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Increasing fiscal deficit threat to economic stability Vote_lcap68%Increasing fiscal deficit threat to economic stability Vote_rcap 68% [ 178 ]
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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Increasing fiscal deficit threat to economic stability

Increasing fiscal deficit threat to economic stability

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Redbulls

Redbulls
Director - Equity Analytics
Director - Equity Analytics

Written by Arthika Vishleshaka

The slowdown in economic growth and the widening trade deficit and balance of payments problem are what have drawn most attention. The deteriorating fiscal position is now seen as a serious threat to economic stability and economic development. If the fiscal deficit reaches higher proportions, the inflationary pressures it generates would destabilize the economy and the economic growth momentum adversely affected even after the current global recession passes away.

The current economic downturn in most sectors is making it hard to achieve this year’s ambitious fiscal deficit target of 6.2 percent of GDP. While public expenditure is increasing, revenue has fallen below budgeted amounts thereby widening the fiscal deficit. The widening fiscal deficit could pose serious repercussion to the economy. It is, therefore, of utmost importance that measures are taken to increase revenue and reduce expenditure so that the deficit will not rise again to high proportions and threaten economic stability and growth.

Fiscal target
Realizing the importance of keeping the fiscal deficit to reasonable proportions, the Treasury is intent in containing the fiscal deficit to its target of 6.2 percent of GDP. However, the adverse economic developments are making it difficult to achieve it. The budget deficit has doubled in the first four months of 2012, with current spending growing at twice the rate of tax revenues. While revenues grew by 7.2 percent to Rs.305.5 billion, current spending increased by 23.4 percent to Rs.445.3 billion rupees. The fiscal deficit, that is the gap between total revenues and current expenses, rose 86 percent to Rs.139.8 billion equal to 1.8 percent of projected gross domestic product.

The treasury is of the view that the fiscal operations in the year as a whole are expected to remain consistent with the targeted deficit of 6.2 percent of GDP. It is difficult to understand how the fiscal deficit could be contained as revenues have fallen and will continue to decline as the economy is not faring well with several sectors that contribute tax revenue likely to decrease output, thereby, decreasing revenue. The lower growth in imports and internal trade is an instance of such lower activity. Exports are also declining. Furthermore, the drought that destroyed food crops and tea production would add to reduced economic activity and hence lower revenue collection from indirect taxes.

Fiscal outturn
The budget for 2012 hoped to collect a trillion rupees in taxes. This was up 23.6 percent higher from that of 2011. As it turned out, revenue during the first four months of this year was 4.4 percent less than during the first four months of last year. Tax revenues grew 10.7 percent to 276.4 billion rupees and non-tax revenues fell 17.5 percent from a year earlier to 29.0 billion rupees. As to be expected tax revenues were below the target owing to the current economic conditions. Total revenue and grants grew 7.49 percent year-on-year to Rs.307.7 billion.

Public expenditure
In contrast to revenue collection, public expenditure increased significantly. Current expenditure increased substantially by 23.4 percent to Rs.445.3 billion rupees. This was due to fertilizer subsidies doubling, interest expenses ballooning to Rs.173.6 billion from 142.2 billion rupees in 2011 and other recurrent expenditures increasing. The fertilizer subsidy had more than doubled to 13.0 billion rupees from 5.6 billion rupees in the first four months of this year compared to the same period last year. Recurrent expenditure reached 5.9 percent of GDP, up from 5.6 percent in 2011 and public investment reached 2 percent of GDP from 1.6 percent. The finance ministry had also stepped up net capital expenditure by 46 percent to 143.8 billion rupees.

Fiscal deficit
The budget deficit during this period amounted to 3.8 percent of GDP, up from 2.7 percent year earlier. The gap between total revenues and current expenses rose 86 percent to 139.8 billion rupees equal to 1.8 percent of projected GDP that is also likely less than the projected figure.
The Finance Ministry explained the fiscal performance: “The first four months outcome reflects the impact of revenue lags and expenditure leads and higher revenue and moderation of expenditure is expected in the second half of the year. Hence, the fiscal operations in the year as a whole are expected to remain consistent with the targeted deficit of 6.2 percent of GDP. The measures taken to provide support for local industries such as the reduction of duty waiver on milk powder imports, increase of Special Commodity Levy (SCL) on sugar, etc. in the wake of declining commodity prices in the international market that required local economy safeguard and commitment controls are conducive for fiscal consolidation.”

Growing fiscal deficit
Among the reasons for the large fiscal deficits over the years are the limited revenue base of only about 15-17 percent of GDP, huge expenditure on public service salaries and pensions, big losses in public enterprises, wasteful conspicuous state consumption expenditure, subsidies and welfare costs and the large debt servicing cost itself. The large public debt has itself led to a massive debt servicing burden. A large proportion of current revenue is used to meet the costs of servicing this debt. Therefore, the government has to resort to further borrowing to meet its recurrent as well as capital expenditure. This results in further increases in debt servicing costs. The economy is caught up in this vicious cycle of a debt trap. In 2002, the public debt was 105 percent of GDP. In subsequent years it was brought down as a proportion of GDP. In 2007, it was 85 percent of GDP; in 2008, it was 81 percent of GDP and in 2009 it was 86 percent of GDP. In 2011, the public debt as a proportion of GDP was brought down to 78.5 percent.

Although the public debt has increased substantially, the debt to GDP ratio has declined owing to increases in the GDP. There is a possibility that the debt:GDP ratio would increase again owing to the deficit increasing due to shortfalls in revenue and increased expenditure. Apart from the increases in expenditure that have already occurred, there is possibility of wage increases, higher losses in public enterprises, drought relief and government expenditure increases owing to the provincial council elections.

An increase in the fiscal deficit would have serious repercussions on inflation and increase the public debt significantly. The reduction of the public debt and its servicing cost is a prerequisite for economic stabilization and growth.
The containment of the fiscal deficit to a reasonable level is recognized as essential. In December 2002, the Fiscal Management Responsibility Act (FMRA) made it mandatory for the government to take measures to ensure that the fiscal deficit is brought down to 5 percent of GDP in 2006 and kept at that level thereafter. As it turned out, the fiscal deficit was 8 percent of GDP that year and averaged 8 percent of GDP in the five years (2004-2008). In each of the two years (2007 and 2008) the fiscal deficits were 7.7 percent of GDP and reached 9.8 percent of GDP in 2009. Since then it was brought down and the target for this year was 6.2 percent of GDP. Will this be realized?

Repercussions
Containing the fiscal deficit is vital for the country’s economy. A large deficit means that it would generate inflationary pressures. This in turn would increase the costs of production and erode the country’s competitiveness in international markets. This necessitates the depreciation of the Rupee to remain competitive with other countries’ lower rates of inflation. Otherwise, the lesser export earnings would increase the trade deficit that would be a strain on the balance of payments. Reduced export earnings imply loss of employment and lower incomes to workers in the industries affected, as has been experienced recently in the e garments industry when exports decreased owing to the global recession.

Conclusion
In the first four months of 2012, the budget deficit doubled with current spending growing at twice the rate of tax revenues. The shortfall in revenue is understandable in a context of economic downturn. Expenditure is what was expected to be contained in the face of the adverse economic performance, However, government expenditure continued to increase beyond the levels originally anticipated. The adverse economic developments and increased government expenditure would undoubtedly increase the fiscal deficit this year unless the resolve of the Finance Ministry to contain it to 6.2 percent of GDP ensures a curtailment of government expenditure.
http://www.nation.lk/edition/opinion/item/8223-increasing-fiscal-deficit-threat-to-economic-stability.html

Hawk Eye

Hawk Eye
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We dodnt have Mahathir Mahammeds or Lee kwan yews. we have Alibaba and the 40 thieves.

Whitebull


Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics

How fast some of our people forget the past.......

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