Budget 2009: Political war dividend or economic crisis differed?

by Muttukrishna Sarvananthan

(December 07, Colombo, Sri Lanka Guardian) In any democratic country, the annual budget of the government is, by and large, a political economic document rather than purely economic, as most economists would like it to be. Hence, economic rationality and economic prudence gives way to political oportunism and manoeuvring. The government’s budget for 2009 presented to the Parliament last month is no exception to this.

Basking on the relentless successes in the battlefields of the north and electoral successes in three provinces for which elections were held during this year (2008), politically astute Chief Executive Officer (President) cum Chief Financial Officer (Minister of Finance) of the government unveiled a populist budget aimed at further wooing the masses keeping in mind the upcoming five Provincial Council elections early next year (2009), which could perhaps lead to a snap Parliamentary election. Although the budgetary allocation of just Rs 1.1 billion for the Department of Elections in 2009 is not adequate for a snap Parliamentary election (on top of the five provincial council elections already in the pipeline), the government could always allocate more money to the Department of Elections through a supplementary budget.

The budget was presented amidst growing gap between the government revenue and expenditure in the domestic sector of the economy, and huge increase in trade deficit and declining total foreign exchange reserves (i.e. deteriorating balance-of-payments) in the external sector of the economy. Thus, the budget deficit increased by 22.5% to Rs 249.3 billion in the first nine months of 2008 from Rs 203.5 billion in the same period last year. Similarly, trade deficit increased by 88% from USD (-) 2,453 million in the first nine months of 2007 to USD (-) 4,613 million in the corresponding period this year. Total foreign exchange reserves stood at US$4,543.5 million at the end of September 2008, marginally higher (0.7%) than at the end of 2007 (US$4,511 million), but have been declining since the end of July 2008. Moreover, annual economic growth, in terms of the Gross Domestic Product (GDP), has been declining to 6.8% in 2007 and 6.5% in 2008 (anticipated) after peaking to 7.7% in 2006.

The global financial crisis is taking a toll on the balance-of-payments of Sri Lanka due to the withdrawal of some foreign portfolio investment in the Colombo Stock Exchange (CSE). However, rapidly declining fuel prices in the world market (crude oil price dipped to less than US$50 a barrel during November 2008) is expected to offset the partial withdrawal of foreign portfolio investment by way of reducing the trade deficit during the last quarter of this year. Besides, inflation dropped dramatically to 16.3 in November after peaking to 28.2% in June 2008, although the former figure appears to be questionable. Despite the tight fiscal and external economic environment, the Finance Minister announced pay hikes to public servants and pensioners (by way of cost of living allowances) and reduction in public & private transport fares (bus and rail) due to declining fuel prices aimed at appeasing the masses reeling under sustained rise in cost of living until the middle of this year, which has been declining since July but still remaining high. There is a call for import substitution in the budget that has resulted in imposing import duties on additional products and hiking the existing rates of import duties of many goods in order to contain the huge rise in trade deficit. Though this strategy seems economically irrational, politically it could be rewarding for the government. It is this conflict of interest between the politics and economics of government budgets that makes governments get away with irrational and imprudent economic policies. The present government is no exception to this norm.

The overall public expenditure would increase by 15.6% to Rs 1,719 billion earmarked for 2009 from Rs 1,487 billion earmarked for 2008, which is expected to be more or less the same as the rise in inflation during 2009 but more than double the expected rate of economic growth. However, the budgetary allocations for the top 12 high spending ministries are expected to decline in real terms, i.e. the rates of increase in budgetary allocation are lower than the anticipated rate of increase in inflation. For example, expenditure on defence is expected to rise by only 6.4% in 2009, which would be lower than the anticipated rise in inflation during 2009 (that could still remain in double digit). Besides, the earmarked rate of increase in defence expenditure for 2009 is expected to be almost the same as the anticipated growth in GDP in 2009 (6-6.5%).

However, during the past 20 years or so, the actual defence expenditure has surpassed the earmarked allocation in every single year. In contrast, the actual expenditures of other Ministries have been lower than the earmarked expenditures, including for education, health and poverty alleviation. Further, defence expenditure does not include pensions for the retired armed forces personnel (which is covered by the Department of Pensions under the Ministry of Public Administration) and disability benefits for the injured soldiers (which is covered by the Ministry of Social Services and Social Welfare). Therefore, the actual expenditure on the armed forces would be much greater than that is reflected in the budgetary allocation for the Ministry of Defence.

The top 12 high spending Ministries would account for 77% of the total public expenditure in 2009 (out of a total of 55 Ministries). Almost one-third of the total public expenditure in 2009 would go for repayments of public debt (both amortisation and interest) as reflected in the allocation for the Ministry of Finance & Planning. Second highest share of total expenditure is for Defence, which is little over 10%. Ministry of Provincial Councils & Local Government (6.4%), Ministry of Public Administration & Home Affairs (5.2%) and Ministry of Highways & Road Development (4.5%) account for the third, fourth and fifth highest shares of public expenditure .

The top four highest spending Ministries (Finance, Defence, Provincial & Local Government and Public Administration) have remained the same for a very long time. Bulk of the budgetary allocation for the Ministry of Finance & Planning goes for public debt repayment. We also have to remember that bulk of the defence expenditure goes for the payment of salaries and allowances for the personnel of the armed forces and the police and not for capital expenditure. Likewise, bulk of the budgetary allocation for the Ministry of Provincial Councils and Local Government is spent on salaries and overtime payments to public servants at the provincial and local tiers of government. Similarly, bulk of the budgetary allocation for the Ministry of Public Administration and Home Affairs goes for the payment of pensions of retired public servants including armed forces personnel, which is growing fast due to an ageing population. In contrast, bulk of the budgetary allocation for the Ministry of Highways & Road Development would go for capital expenditure, i.e. 99.8% of the total.

Thus, in the five year period under consideration (2005-2009), about two-thirds of the public expenditure had gone for the salaries and allowances of public administration personnel, pensions of past personnel and public debt repayments. Moreover, a significant amount of the budgetary allocations of the Ministries of Education and Health are spent on salaries, overtime payments and cost of living allowances of the personnel employed in these Ministries. Therefore, the total cost of all public services would be even higher. However, public debt repayments include capital expenditure of the government (public investment) in the past as well. Total government revenue (tax plus non-tax revenue) has not been sufficient to meet even the recurrent expenditures of the government in the past twenty years (since 1989).

The foregoing facts and figures indicate that a crisis has been brewing in the economy for a very long time under different governments. The approach of successive governments has been to differ the crisis to the future, except during the period 2002-2003 when a genuine attempt was made to rein on public expenditure and public debt by the then short-lived government. In many democracies incumbent governments attempt to pass the buck on crises in public finances to future governments. The present government has been very successful in using or abusing the political war dividend to differ the looming economic crisis, which to a large extent was created by the enduring civil war.

In spite of double-digit inflation for more than two years now, the government has been successful in weathering public unrest because of the political war dividend created by sustained successes in the theatres of war in the East and North, which continues to date. In summary the political war dividend has been able to postpone the economic crisis. However, it remains to be seen how long the political war dividend could differ the economic crisis.

(The writer is the Principal Researcher of the Point Pedro Institute of Development, Point Pedro. He is currently a Fulbright Visiting Research Scholar at the Elliott School of International Affairs, George Washington University, Washington, U.S.A. Corrections, comments and suggestions are welcome to sarvi@gwu.edu). - Sri Lanka Guardian