LBRMoney,Wednesday 21 April 2010

Post-war Sri Lanka’s main priorities in accelerating economic growth would be to rein in ballooning budget deficits and inflation, the Asian Development Bank said.

“On the fiscal side, we feel the whole focus of policy in the next one year would be on how to contain the fiscal deficit,” Narhari Rao, Lead Economist of the ADB’s Sri Lanka office said.

The bank forecasts it would be possible for the government to bring down the deficit to eight percent this year, seven percent by 2011 and thereafter to around five percent.

“It may not be possible to have a faster reduction,” Rao told a news conference held to unveil the ADB’s Asian development outlook for 2010.

Challenged

Over the years Sri Lanka’s policy makers and rulers have promised various reductions to budget deficits but have systematically broken all promises, including targets set by a fiscal responsibility law, by unrestrained spending.

The usual excuse has been that the targets are ‘challenging’, while ordinary people paid high levels of taxes on basic foods, were hit by increased trade protectionism and were systematically impoverished by high inflation.

The ADB’s Sri Lanka country director Richard Vokes said they hope a government fiscal management efficiency improvement project the bank is supporting with a loan approved last week will help it improve revenue management.

The ADB report forecast the budget deficit will fall “provided revenue enhancing measures are implemented and complemented by measures to rationalize expenditure.”

The government is expected to introduce reforms to broaden the tax base and reduce tax exemptions in the 2011 budget in order to increase revenue, said Rao

“If you reduce taxes it is possible in the short-run revenue will fall,” he said. “But then it will start rising again as the economy improves. Tax reforms and fiscal consolidation will be big issues in bringing the fiscal deficit down.”

Sri Lanka’s rulers and state workers are exempted from income tax on their salaries.

Growth Prospects

Rao said Sri Lanka did “fairly well” last year to achieve a growth rate of 3.5 percent, which although down from six percent the previous year was commendable given global recession and a devastating war that however ended in May 2009.

But he said the growing fiscal deficit was a “worrying” sign that would need to be addressed by policymakers.

Sri Lankan authorities have said the deficit is 9.8 percent based on a different accounting treatment from this year, though it is over 10.2 percent based on the process in previous years.

“The deficit is extremely high and would need a major correction,” Rao said. “That’s where the major focus of policy would likely be.”

The ADB expects Sri Lanka to make a “very healthy recovery” in 2010 with confidence much higher after the conflict and war-related spending diverted to investment, along with inflows of external finance.

The ADB forecasts Sri Lanka will grow six percent this year and seven percent in 2011.

Rao also said there had been a “steep drop” in inflation because of tight monetary policy and

lower import prices.

But the policy dilemma faced by decision-makers would be when to loosen monetary policy without risking higher inflation.

“The dilemma is between growth and inflation. We feel the government will be able to achieve a balance with an economic growth rate of 6-6.5 percent and inflation of 6-6.5 percent in 2010,” Rao said.

“You could have higher growth but it would come at the cost of higher inflation which is not sustainable. You have to target inflation and get it into the moderate range of 5-6 percent.”

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