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National Budget

P. Samarasiri-Thursday, October 25, 2018

Everybody wants the support of the government to have a good life. On one
hand, economists recommend the government to fix all macroeconomic ills
whether it is general inflation or high cost of living or low economic growth or
balance of payment (BOP) deficit or currency depreciation or unemployment
or household income disparity or elephant attacks (or human attacks on
elephants) or recovery from wars or disasters (floods, droughts, earthquakes)
or social backwardness. On the other hand, they all find the government as
the scapegoat for all those ills, social and economic. Everything we tell the
government to do or what it does will end up in the national budget, mostly as
expenditure and debt, as things we propose for income are virtually rare.

Some ambitious economists, while telling the
government to fix structural economic problems such as chronic balance of
payments deficits or poor exports or inflation, they simultaneously
recommend the government to scale down the budget as the solution. Nobody
seems to talk about how various segments of the public benefit economically
and socially from the budget or its actual socio-economic impact when the
budget is criticized. The budget is the reflection of the size and the quality of
the Public Service in the country. Therefore, before we criticize the budget, we
have to assess its socio-economic impact and whether it is justified, given the
circumstances applicable to the country.

In economics, the budget is the top macroeconomic policy or the fiscal policy
implemented to influence the aggregate demand (total spending on
consumption and investments) in the economy for promoting growth,
employment, resource utilization, etc., and setting the socio-economic policy of
the country. The other macroeconomic policy assigned to the Central Bank
(CB) is the monetary policy to regulate the monetary side of the economy for
same economic objectives, generally independent of the government, but with
close coordination to avoid policy conflicts.

Budget Number Crunching

Both compilation and analysis of the budget are necessarily a number-
crunching exercise for the future, similar to the budget of a person or a
household or an institution.

* Information Problem

Its quality depends on the information system at micro level on all activities,
expenses, incomes, debt profile, operational targets, etc. If budget estimates
are not based on reliable set of such information, the estimates will be nothing
but adding some hypothetical changes to existing budget numbers. Generally,
people over-estimate expenses and under-estimate income or vice versa,
depending on the motives. In general, actual outcome is worse than the budget
as proved by several supplementary budgets and revised budgets. Therefore,
budget numbers could be highly misrepresentative unless information
reporting systems are maintained, audited and verified for reliability.

* Budget Structure

The budget provides numbers on receipts, expenses and financing which
reflect the size and nature of the fiscal front and immediate financial impact
on the public with details on activities covered in the budget. Receipts are the
proceeds of taxes and grants. Expenses are the recurrent expenses and
investment expenses (new capital). The overall budget is the gap between total
receipts and total expenses that requires financing, i.e., borrowing in the case
of deficit and lending in the case of surplus. The financing or mostly
borrowing is classified by sources such as foreign and domestic and by
borrowing instruments such as market, project and others to assess the
composition,
concentrations and possible risks of debt. The actual borrowing during the
year is much higher as borrowing is reported as net of repayment of debt
(inclusive of roll-overs) which is not reported as an expense.

* Budget Numbers Analysis

Several concepts are used to assess direct financial plight of the budget. The
current account, primary account and overall budget are used to understand
the plight of the budget gap. The current account is the gap between the
income (without proceeds of grants) and recurrent expenses (without
investment-related expenses) which shows whether the income is adequate to
finance routine expenses such as salaries and maintenance. Primary account
which is the gap between the total receipts (income and grants) and total
expenses excluding interest payments on debt stock shows interest cost
excluded- budget gap. When the overall budget is a big gap, above sub-gaps
are meaningless.

While the numbers are commented in absolute terms, their percentages
against the country’s income (or GDP) are mostly used by economists to
analyze in relative magnitudes. We should not forget controversies
surrounding the GDP numbers on account of alleged creative accounting
methods when such percentages are used.

Deficit budget is a global macroeconomic policy standard unless the deficit is
horribly high with fiscal expenses dominating the economy over decades that
will end up in catastrophes. See Table
Budget’s Socio-economic Impact Assessment

All income, expenses and borrowing have beneficial effects as well as adverse
effects to various categories of the public. What is underlying the budget is the
wider public service that arouses such effects. Public service broadly covers
all government operations such as policies, business stimuluses, regulations,
business enterprises, infrastructure facilities and social safety net. Therefore,
for making a reasonably objective and impartial impact assessment, we need a
list of all public services, their net cash flows, respective service deliverables,
targets set for respective deliverables at the time of making budget estimates
and performance status on such targets within the budget year or a
reasonably long period given to cover lactation periods of budget items and
policies.

Our budget offices do
not have such information other than budget numbers and actuals. No such
performance information is presented at the time of the presentation of the
budget to the Parliament. Therefore, we need to find some proxies/indicators
to be fair by the government and general public, given their non-
macroeconomic profiles. I provide few numbers below to arouse further
research. All numbers are for 2017 extracted and computed by me from the
CB’s publications.

* Generation of Employment

Total government spending, 19% of GDP or country’s total spending, boosts
economic activities and employment. Direct employment in the public service
funded by 19% of the country’s spending is 1.4 mn or 14.4% of the total
employment in the country. The private spending which dominates the
economy with a share of 81% generated nearly 6.8 mn jobs. Accordingly,
direct employment generation ability in the public sector is lower than that in
the private sector, i.e. government spending of 1% of GDP generates 72,000
direct jobs in the public sector as compared to 84,500 private sector jobs per
its spending of 1% of GDP. However, the indirect employment created in the
private sector by the budgetary policies, purchase of goods and services and
implementation of public tendered protects should be a sizable number. Still,
public spending being 19% may not be an excessive or unmanageable level,
given the countless projects expected by the public from the government.

* Supply of Economic Infrastructure

The state supplied infrastructure is the key for the economy. Road network
maintained by the government to support the economy is nearly 32,800 kms.
The railway’s operated service of 11.7 mn kms facilitated136mnof passenger
journeys at a subsidy of Rs. 7.6 bn. Paddy area cultivated on state irrigation
service is nearly 792,000 hectares or 80% of total paddy area which produces
nearly 4.4 million MT of paddy with a yield of nearly 4,300 kg per hectare for
self-sufficiency in rice being the staple food. The irrigated area for other field
crops under Mahaweli scheme is nearly 24,000 hectares along with the paddy
area constituting 12% of total paddy area in the country. If not for such
irrigation, the country would not have a domestic agriculture sector by now.
The state electricity capacity is nearly 2,890 MW or 70% of the total capacity
in the country. The forest cover is maintained at nearly 1.9 million hectares to
keep the climate and environment balance.

* Support for Human Resource

Human resource side, state health and education provided at low price in
increasing volumes decide the quality of human resource base in the country.
State student population reached 4.2 mn supported by state employment in
education rising to 258,000 while general education expenditure vote rose to
Rs. 19,460 per student. These are good performance numbers at any standard.
The quality of the education and employability of students are different
technical subjects. As regards health service, treatment for 60 mn patients
(nearly three times of each person in population) at a low annual price of Rs.
3,300 per patient supported by health employment of 64,600 is a significant
performance. Good health and education are unique returns to any country.

* Control of Cost of Living

The cost of living and thereby overall inflation is kept low by administered
prices and subsidized prices and costs. Many commodities and services in the
household consumer basket are at administratively controlled prices with
virtually free health and education services. Various production subsidies
keep the cost at low. If not for such cost of living support, the country’s
inflation and wage demands would be greater and affect adversely the export
competitiveness and economic growth. The budget can control the inflation
overnight within the broader macroeconomic policy as against the intellectual
model-based monetary policy of the CB with unknown long-lags.

* Maintenance of Socio-economic Safety Net

The government being the guardian of the society provides numerous services
to keep the social balance and justice under check. The basic role of
governments is to provide a stable environment for the economy. Everybody
knows how civil wars and societal insecurity would produce economic and
social catastrophes. The government spends 29% of its spending or 5.7% of
GDP or Rs. 35,280 per person on civil administration and defense to prevent
such catastrophes. Nearly 325,900 births and 139,400 deaths with post-
mortems were registered to keep track of the population care.

Subsidies have been
increased to 28% of the budget with nearly a half to households amounting to
Rs.16,300 per person of population (total subsidies-Rs. 33,280 per person)
with Samurdhi subsidy of Rs. 40 bn for nearly 1.4 mn families. Economists
criticize subsidies on its economic meaning in market economies without
assessing its socio-economic role although the government is not a business
enterprise.

* Provision of Safest Financial Investments

Government debt is the safest investment avenue to the public. Increase in
domestic debt by Rs. 3 trillion or 2% of GDP between 2010 and 2017 is a
significant increase in safest investments of the domestic public. This is why
economists allege that protracted budget deficits crowd out private
investments as private savers move to safer investments in government debt.
Meantime, foreign debt provides a firm source of foreign capital inflow to
finance the chronic BOP deficits as private capital inflow is low and not
reliable. The increase in foreign debt by an estimated US$ 15.2 bn between
2017 and 2010 was a great comfort to the stability of the economy.

The CB desperately depends on the government’s foreign borrowing to do its
duty on the maintenance of the international stability of the currency.
Further, the CB carries out monetary operations in the inter-bank market
based on government securities and further printing of money by granting
credit/loans to the government by way of advances and purchase of
government securities.

On average, nearly 25%of the increase in money in circulation (money M2)
was created by bank credit granted to the government. Meanwhile, nearly
21% of new money printed by the CB was its credit granted to the
government. If not for government debt, the CB has to print this amount of
money by credit granted on risky private securities taken as collaterals.

The financial dealing industry makes income and profit on debt-trades. As
reported by the CB, the primary dealers alone made nearly Rs. 13.4 bn of
profit on trade of government securities of value Rs. 17 trillion (primary
market: 1.6 trillion, secondary market: 15.4 trillion) (i.e., a post-tax dealer net
margin of 0.078%, increased from 0.067 in 2016) although the dealers’ total
income was not reported.

Fundamental Problem – The Budget or the Public Service Delivery System
underlying the Budget?
Most analysts criticize both the budget and government without research on
socio-economic impact of the budget in the context of its macroeconomic
management policy role. Accumulating debt stock, inefficiency of the public
service and poor government revenue are the cornerstones for such criticism.
These relate to issues on the budget administrators and not on the budget per
se.

* Concern on Debt Accumulation

Whether debt stock is too high or economically and socially justifiable has to
be assessed on different economic criteria (See my article on public debt in
Daily News 26.09.2018) where just the debt number 77% or 100% or 200% of
GDP does not have any economic meaning, given its economic role in debt-
financed-macroeconomies.

* Concern on Poor Quality of Public Service

This has to be assessed in the context whether the private sector or the market
mechanism is ready to govern the economy and society and provide more
productive economic environment. The poor service quality is a problem of
the state bureaucracy or those who manage public institutions. If the
management of public institutions is assigned as the return to those who
undertake political funding or those with permanent foot-prints aboard or
spending most part of the year in foreign travels at public funds while leaving
out best talents created by the public education, nobody can expect a quality
public service for the country.

* Concern on Insufficient Revenue

It is the fundamental problem of low price charged on public service than the
cost and evasion of paying the price (tax) by those who are due. If the price or
tax rate is 12% to 14% of GDP while incurring a cost of 17% to 20% of GDP,
the resulting cash flow deficit of 5% to 6% of GDP is annual rate of debt add-
on. The leakage of budget/public funds from both the source (collection) and
use (spending) is well known. Although the Inland Revenue estimates tax in
default as Rs. 197 bn. as at end of 2017, professional lawyers and accountants
know well that it is much more due to creative accounting techniques and
legal interpretation of business transactions subject to tax due to confusing tax
circulars being a problem world over.
A CB’s Senior Deputy Governor commented at a Parliamentary Finance
Committee in July 2017, when discussing means to raise tax collection, that
tax revenue cannot be raised unless national income increases. The Committee
chair being a good practical economist responded that the matter was for
improvement of revenue collection on exiting national income. Although I, as
another Deputy Governor at that time, calcified the urgent need for a system
to prevent colossal evasion/robbery of stamp duties on land transactions, at
least by making aware the public of the due procedure for payment of stamp
duties and deed registrations. I am sure there is capable parliamentarians and
public servants who can fix this revenue problem though excessively painful.
In addition, the budget administrators do not have a macroeconomic policy
framework for the budget and, therefore, ad-hoc decisions taken to favour
segments of the public focusing on vote-base targets dominate the budget.

Macro Demand Management in the Economy

In macroeconomics, fiscal expansion and monetary expansion are the policies
recommended to increase or fine-tune the total spending (consumption and
investments) in the economy which will have several rounds of multiplier
effects on spending, production, employment, interest rates and inflation.
Advanced economies have been adopting both in the past decade to recover
from the recession caused by the last global financial crisis 2007/09. In
general, emerging market economies follow expansionary demand policies in
both fiscal policy and monetary policy to promote economic activities
although the rate of expansion may vary.

Monetary and Fiscal Policy Impact

The eventual economic impact of both policies has not been quantified
separately or in aggregate in the CB’s macroeconomic models as they can’t
detect separately the lagged effects of policies, supply side changes and other
external shocks to the economy. Unlike monetary policy for regulation of
overall expansion of money supply and credit to cause an indirect impact on
the aggregate demand, the fiscal policy has sectoral and fast effects as
spending is made fast on identified activities. For example, recurrent expense,
i.e., 75% of total fiscal spending, takes no time to push the aggregate demand.

Policy Stimulus in 2017
The fiscal expansion/stimulus keeps the economy growing and out of
recession. For example, total expansion through both fiscal deficit and
increase in money supply (M2) to private sector (net of fiscal borrowing from
banks to eliminate the double counting as money supply contains fiscal
borrowings from banks) was 11% of GDP in 2017. The fiscal stimulus/deficit
constituted nearly 52% of the total expansion/stimulus (The balance being the
private sector funded by the monetary policy). In fact, the CB’s money
printing (i.e., increase in its balance sheet) has not been a reliable source to
expand the monetary base and, therefore, bank-created money facilitates the
economy. On year-end basis, CB’s new money printing has decelerated to Rs.
76 bn in 2017(due to faster monetary tightening adopted since January 2016,
despite the slack of the economy) and highly fluctuated between Rs. 103 bn to
Rs.218 bn during the past 6 years where a net absorption (a decline) of Rs. 38
bn was reported in each 2013 and 2015. See Graphic

Economic Recession if not for Fiscal Stimulus

In this context, if fiscal expansion had been cut-down in the recent past as
some economists propose, the economy could be suffering from the protracted
recession by now, given the fact that the growth has been continuously low
(3%-5%)even with such fiscal expansion. This indicates that the private sector
is still not able to generate a level of spending (consumption and investments)
to boost the economy even with prevailing level of fiscal spending. As the
demand/spending has to come from credit, the credit delivery mechanism
(intermediation and private credit markets) has not developed to create a flow
of credit friendly to business environment. Therefore, the reduction of fiscal
front is not feasible without confronting a recession or slower growth and
employment.

Some argue to cut the fiscal front to fix the current problem of excessive
currency depreciation on the basis of theoretical macroeconomic calculation
that budget deficit always accompanies a current account deficit in the BOP
and/or private net savings (savings less investments) which are the sources to
finance the budget deficit. The two-handed economists know that the economy
will confront a severe recession and wide market imbalances if the fiscal front
is cut in this argument.

I recommend that the national budget officers have a list of public services,
their net cash flows and service targets achieved to justify the economics of the
budget professionally and counter-critics on the budget, at least to be fair by
those critics. The Auditor General and internal audits will verify the
information reporting/number crunching systems underlying the budget for
good governance of statistics.

These are not rocket sciences but the use of common sense objectively in the
national interest. Budget officers, official financial advisers and debt
managers to the government can get spiced up to make quality decisions for
national economic management if they listen, at no cost, to veteran business
leaders such as Dhammika Perera, Soli Captain, Jeff Bezos, Warren Buffet,
Jac Ma, Satya Nadella and many others how they resolve business
problems/bottlenecks and innovate businesses without any complaints to the
public.

(The writer is a recently retired public servant as a Deputy Governor of the
CB supervising the financial sector and a chairman and a member of six
Public Boards. In his nearly 35 years’ service in the CB, he also served as the
Director of Bank Supervision and the Secretary to the Monetary and
authored five economics and financial books published by the CB and several
articles covering this subject)
Posted by Thavam