ECONOMYNEXT – Sri Lanka is planning to cut the budget deficit to 6.8 percent of gross domestic product in 2023 from an expected 9.9 percent in 2022 with a combination of tax hikes and spending cuts, cabinet spokesman Minister Bandula Gunewardena said.
The cabinet of ministers had approved a fiscal framework for 2023-2025.
“Sri Lanka is facing the worst fiscal crisis in its history,” Minister Gunewardena said. “We have to eventually bring down the deficit to 5 percent of GDP to manage debt, reduce money printing and have low inflation.”
“We will reduce the deficit by increasing revenues (revenue based fiscal consolidation) and cutting spending (spending based consolidation).”
Sri Lanka expects to increase state revenues to 11.3 percent of GDP in 2023 from 9.1 percent this year.
Government spending will be cut to 18.1 percent of GDP from 18.9 percent.
Sri Lanka saw spending as a share of GDP shoot up after abandoning spending based consolidation under a ‘revenue based fiscal consolidation’ in an unusual illiberal or leftist-progressive move.
Though taxes were raised there was no strong gains in deficit control as spending to GDP rose from around 17 to 20 percent of GDP.
The overall budget deficit tends to be high immediately after a currency crisis due to high interest rates required to smash private credit, reduce outflows and restore the credibility of the soft-peg.
The credibility of soft-peg is usually broken and forex shortages are triggered by sustained money printing for post-sterilization of reserves used for imports (money printed to stop reserve money adjusting downwards) or to keep interest rates artificially low or in some cases deficit finance.
Soft-pegged countries (now called a flexible exchange rate) then go to the IMF which asks for monetary tightening and deficit reduction, usually amid social unrest and impoverishment caused by currency collapses.
Sri Lanka is to begin a round of discussions with a visiting International Monetary Fund this week.
The primary deficit (before interest costs) will be reduced from a negative 4.0 percent of GDP to a negative 1.0 percent of GDP, Gunewardena said.
A primary deficit target reduces the incentive for a third world currency crisis prone central bank to attempt to keep rates down by printing money.
Sri Lanka began to print money through open market operations from around September 2014 triggering currency crisis in 2015/16 and 2018 under flexible inflation targeting with a reserve collecting peg combined with output gap targeting.
The currency crises were followed by output shocks (low growth).
In 2020 unusual levels of money was printed by crippling Treasuries auctions with price controls and taxes were also cut saying there was a ‘persistent output gap’, eventually triggering the worst currency crisis in the history of the soft-pegged central bank and a default of foreign debt.
Sri Lanka will also have to shutdown loss making state enterprises and reform them to improve state enterprises, Minister Gunewardena said.
There were discussions about offering a voluntary retirement scheme for state media employees, he said. (Colombo/Aug23/2022)