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ECONOMYNEXT – Sri Lanka plans to reduce the budget deficit to 6.8% of gross domestic product in 2023, from an expected 9.9% in 2022, with a combination of tax hikes and spending cuts, the gatekeeper said – cabinet spokesperson, Minister Bandula Gunewardena.

The cabinet of ministers had approved a budget framework for 2023-2025.

“Sri Lanka is facing the worst fiscal crisis in its history,” said Minister Gunewardena. “We eventually need to bring the deficit down to 5% of GDP to manage debt, reduce money printing and have low inflation.”

“We will reduce the deficit by increasing revenue (revenue-based fiscal consolidation) and reducing spending (expenditure-based consolidation).”

Sri Lanka plans to increase state revenue to 11.3% of GDP in 2023 from 9.1% this year.

Public expenditure will be reduced to 18.1% of GDP against 18.9%.

Sri Lanka has seen its spending as a percentage of GDP rise after moving away from expenditure-based consolidation to “revenue-based fiscal consolidation” in an unusual illiberal or left-progressive move.

Although taxes were raised, there were no major gains in controlling the deficit, as spending relative to GDP rose from about 17 to 20 percent of GDP.

The overall fiscal deficit tends to be high immediately after a currency crisis because of the high interest rates needed to crush private credit, reduce outflows, and restore credibility to the soft peg.

The credibility of the soft peg is usually broken and currency shortages are triggered by sustained money printing for post-sterilization of reserves used for imports (money printed to prevent downward adjustment of reserve currency ) or to keep interest rates artificially low or, in some cases, deficit financing. .

Countries with loose pegs (now called flexible exchange rates) then go to the IMF for monetary tightening and deficit reduction, usually amid social unrest and impoverishment caused by currency meltdowns.

Sri Lanka is due to begin a series of talks with a visiting representative from the International Monetary Fund this week.

The primary deficit (before interest charges) will be reduced from minus 4.0% of GDP to minus 1.0% of GDP, Gunewardena said.

A primary deficit target reduces the incentive for a monetary crisis-prone Third World central bank to try to keep rates low by printing money.

Sri Lanka started printing money through open market operations from around September 2014, triggering a currency crisis in 2015/16 and 2018 under flexible inflation targeting with reserve collection parity combined with production gap targeting.

Currency crises were followed by production shocks (weak growth).

In 2020 unusual levels of money were printed by crippling Treasury auctions with price controls and taxes were also reduced saying there was a ‘persistent output gap’, ultimately triggering the worst monetary crisis in the history of the loosely pegged central bank and an external debt default.

Sri Lanka will also have to close loss-making state enterprises and reform them to improve state enterprises, Minister Gunewardena said.

There have been talks of offering a voluntary pension plan for state media employees, he said. (Colombo/August 23, 2022)


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