Govt and Central Bank in a mood for fiscal consolidation

by Sanath Nanayakkare

A recap of remarks at a recent webinar hosted by the Central Bank of Sri Lanka made it evident that both fiscal and monetary authorities are in a mood for increased tax collection and reduced public spending in the medium term in order to reduce the burgeoning budget deficit in 2021.

Responding to a question from the audience whether the policymakers would take a path of revenue based consolidation in this backdrop, Mahinda Siriwardana, Deputy Governor of the Central Bank said,” You can see that as per the medium term policy framework presented by the Central Bank, revenue is expected to increase gradually and at the same time overall expenditure is expected to go down. It will be a kind of combination of revenue enhancing and expenditure reduction measures as has been announced by the government.”

“As a result, the expectation is to have improvements in both the Current Account and the Primary Account going forward. So these could be the main driving forces in the future in order to reduce the budget deficit, So I’d say the mechanism will be a combination of these two metrics.”

“There was an increase in the budget deficit in 2020. It reflected two things. There was a decline in revenue and at the same time there was an unexpected increase in the recurrent expenditure due to the ongoing pandemic. You know that the government introduced significant changes to the country’s tax policy in 2019 – the idea behind that was to encourage the economic activity. By maintaining a low tax regime in the country. However, the expectations were not entirely met given the subsequent developments, particularly due to Covid-19 and related developments. There was a 3.6% contraction in the economy. That had an impact on the expected revenue generation. At the same time there was an overrun in the recurrent expenditure as well. So the response to your question is in the Central Bank’s medium term framework,” the Deputy Governor said.

According to the Annual Report of the Central Bank, due to the economic fallout from the COVID-19 pandemic, the fiscal outcome deviated from expectations as reflected in the decline of the government revenue and a rise in government recurrent expenditure, thereby widening the budget deficit and raising the outstanding central government debt. Heavy reliance on domestic sources in financing the budget deficit in 2020 reflected the impact of extremely challenging global market conditions that limited access to foreign financing, and the expressed preference of the government to reduce the reliance on foreign financing.

Despite the limited fiscal space in 2020, the government, under extremely challenging circumstances, continued to support the businesses and individuals affected by the pandemic. Going forward, near term risks to the fiscal sector could remain elevated due to low revenue mobilisation and the large foreign currency debt service requirements. Persistent deviations of the budget deficit and the elevated level of outstanding central government debt warrant a firm commitment towards fiscal consolidation as envisaged in the National Policy Framework of the government, the CBSL Annual Report states.