Think Tank : Populist measures of new govt could cost Rs 200 bn

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Pathfinder foundation, a pro-market think tank has warned that the populist measures put down under President Sirisena’s manifesto could cost nearly Rs.200 billion to implement, with the possibility of worsening the fiscal deficit.

From the Pathfindereconomic Alert:

The populist measures, which have been promised, have either revenue or expenditure implications for the Government’s budget. If all the populist measures in the manifesto of the common Opposition candidate are implemented, a back of the envelope calculation seems to indicate that it could cost close to Rs. 200 billion. In the absence of mitigating revenue measures, this would increase the budget deficit to 8% or more of GDP.
If one focuses only on the commitments in the 100-Day program, the removal of taxes on fuel (loss of Rs. 40 billion per year in revenue) and the reduction of tariffs on essential items would result in a significant decline in Government revenue when it has already fallen to about 11% of GDP. This figure tends to be close to 20% of GDP in countries in our peer group. In addition, the proposal to increase public servants’ salaries is likely to add about Rs. 17 billion to Government recurrent expenditure.

This combination of reduced revenue and increased expenditure will inevitably result in an increase in the budget deficit, unless the Vote on Account includes new revenue measures. In the absence of this, there would have to be additional borrowing in a context where the country’s debt dynamics are already in amber light territory.
It is also important to point out that the prospects for increased foreign borrowing will be affected by the greater volatility in international capital markets expected when the US Federal Reserve raises interest rates after April 2015. While the ECB and the Bank of Japan pursue Quantitative Easing (bond buying programs). If there is fiscal slippage, the terms and conditions of borrowing available to Sri Lanka will also automatically harden. In the event of greater recourse to domestic borrowing, there will be upward pressure on interest rates and a crowding out of the private sector.
A repeating vicious cycle: Hand-outs to austerity
It is important to recognise that Sri Lanka has been afflicted by repeating cycles of stop-go measures over several decades due to populist policies which undermine fiscal discipline. These have inevitably generated excess aggregate demand which has resulted in an over-heating of the economy (i.e. increased inflation and balance of payment pressure).
When this happens, the inevitable consequences were stabilisation (austerity) measures: tax increases, expenditure cuts (often including a reduction in the real incomes of public servants and cuts in public investment), increased interest rates and depreciation of the currency. The upshot has been that the hand-outs given to the people have had to be taken away/eroded subsequently through such austerity measures. The PF urges the new Government to avoid repeating the non-virtuous cycle which has characterised economic policy-making over the last four decades.
The non-productivity linked salary increases promised to the public servants in the 100-Day Program will fuel demand-pull inflation. As the PF has already noted Sri Lanka’s over bloated public service has nearly 1.7 million employees. These price pressures will be exacerbated as there is likely to be agitation for similar salary increases in the private sector as well. Inflationary forces are also likely to be compounded by the cost-push pressures arising from the promised increases in the guaranteed price of key food commodities, particularly paddy.

Read the full report.