Monday, June 28, 2010

Sri Lanka: Budget deficit and public debt set to balloon

By Kumar David

The expenditure estimates for 2010 (Appropriations Bill) tabled in parliament on June 8, taken with the revenue and expenditure accounts for last year (2009) make for gloomy reading. The scene is getting ugly, much rougher than I had thought, another Greece with cutbacks and political turbulence in the making. The government will try to avoid a once and for all big-bang correction in its finances and will spread the pain over a few years to limit political backlash.

The final accounts for 2009 have not been released so I have made forecasts using available Central Bank data, and also January to October 10-month data and provisional annualised data in the Lanka Business Online website of 15 February and 14 June, respectively. I have rounded off numbers to eliminate clutter and present information in easy to remember format - for example 490-something would be rounded to 500, and anything between 9.75 and 9.79% would become 9.8%.

What the numbers say

My best, and I assure you pretty reliable estimates, of what happened last year are as follows: Government Revenue was Rs.700 billion, Government Expenditure Rs.1200 billion and therefore the Deficit Rs.500 billion. Observe that current expenditure was 170% of current revenue, that is, exceeded revenue by 70%. Now this is without including debt-servicing (interest and capital repayment) schedules. Interest and capital repayments to service public (government or sovereign) debt in 2009 were Rs300 billion and Rs500 billion, respectively (the latter figure is an estimate derived from Central Bank publications) and cover both local and foreign debt. Now don’t add these to the budget deficit or you will wet your pants. The other important number to bear in mind is Lanka’s nominal GDP, which was Rs.4900 billion in 2009.

Although debt servicing was Rs800 billion, new local and foreign debt of about Rs1000 billion (one trillion) was incurred to pay this and to eat even further into our children’s future. Therefore, in 2009, as in all the years since NM paid down our debts, we have, again, been borrowing ever more in a descending spiral to service previous loans, and in addition, borrowing over and above this to shell out for the shortfall of current revenue below current expenditure; that is drowning in a deepening pool of red ink.

If all this looks gloomy, the scenario for 2010 is worse. The gross outgoings in 2010 will be nearly Rs1800 billion. Current expenditure (both recurrent and capital) will be about Rs1000 billion and Rs785 billion more is needed for debt servicing. Observe that debt servicing is 45% of the gross, current expenditure only 55%! The order of magnitude of these two percentages will reverse in 2011 or 2012. To put it in layman’s terms, what we will then incur servicing past profligacy will exceed what we spend on living and capital for new development. But read on, there is worse to come!

Grimm’s & Anderson’s Fairytales

I have given you the briefest possible outline of expected 2010 expenditure. When the Budget is tabled, a few days after you read this, you will be entertained by fairytales of how the government expects to collect revenue and promises of not drowning in red ink. If you are a World Cup addict your first thought will be: “Give the bloody Finance Minister a Red Card!”

Let me tell you the 2009 expenditure story first. The Government first said that its revenue would be Rs855 billion, collected by a variety of mythological methods such as better tax collection, less corruption - ha, ha, haa! When the fib collapsed like a pack of cards it revised the budget in mid-stream and said “Ok, ok, 2009 revenue will be only Rs730 billion”. This too was plain Grimm’s fairytales; the best estimate is that 2009 revenue will turn out to have been only Rs700 billion. Want to bet? A bottle of single malt; all takers welcome.

Let’s move on. If government revenue, plus/minus whatever you like, was Rs700 billion in 2009, what do you expect it to be in 2010? If a Red Card holding Finance Minister were to tell you he’s going to raise, say Rs900, are you dumb enough to believe him, or will you say “Go tell it to the marines”? Realistically, Rs800 billion is the upper limit for what 2010 revenue will turn out to be.

I understand new international bond floats adding to $1 billion are being planned. This would increase the nation’s indebtedness from $20 billion now to $21 billion (Rs23, 850 billion). In the course of the year more treasury bonds will be issued, IMF grants implored and other foreign and local debts incurred. All this, less the repayment component of the Rs785 billion debts servicing for 2010 mentioned before - I have not yet been able to break this into interest and repayment components - will add to sovereign debt.

Be assured that Sri Lanka’s sovereign debt by the end of the 2010 financial year will increase 10 to 15% above its end 2009 figure of Rs4100 billion (Rs4.1 trillion). That is, it will reach Rs4.5 to 4.7 trillion. This will push our debt to GDP ratio to over 90% for the first time - I estimate 2010 GDP at about Rs5100 billion assuming a growth rate of 4%. At the time when the Greek economy collapsed its debt to GDP ratio was about 120%.

Gaming the crisis

The government will have to game the crisis. Let us see if we can forecast what it will attempt. A Rs.2500 monthly salary increase was promised to public servants as an election gundu; but the government is broke so how to pay? Not to pay is to provoke a strike, but trapped between a rock and a hard place my guess is that it will dodge the commitment. The Rs.1000 billion expenditure estimate for 2010 in the Appropriations Bill is bollocks (less than even the Rs.1200 in 2009!) and the eventual figure will be about Rs.1400 billion. The Rs.1000 billion cannot include provision for this salary increase; so the government has shown its hand. Military spending however is retained at Rs200 billion; the Tamil militants have been wiped out, but dictatorship will have to deal with Sinhala opposition.

There will be slightly higher taxes on the rich, and revenue raising measures that affect everyone, including the poor, such as electricity, postal, petroleum, railway price hikes and VAT increases. However there is fear of political instability. It is after taking both aspects into account that I projected a 2010 revenue of Rs800 billion. Hence the eventual deficit will be around Rs.600 billion (1400-800). In any case the horrendous defence budget will not be touched; having finished off the Tamil militants the government still needs firepower to deal with Sinhalese militants in the next phase.

The 2009 budget deficit of Rs.500 billion was 10.3% of GDP, way above the 7% promise made to the IMF, and above 8% in the previous year, 2008. The 2010 GDP estimate of Rs.5100 billion makes a Rs.600 billion deficit 11.8% of GDP and comparable with Greece’s 12.5% at the time its economy collapsed. We are in bad company!

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