now going down. This is a positive trend we can see in fiscal management. From the point of view of debt dynamism, ratio of debt to GDP is still feasible. Debt dynamism measures the capacity to repay debt and if the economy grows faster than debt, the debt-to-GDP ratio falls.

GDP grows with demand expansion, and debt grows at the pace of the interest on debt. Therefore, if the economy grows faster than the rate of interest, then the debt-to-GDP ratio falls even if the government runs deficits.

Mathai said that in the Sri Lankan case the ratio is low because of its debt portfolio. In the past, as a developing country Sri Lanka borrowed money at low interest rates from foreign sources.

However, today as a middle-income country this situation will change. Domestically, there are sources such as EPF and ETF to borrow at low rates. This situation too will change with the development of the debt market.Another issue we see is that the share of bank credit that goes to government enterprises is high and is increasing. The reason is loss-making state-owned enterprises.

The IMF always advocates adjusting fiscal position. We do not call for increasing tax rates but to widen the tax base and tax compliance. Compared to other competing countries, Sri Lanka has a reasonable VAT rate but high corporate tax rate and low personal tax rate.

Tax efficiency is poor and in VAT and personal income tax there is room for improvement. Fiscal consolidation will provide policy manoeuvres for governments. Sometimes governments worsen volatility of the economy by spending more in booms and cutting expenditure during recessions, he said.