Budget and Public Expenditure

Economic and Development Journalism(SLCJ – February 06,2007

Asantha Sirimanne, ETV/LBO

What’s ahead…

Public expenditure concepts – done

How do we report budgets in Sri LankaWhat to look for/from whereRecent fiscal trends in Sri LankaDeficitsLinks with monetary policy

Some ground realities

Government gets money from people themselves and spends it.Is there any other way to get money?

Taxes/charges for servicesForeign grants/borrowingLocal borrowingBanking system/ Central Bank credit/ Creating money

Some ground realities

For what?To give economic servicesTo build infrastructureAnything else ???To reduce poverty?Subsidies? To satisfy peopleSatisfy lobby groups?To get back into power?

What do we report?

We report the impact on people.

‘Benefits' given to the people (‘Sahana’)Subsidies, salary increases to government servantsTax-cuts, incentives for companies/also tax increasesTax – increases or decreases for private sector workersGrand programs plans.

Impact - Sri Lanka

Does the budget deficit impact people?Any problems with the budget deficit?Can increase interest rates (your deposits/your housing loan/your credit card)Budget deficit can increase inflation through Bank financing/printing (Real value of your salary, EPF, savings goes down/ Nominal value of your house, car, shares, business revenues can go up)

Long term - national debt can go up - if not invested wisely - resources diverted for interest and debt repayment

What really affect people the most?

What do we have?

Budget speech – Finance MinistryRecent Economic Development – Central BankEconomists – analysisGovernment economists (are they reliable?)Independent economists/financial sector (are there any?)Opposition members (are they reliable?)Keeping track (Fiscal Responsibility Act – mid year and November)Central Bank weeklyProblems getting info? Most info on web

Getting information Budget in rupees

How the deficit is financed

As a % of GDP

(value added in total

economy)

Making sense

RevenueRs 599.8 bn

Recurrent ExpendRs 596.1 bn

Revenue Deficit/SurplusCurrent budget Rs 3.6bn

Public investment (Capital Budget)

Rs 240.4 bn

Overall deficitRs 235.0 bn

Budget simplified (2006)

Revenue 482Current Expenditure 547Revenue deficit/surplus -65 (Golden Rule)

Capital Expenditure 162 (-9)Budget deficit 218

Making sense

Revenue

Recurrent Expend

Public investment

Revenue Deficit/SurplusCurrent budget

Tsunami? 1.9

Overall Deficit 7.2 + 1.9 = 9.1

Revenue deficit - implications

Current budget surplus (Golden Rule)No surplus since 1987It means revenue is not enough to meet day to day expensesBorrows for current expenditureNational debt risesEntire public investment financed out of debt -usually foreign (WB/ADB etc)Impact on national savingsSri Lanka’s private savings are high but national savings low because govt, dis-saving

Sustainable budget deficit

Simply put, this is the deficit at which the national debt (debt to GDP ratio) either remains stable or falls.Sri Lanka’s national debt has been around 90-105% during the last 10 years.So if we get high (nominal) GDP growth national debt will fall.When there is inflation nominal GDP grows fast (in 2006, real GDP about 7% GDP deflator about 10%).

In 1948 national debt was 18%

National debt

Source: RED Central Bank

Capital expenditure trends

Capital expenditure and net lending Capital expenditure and net lending vsvs current expenditurecurrent expenditure

Current expenditure trends

Is the money being well spent?

Financing the deficit - recap

Borrow locally – rates rise, crowding outNon-bank EPF/ETFBank borrowings/Development BondsBorrow abroad – donors will give for projects Low interest deficit finance – reforms and program loans (we have stopped reforms)Foreign commercial borrowing (Syndicated loans)

Printing – Central Bank credit

Financing the deficit

Dollar Bonds

.

No printing claim

Financing the deficit

Bank financing - see Money Supply

Feb 2006 Rs 61.9 bnOct 2006 108.3 bn

Source: Central Bank weekly

Monetary – Fiscal link

Printed money (a dirty word)Borrowing from Banking systemExpansionary fiscal policyLoose monetary policyMoney supply is expanded so that government can borrow and use it to finance deficit.

How? Selling t-bills to central bank, provisional advances.

Monetary Policy

Central Bank has power to print money and IGNITE inflation – or STOP it.Rupees are made when dollars are bought by the central bank and rupees are given to - say - exporters, (notes backed by dollars), or when rupees are issued in exchange for treasury bills (domestic assets)

Fiscal Dominance

The monetary board has a treasury representative. By keeping policy rates low, central bank is forced to defend it and buy t-bills.This is called fiscal dominance of monetary policy. (Usually CB is unwilling tool of Government/Treasury/Politicians)

How does the Treasury persuade Central Bank to print money?

Currency Boards - Singapore

“The way to a better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the work place. Diligence, education and skills will create wealth, not Central Bank credit.” - Dr Goh Keng Swee, Singapore’s first Finance Minister in Prime Minister Lee Kwan Yew’s government.

Singapore decided not to have a Central bank after independence

Currency Boards

“What will happen if the electorate chooses this option is that after a brief period of high living, Singapore will spiral downwards and eventually become another miserable developing country. ”Dr Goh Keng Swee, Singapore’s first Finance Minister in Prime Minister Lee Kwan Yew’s government.

Singapore decided not to have a Central bank after independence

Money printing - Inflation

Financing the deficit

Bank financing -

Feb 2006 Rs 61.9 bnOct 2006 108.3 bn

Source: Central Bank weekly

Inflation in Nov/ Dec – not rain or vegies

National currency weakens

Exchange rate is the foreign value. The currency will fall in response to printing, or Central Bank will lose reserves trying to defend it, or both. In 2004 and 2006 both happened.

Inflation is the domestic value of money

BOP problems

“Our economy was and is both small and open. Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster. There was no effective way of exchange control in an open trading economy like ours to deal with the inevitable balance of payments troubles.” - Dr Goh Keng Swee, Singapore’s first Finance Minister in Prime Minister Lee Kwan Yew’s government.

Singapore – currency board for stability

Macro-economic instability

InflationBalance of payments problemsVolatile interest ratesUncertaintyBad loans/bank collapse

Winners and Losers

Money printing will cause a balance of payments crisis, by promoting imports. Is it oil or printing?Low interest means, the EPF the ETF and bank savings will lose value.Asset owning people, businesses benefit, while wage earners lose.If you have paper money – it has to be treated with respect

Paper money problem

"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.”

John Maynard Keynes – deficit promoter

Legal Robbery

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

John Maynard Keynes – deficit promoter

T-bill rates and inflation (EPF)

0

5

10

15

20

25Ja

n-01

June Nov

Apr

il

Sep

t

Feb

July

Dec

e

May

Oct

ob Mar

Aug

Jan-

06 Jun

Nov

T-bill rates and Inflation CCPI (not matched)

NSB Savings and Inflation

0

5

10

15

20

25Ja

n-01

May

Sep

t

Jan-

02

May

Sep

t

Jan-

03

May

Sep

t

Jan-

04

May

Sep

t

Jan-

05

May

Sep

Jan-

06

May

Sep Ja

n

CCPI p-p NSB - Fixed NSB - sav

How do you fix this?

Have prudent monetary policyCentral Bank is tightening policy, not printing money in January – inflation will start to fall in 2-3 months.But interest rates will rise. Companies will find it difficult to surviveUnless budget deficit is CUT – prudent fiscal policy

Care to make forecasts?

If inflation falls expected revenue may not come

Tight money Interest costs will rise

Usual solution – cut public investment

Income tax may fall if company

profits fall due to interest costs

Borrow more domestically.

Borrow abroad

Where does that get us?

High interest rates – low growthLow public investment, future potential lost.Borrowing for current expenditure – national debt will rise, pass the burden to next generation.Borrow abroad – will have a debt crisis, currency overvaluation, bad for exports. Latin American syndrome.Poverty. Concentration of wealth

Vicious Cycle

Who can fix this?

High public investment – prioritize expenditureLow deficit – savings generated in the budget, revenue surplus (Malaysia 7-8%)Low interest rates (no crowding out – so high private sector investment)People will have to ask for this.

Virtuous Cycle

Who can fix this?

Politicians will have to learn economics, and not talk about socialism and capitalism – it is irrelevantPeople will have to understand that they are deceiving themselves. (Last year public sector wage index 17.1%. Inflation 19.3 %)

People will have to ask for this

Questions?

Budget and Public Expenditure

Economic and Development Journalism(SLCJ – February 06, 2007)

Asantha Sirimanne, ETV/LBO