ECONOMYNEXT – Sri Lanka’s budget deficit has collapsed to 361 billion rupees up to April 2024 from 824.2 helped by higher tax revenues and a falling interest bill, official data show.
Revenues surged 48 percent to 1,216 billion rupees to April 2024, ahead of the 35 percent annual growth projected in a budget, with higher value added and income tax rates as well as economic activity recovering close to previous levels.
Sri Lanka is emerging from the worst case of ‘policy support’ deployed by macroeconomists since the central bank was set up in 1950 where the usual inflationary rate cuts which trigger currency crises and IMF programs, was also backed up tax cuts.
Giving policy support and denying monetary stability has become mainstream in the age of inflation and ‘age of external defaults without a war’ due to so-called Saltwater-Cambridge doctrine, critics say.
However, Sri Lanka is now starting to grow without any ‘policy support’ as monetary stability was provided by the central bank with nominal growth in the first quarter at 8.3 percent (real growth 5.3 percent) and market rates.
Inflation as measured by the consumer price index at around 3 percent for 21 months providing a strong foundation for growth, as the 5-7 percent inflation target was undershot.
Tax revenue went up 51 percent to 1,117 billion rupees, and non tax revenues 27 percent to 98.3 billion rupees.
Interest Bill
Current spending fell absolutely by 4 percent to 1,419.3 billion rupees, with wage restraint.
The interest bill has also started to fall after debt restructuring and confidence from monetary stability as debt is re-financed at lower rates.
Analysts however warn that the steady easing of interest rates may be hit roadblocks due to a ‘flexible exchange rate’ backed by ad hoc or inconsistent policy, that deliver simultaneous confidence shocks to both exchange and credit markets.
Sri Lanka is going through such an episode in June.
The interest bill fell to 726.1 billion rupees in the first four months of 2024, from 819 billion rupees a year earlier.
Capital spending was kept at 159 billion rupees for the first four months from 160 billion rupees last year with foreign loan backed projects being stopped due to a sovereign default.
The overall budget deficit was 361.1 billion rupees down 56 percent from 824.3 billion rupees last year.
The primary deficit was 365 billion rupees, with the high interest bill exceeding the overall budget deficit.
Sri Lanka has had very few years with a primary surplus, where the interest bill was so high that it exceeded the overall budget deficit.
Sri Lanka’s interest bill started to soar under so called flexible inflation targeting (printing money to target a high inflation rate without a clean floating exchange rate) which triggered multiple currency crises after the end of a civil war.
The serial currency crisis led to a slowing growth as stabilization policies were applied, expanding debt from budget deficits which in turn were pushed up by high nominal rates.
In an IMF stabilization program, the primary deficit is targeted as the interest rates have to be driven to unusually high levels to restore confidence in the national currency broken by previous rate cuts made to target potential output or inflation or both.
Current Account
In the four months to April 2024 balance in the current account or total revenues less current spending, the ultimate measure of good budgeting, also narrowed to 203 billion rupees from 664.9 billion rupees.
Ideally a country should at least run a surplus in the current account of the budget, where current spending does not exceed total revenues and only borrow to finance capital spending.
The primary surplus could come under pressure in the future from a falling interest bill and also higher capex which can boost the budget deficit.
If the current account deficit is trimmed in line with the increase in capex, with expenditure restraint as revenues to up, the debt burden will fall.
Sri Lanka’s public sector wages however have not been adjusted upwards in line with the inflation created by the central bank in the last crisis. Substantial amounts of taxes paid by the people, will also have to be used for salary hikes in 2025, unless the public sector is allowed to reduce.
After the break-up of the Bretton Woods in 1971 most countries lost the ability to run surpluses, as monetary standards deteriorated making it difficult to run budgets.
The Clinton-era US at the tail end of the Great Moderation ran surplus budgets shortly before Ben Bernanke misled Greenspan into reflating the economy from 2000 claiming there was ‘deflation’ (Deflation: Making Sure “It” Doesn’t Happen Here).
(Colombo/June29/2024)