9. GOVERNMENT FINANCE

Transcription

1 9. GOVERNMENT FINANCE The Fiscal Management (Responsibility) Act (FMRA), which came into effect in 2003, aims to improve transparency and accountability in fiscal management. It requires that the overall fiscal deficit be reduced to 5 per cent of GDP by 2006 and maintained below that level thereafter. It also requires reducing the government debt to GDP ratio to 85 per cent by 2006 and to 60 per cent by The fiscal policy strategy and the fiscal framework, announced in Budget 2003, were based on these broad medium-term policy objectives. The main aim of the fiscal policy strategy announced in Budget 2003 was to continue the medium-term fiscal consolidation process in a sustainable manner, while providing support necessary for long-term economic growth. Fiscal performance so far in 2003 and projections for the balance period indicate that there could be some slippage mainly due to a revenue shortfall, a serious issue that needs strong and immediate remedial measures. Current expenditure is likely to be contained as expected. Any reduction of much needed capital expenditure to maintain the deficit targets may result in negative effects on expansion in potential growth. It is essential to continue the favourable developments that have been achieved in the recent past, despite setbacks in some areas. The public needs to be made aware continuously of the need for economic reforms to improve the effectiveness of the reforms and obtain wider public participation in the reform process. As a % of GDP Total revenue Current A/C deficit Fiscal Policy Strategy Chart 9.1 Fiscal Developments Est. Total expenditure & net lending Overall deficit The fiscal policy strategy in 2003 focused on continuing the three principles introduced in Budget 2002, viz., reduce public debt to a sustainable level, stimulate economic growth and increase employment opportunities and earning capacity, to ensure consistent economic development over the medium term. Within this policy framework, the fiscal policy strategy announced in Budget 2003 aimed at strengthening the fiscal consolidation process. The reduction of the public debt to a sustainable level has become the main theme in the overall fiscal strategy, as debt service payments have increased to an unsustainable level in the recent past. Hence, fiscal consolidation is being implemented to arrest increasing debt. Public debt management is being strengthened to support this. The FMRA indicated the fiscal targets to be maintained in the medium term. To this end, Budget 2003 announced measures aimed at enhancing revenue, reducing expenditure and improving debt management. The target was to achieve an overall deficit of 7.5 per cent of GDP and to reverse the increasing trend in the debt to GDP ratio in A decline in revenue collection, particularly tax revenue, over the years has been the major concern when planning fiscal operations. The government introduced a series of policy measures to improve revenue performance in A number of measures were proposed to expand the Value Added Tax (VAT) base, the main source of tax revenue. Among them were extending VAT to financial services and retail and wholesale businesses, correcting weaknesses in the VAT structure and improving tax administration. The income tax structure was further rationalised by reducing the highest tax rate to 30 per cent from 35 per cent. A new tariff rate of 2 per cent was imposed in Budget 2003, on most exempted imports as the average duty 50

2 rate (i.e., ratio of total duty collection to total value of imports) had declined significantly over the years. The excise tax on liquor was streamlined by consolidating total excise liabilities under the Excise Ordinance. Meanwhile, the establishment of a Revenue Authority to improve co-ordination in tax policy and administration is in progress. On the expenditure side, the government continued measures to contain expenditure introduced in Measures were taken to rationalise both current and capital expenditure with a view to reducing the overall deficit towards the medium-term targets set out in the FMRA. Strong efforts were made to contain recurrent expenditure and rupee funded nonpriority capital expenses, while encouraging the implementation of externally funded public investment programmes. Among the key measures continued to reduce the overall expenditure in the short-run, were the suspension of recruitment to the public sector, avoidance of general wage and pension increases, the rationalization in provision for defence services, better targeting of welfare programmes and limits on revenue allocation for unforeseen and unclassified expenses. Policies introduced to rationalise expenditure in the medium-term include the establishment of an independent public debt management office, the imposition of limits on government guarantees under the FMRA, continuation of the contributory pension scheme for new recruits to the public sector, the design of an overall targeted welfare programme under the Welfare Benefit Law and reforms in public enterprises. The interest cost of government debt has become the single largest expenditure item and total debt service payments exceeded the total revenue collection of the government, raising concerns on the sustainability of public debt. Therefore, Budget 2003 emphasised the need to establish an independent public debt management office to improve overall public debt management, as the responsibility for managing the public debt is dispersed among a number of institutions at present. Budget 2003 envisaged a further reduction in high cost government liabilities to the banking system in Accordingly, the government aimed at settling outstanding letters of credit (LCs) of around Rs. 14 billion with state banks, continuing the policy adopted in 2002 under which the accumulated overdrafts with the two state banks were converted into marketable debt securities. Fiscal Sector Performance in 2003 Overall Developments In 2003, the government was able to implement its annual fiscal plan as expected in Budget 2003 from the beginning of the year. This process had been disturbed during the preceding three consecutive years due to delays in presenting the annual budgets in Parliament. As a result, budgetary operations during the first 3-4 months in these years were implemented under a Vote on Account framework. The fiscal performance during the first half of 2003 showed a continuation of the consolidation process in the budgetary operations, which commenced in The overall deficit as a percentage of GDP declined to 3.9 per cent from 4.5 per cent in The primary deficit (overall budget deficit net of interest cost) and current account deficit (government dissavings) also recorded improvements. Primary deficit decreased from 1.0 per cent in 2002 to 0.4 per cent of GDP and the current account deficit declined from 2.2 per cent in 2002 to 1.8 per cent of GDP. These improvements were entirely due to the sharp reduction in non-interest recurrent expenditure, which declined from 6.7 per cent of GDP in the first half of 2002 to 5.9 per cent in

3 The revised budget outturn for 2003 indicates that the overall budget deficit is likely to increase to 7.8 per cent of GDP in comparison to the original target of 7.5 per cent. However, this estimated outcome will be an improvement compared to the overall deficit of 8.9 per cent of GDP in The primary deficit and the current account deficit are estimated to be 0.8 per cent and 2.7 per cent of GDP in comparison to the original target of 0.2 per cent and 2.3 per cent of GDP, respectively. These would be considerably lower than the primary deficit of 1.6 per cent and the current account deficit of 4.4 per cent of GDP in The original budgetary targets for tax and nontax revenue were Rs billion (14.9 per cent of GDP) and Rs billion (2.2 per cent of GDP), respectively. The major cause for the shortfall in revenue collection in 2003 would be the decline in the revenue from VAT. This decline is expected mainly due to the contraction of the VAT base, postponement in implementing tax proposals, weaknesses in the tax systems, tax amnesty issues and poor tax administration, as well as overestimation of revenue from VAT. Revenue Tax revenue will be significantly lower than the original targets in The major factors that contribute to the decline are the contraction of tax bases, postponement and delays in implementing some tax proposals, weaknesses in the tax systems, the tax amnesty, tax administration issues and overestimation of revenue. During the first half of 2003, tax revenue collection declined to 6.1 per cent of GDP from 6.6 per cent in the preceding year. The underperformance in the collection from VAT and corporate income tax was the main cause for this poor performance. In contrast, non-tax revenue increased to 1.5 per cent of GDP from 1.3 per cent in This increase was mainly due to unanticipated non-tax receipts from the insurance sector. The revised annual estimates for 2003 indicate that total revenue of the government will fall short by about Rs billion from the original target of Rs billion (17.1 per cent of GDP) to Rs billion (16.4 per cent of GDP). This shortfall will be the combined outcome of expected decline in tax revenue by Rs billion to Rs billion (14.1 per cent of GDP) and expected increase in non-tax revenue by Rs. 3 billion to Rs billion (2.4 per cent of GDP). A decline is expected in revenue collection from the corporate tax as a result of the reduction in the tax base, removal of Advanced Company Tax (ACT), deviation of taxation policy from the global income approach, the effect of the tax amnesty and weaknesses in tax administration. In addition, revenue collection from the debit tax and licence fees is likely to be below target. However, revenue from excise taxes is expected to be maintained at the budgeted level. Meanwhile, the higher than anticipated revenue expected from withholding taxes and VAT on financial services, would help recoup the loss to some extent. Corrective measures taken after the mid-year fiscal review, such as the extension of the coverage of VAT to any person providing financial services, restriction of input tax credit entitlement on assets acquired to be made available to 10 per cent under VAT, upward revision of excise tax on cigarettes, liquor and petroleum products and upward revision of customs duty of 2 per cent to 2.5 per cent will help to minimise the revenue shortfall in

4 Collection from import duty is expected to be better than anticipated mainly due to the expected increase in imports and the imposition of duty on most non-dutiable imports. Correspondingly, the collection from the Ports and Airports Development Levy (PAL) on imports is expected to be maintained at the budgeted level. Revenue from other taxes is estimated to be lower than expected mainly due to the inability to implement the planned special charges on radio frequencies and number blocks in the telecom sector as announced in Budget The collection of non-tax revenue is estimated to be better than the target in the Budget mainly due to unanticipated revenue transfers, such as a special levy on the Strike, Riot, Civil Commotion and Terrorism Fund and National Savings Bank (NSB) and dividends transferred from Sri Lanka Insurance Corporation (SLIC). Expenditure The containment of the non-interest recurrent expenditure helped to reduce recurrent expenditure during the first half of To contain non-interest current expenditure the government stopped hiring personnel and avoided granting ad hoc salary increases. The continuing peace process helped contain defence expenditure. The government strictly controlled releasing cash for non-priority purposes. Welfare policies were better targeted. Expenditure on interest and public investment remained at the same level as in the previous year (3.5 per cent of GDP and 2.2 per cent of GDP, respectively). Accordingly, total government expenditure in terms of GDP declined from 12.4 per cent in the previous year to 11.5 per cent. According to the revised annual estimates for 2003, total government expenditure and net lending are estimated to decline by Rs.4.5 billion to Rs billion (24.3 per cent of GDP). Recurrent expenditure is expected to be reduced from 20.8 per cent (Rs billion) in 2002 to 19.2 per cent of GDP (Rs billion). This will be mainly due to the savings in interest payments, and pensions. However, expenditure overruns are expected on salaries and wages, and departmental enterprises as well as expenditure on flood relief to households. The shortfall in revenue collection would compel the government to restrict the release of funds for low priority capital expenditure programmes to arrest the widening resource gap. As a result, public investment is estimated to decline by Rs.3 billion to Rs.92 billion (5.1 per cent of GDP). Meanwhile, low repayment on onlending activity by public enterprises, particularly as a result of the weak financial position of the CEB, would however, increase net lending in Financing The overall budget deficit during the first half of 2003 amounted to 3.9 per cent of GDP (Rs.69.6 billion). In financing the resource gap, net resources available from external sources (loans and grants) amounted to 0.9 per cent of GDP (Rs.15.9 billion) during the first half of

5 The total privatisation proceeds realised for the financing of budgetary operations amounted to 0.3 per cent of GDP (Rs.6.1 billion). These relatively higher receipts from external sources and the privatisation programme, as well as the reduction in the total resource gap during the first half of 2003, contributed to lower borrowings from the domestic market. Reflecting these favourable developments, the total amount of domestic borrowing, on a net basis, decreased to 2.7 per cent of GDP (Rs.47.7 billion) during the first half of 2003 in comparison to 4.2 per cent (Rs.67.2 billion) in the previous year. This helped to reduce pressure in the domestic financial market, thereby facilitating reductions in domestic interest rates and increasing the resources available to the private sector for economic activity. The lower level of government borrowings, excess liquidity in the market and reductions in the Central Bank s policy rates (Repo and Reverse Repo rates) resulted in a significant decline in interest rates in the domestic market. million through the Citibank - NEXI loan and US dollars 265 million of programme loans from multilateral and bilateral donors. The sharp increase in net external resources in the budget is a significant improvement compared with the lower level of foreign resources received for budgetary financing in the recent past. The privatisation programme is expected to generate Rs.13.5 billion to finance budgetary operations. This includes the divestiture of Sri Lanka Insurance Corporation (SLIC) (Rs.6 billion) and a part of the proceeds from the proposed liberalisation of petroleum import and supply (total US dollars 75 million). A part of the privatisation proceeds will be used to reduce CPC s existing bank loans. The other divestiture programmes include the sale of the government s shares in NDB, Shell Gas and plantation companies. The improved liquidity situation that prevailed in the domestic non-bank sector contributed to a reduction in the government s liability to the banking system by Rs.13.2 billion during the first half of That was the net outcome of a reduction in government liabilities to the Central Bank by Rs.18.2 billion and an increase in government liabilities to commercial banks by Rs.5.0 billion resulting from an increase in their investment in Treasury bills and Treasury bonds. According to the revised budget outturn, the total resource gap in 2003 is estimated to be Rs billion (7.8 per cent of GDP). External resources (loans and grants) available in 2003 to finance the budget deficit are estimated at Rs.49.1 billion, which is the net outcome of gross borrowings of Rs.74.4 billion, foreign amortisation payments of Rs.34.2 billion and foreign grants of Rs. 8.9 billion. The gross borrowing programme includes the commercial borrowing of US dollars 100 Accordingly, the balance resource requirement of Rs.77.7 billion, which is lower than the original estimate of Rs.87.3 billion, is expected to be raised from the domestic sources. As resource availability in the non-bank sector is estimated to be Rs.120 billion, the entire resource requirement could be raised from domestic nonbank sources without imposing pressure on interest rates in the market. The liabilities to the banking system would be further reduced significantly in 2003, continuing the repayment process that commenced in This would also help to improve the monetary management process in the economy. 54

6 be Rs (12.3 per cent of GDP), and Rs billion (7 per cent of GDP), respectively. Total debt service payments would account for about 118 per cent of the total revenue collection in 2003 thereby requiring new borrowing even to finance debt service payments in addition to the borrowing needs to cover all other expenses of the government. Government Debt Unlike in the recent past, government s outstanding debt stock is expected to grow at a lower rate than nominal GDP in As a result, the debt to GDP ratio is estimated to decline from per cent in 2002 to per cent, reversing its rising trend. The containment of the overall deficit, net of privatisation and after grants (Rs billion or 6.6 per cent of GDP), the slower depreciation of the rupee against major currencies and higher growth in the economy would be the main contributory factors to reducing the debt to GDP ratio in The significantly higher amount of amortisation payments, which was seen in 2002 as well as in 2003, was mainly a result of the bunching of maturities due to the medium-term borrowings raised before 2002, when the domestic market interest rates were at very high levels. However, this problem would be eased from 2004 with the smoothening of the maturity structure of the outstanding debt, thereby creating more room for maneuver in the budgetary process. Although the debt to GDP ratio will be lower than at the end of the previous year, further action is necessary to strengthen debt management and the deficit financing process, not only to reduce the debt, but also to reduce the burden of interest cost on the government budget. Debt Service Payments Debt service payments in 2003 are estimated to be Rs billion (19.3 per cent of GDP), of which amortisation payments (including early retirement of optional Rupee loans amounting to Rs billion) and interest payments will According to revised estimates, interest payments will be Rs. 4.4 billion lower than in the original estimates, 2003, mainly due to the decline in market interest rates and the replacement of high cost debt with debt instruments with lower rates of interest. However, the interest cost is the largest single expenditure item, absorbing about 43 per cent of the estimated revenue in 2003, leaving only just over half the government revenue for other priority expenditure and much needed investment. This situation emphasises the need for improving the debt management strategy of the government to lower interest costs in the future. Fiscal Sector In order to maintain the medium-term fiscal targets and overall macroeconomic stability, the overall budget deficit is expected to be contained 55

7 at about 6.5 per cent of GDP in 2004; a level compatible with the other macro variables and the medium-term fiscal strategy. At the same time, it would be necessary to maintain public investment at a level of 6 per cent of GDP to provide adequate infrastructure to facilitate private sector led medium-term growth momentum. Hence, the budget deficit has to be reduced through current operations (i.e. raising revenue and curtailing current expenditure), without dampening activities in the economy. Revenue collection in 2004 is expected to increase with continued recovery in the economy. The establishment of the proposed Revenue Authority would help to improve tax administration and increase tax collection. In the context of international trade related taxes, the expected increase in imports would help to raise revenue collection in Meanwhile, total expenditure in terms of GDP, is expected to continue the declining trend observed in the previous year. The decline in recurrent expenditure is expected mainly through reductions in interest payments, transfers to households and expenditure on other goods and services. Meanwhile, if granted in 2004, the proposed salary increase to public sector employees would increase expenditure on salaries and wages and transfer payments to institutions. Public investment is also expected to increase in It is expected that public enterprises (especially the CEB) would honour their repayment commitments to the government on their on-lending, thereby helping to contain overall capital expenditure and net lending at a compatible level. The expected improvement in the fiscal sector in 2004 is entirely based on the implementation of strong fiscal measures, coupled with the continuation of high growth in economic activity and low inflation. The projections on the fiscal performance are based on several assumptions, mainly a continuation of the current peace process, no general elections or election related fiscal incentives, and effective utilisation of donor support pledged under the PRGF-EFF and the Tokyo donor conference. However, the success of achieving the expected fiscal consolidation targets are highly dependant on strong policy commitments and close monitoring of the performance of both revenue generating as well as expenditure incurring units. The realisation of the overall fiscal target therefore, would depend on the government s ability to sustain the above assumptions. In addition, the government should actively participate as a facilitator to accommodate the overall development of the economy. The continuation of awareness programmes to educate the general public about the on-going fiscal consolidation measures and structural reforms and their long-term benefits is necessary to generate public support, without which achieving the medium-term goals would be a difficult task. 56