ECONOMYNEXT – Sri Lanka’s state salary bill fell to 49 percent of taxes in the nine months to September 2023, or levels seen before revenue based fiscal consolidation pushed up spending and potential output targeting triggered growth shocks.
Sri Lanka’s salary bill was 47 percent of taxes in 2014 before spending started to ratchet up under ‘revenue based fiscal consolidation.’
The fall came amid classical fiscal consolidation involving revenue as well spending based consolidation.
Heedless Spending
Revenue based fiscal consolidation advocated by the International Monetary Funds was a never-before-heard-strategy where spending-based-consolidation (expenditure restraint) which is the main plank of classical fiscal consolidation was abandoned.
Spending which was around 17 percent of GDP in 2014 went to 20 percent over the next few years under ‘revenue based fiscal consolidation.’
Classical economist B R Shenoy warned Sri Lanka in the 1960s when the country started its first IMF program after printing money (mostly for rural credit re-finance), not to engage in revenue based fiscal consolidation, which he called a ‘statistical alternative of balancing the budget’.
“This alternative is beset with pitfalls,” Shenoy warned in a report commissioned by ex-President J R Jayewardena.
“Past experience in Ceylon, which is in line with experience in virtually all parts of the world, is that in a democratic set up political and other pressures are heavily on the side of more and more spending by the government.
“When Revenues increase, under the weight of these pressures, expenditures too increase to meet, or even exceed, Revenue collections. In Ceylon during the past seven years Revenues rose by 45 per cent and Expenditures charged to Revenues by 48 per cent.”
From December 2014 to November 2019 tax revenues went up 65 percent to 1,612 billion rupees and recurrent spending went up 55 percent to 2,053 billion rupees, before taxes were cut in December to target ‘potential output’.
Revenue based fiscal consolidation, which is in line with a ‘heedless spending’ ideology that emerged among English speaking academics (US ‘progressives’ or post-Keynesians) combined with nationalized central banks, led to a spike in spending to GDP as salaries and subsidies were hiked with no restraint from 2015.
Printing Money for Growth
The IMF also taught Sri Lanka to calculate a ‘potential output’ leading to the central bank cutting rates to close an output gap by inflationary open market operations (aggressive macro-economic policy) leading to serial currency crises.
The currency crises were followed by output shocks including under an IMF program, missing reserve targets, and stabilization policies kicked in. The monetary debasement has also led to high nominal interest rates and an increasing interest bill.
As repeated output shocks came from the deployment of macro-economic policy until 2019 followed by stabilization, economic bureaucrats deployed even more aggressive macro-economic policy in 2020 involving more money printing and coupled with tax cuts, to target what was said to be a ‘persistent output gap.’
In 2019 following a change in government, revenue based fiscal consolidation was also reversed by cutting taxes and only potential output targeting was left. The country then defaulted in 2022 and finally rates were allowed to go up by restraining open market operations to prevent possible hyperinflation.
The Supreme Court haw now faulted the economists, as well as the Monetary Board of the central bank for triggering the crisis as well as the President and Finance Minister.
Countries with bad money and depreciating currencies tend to have high nominal interest rate.
Sri Lanka has a large public sector and an over-large military, but according to the IMF and World Bank 20 percent of GDP is a very reasonable amount for rulers and bureaucrats to take and spend as they wish based on econometrics.
Last year out of a 960 billion rupees salary bill 222 billion went to the military.
Under fresh efforts to stabilize finances taxes have now been raised by the current administration.
The current administration and the current Treasury Secretary is also engaging in spending-based -consolidation and the country has returned to classical fiscal consolidation.
The public sector has now started to shrink amid retirements and hiring freezes. A salary hike was proposed by President Ranil Wickremesinghe along with a hike in Value Added Tax. (Colombo/Nov15/2023)