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Monday May 17th, 2021

Sri Lanka to restrain budget deficits by law: CB Governor

ECONOMYNEXT – Sri Lanka will strengthen a fiscal law to make it difficult to overshoot budget deficit and national debt targets so that the economy will be stable and people can become prosperous, Central Bank Governor Indrajit Coomaraswamy said.

Sri Lanka already has a Fiscal Management Responsibility Law, brought in 2003, after national debt went over 100 percent of gross domestic product, but its deficit and debt reduction targets have been breached in almost every year.

Analysts say Sri Lanka no longer has a civil war, and the war is the desire by Marxist-nationalists and mainstream politicians to give state jobs, give handouts in general and fuel subsidies in particular and gamble tax revenues on state-owned businesses, that threatens stability.

Binding Targets

"The government is considering giving teeth to the Fiscal Management Responsibility Act by specifying the reasons why you can go outside the target," Governor Coomaraswamy told a forum at the Ceylon Chamber of Commerce.

"For instance there could be a major shock to the economy, resulting in a severe recession, in which case clearly you will need counter-cyclical fiscal policy to pump demand into the system in order to bring about a recovery. So you may have to temporarily exceed the target."

"That could be a natural disaster like tsunami which requires major fiscal operations. So it will specify – if we can get this through – when the government can exceed these targets.

"And then the government must set up how it will come back – the path It must take to come back when it exceeds the targets."

This year Sri Lanka is targeting a 4.8 percent of gross domestic product deficit, which will be progressively brought down by 2020.
This year a surplus in the current budget (total revenues to exceed current spending) is expected for the for the first time since 1987, he said.

Current surpluses have been promised for many years in the past 20 years but they have not been achieved.

Fiscal Gains

Governor Coomaraswamy said recent improvements in revenue, tax laws and computerised tax operations had reduced deficits and was ‘major improvement’ in fiscal operations.
"The main source of instability has been government fiscal operations over the year," Coomaraswmay said.

Especially after 1977, Sri Lanka had been high budget deficit, high inflation, high nominal interest rate, overvalued exchange rate country, he said.

"[It is] diametrically opposite what East Asia, successful countries in East Asia had achieved," he said.

"So if we can crack the fiscal challenge we will go a long way towards stabilizing the economy and some progress has been made towards doing that."

Sri Lanka’s national debt is now around 80 percent of GDP, though it was only 16 percent when the country got independence.

Governor Coomaraswamy said in 2017, Sri Lanka was estimated to have run primary surplus in the budget (a surplus before interest costs) for the first time since 1954.

"So that partly explains why were only second to Japan in Asia at the time of independence, and now we are well behind."

Hard Budget Constraint

However other analysts point out that Sri Lanka’s fiscal profligacy is directly related to the establishment of a money printing central bank in 1951, which allowed rulers to run deficits and avoid default by currency depreciation and inflation, by abolishing a currency board.

A currency board is a hard budget constraint, which makes it difficult to deficit spend without default. Any deficit spending automatically pushes up interest rates, instantly slowing growth so there is no temporary bubble and no balance of payments crises are possible.

Even now rulers are scrambling to avoid default on foreign borrowings, as it is not possible to depreciate and rob real value of dollar denominated debt, unlike rupee debt sold to pension funds like the Employees Provident Fund.

Even in Ceylon, under British rule when money printing was allowed in the early 1800s, to issue paper Rix Dollars (which was trading above it silver value during Dutch rule) the ensuing BOP crisis led to starved children of poor people in Colombo as rice prices rocketed up, and wages lagged behind.

East Asian countries like Hong Kong and Singapore prospered with currency boards and others like Malaysia and Taiwan and China from the early 1990s operated near fixed exchange rates which economists call ‘exchange rate fixity’ to keep inflation low or matched with the US.

Classical economists have pointed out that East Asian nations ‘undervalued’ their currencies is a false charge levelled by US mercantilists in bid to force such counries to apprciate and it was simply not true.

The best performing East Asian nations had high real effective exchange (REER) rates especially when bad monetary policy led to collapses in curencies of trading partners which were in the index basket.

Economic analysts say in general East Asian countries like Hong Kong which had real currency boards had interest rates close to the US, those with better peg (like Malaysia and China) had nominal rates higher than currency boards.

However Singapore which modified its currency board to appreciate the currency when the Fed printed money and fired commodity bubbles had generally lower nominal interest rates than Hong Kong.

Poor performing East Asian nations such as the Philippines, which are net exporters of labour has a central bank like Sri Lanka, set up by the same Federal Reserve officer under US diplomatic pressure.

Indonesia where the finance minister is the central bank governor is another laggard which exports labour to the Middle East after depreciating the currency. Ironically Indonesia is an oil producer which is also rich in other natural resources. (Colombo/Jan30/2018)

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