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Presidential election tomorrow and analysts cautious on promises Fiscal position ‘in danger’


A Citigroup report on Sri Lanka’s presidential elections to be held tomorrow says the promises made by President Mahinda Rajapaksa and his rival Rtd. General Sarath Fonseka to increase public sector wages and subsidies may prove to be difficult to implement given the state of the country’s public finances — a warning often repeated by economist and analysts with the Central Bank being more vocal.

"Both candidates promise higher public sector salaries and larger subsidies, although this may be difficult to implement given the fiscal deficit stipulations required by the IMF’s (US$ 2.6 billion) Stand-By Arrangement," said a Citigroup report titled ‘Sri Lanka Macro Flash: Elections — What can We Expect on January 26’. The stipulations of the IMF for Sri Lanka’s budget deficit is based on the government’s own targets set on the Fiscal Management Responsibility Act, where the deficit — historically underestimated at each budget — is expected to reach five percent of GDP by 2011.

The government proposes to achieve this target by rationalising public spending and broadening the tax net, without introducing new taxes.

While the IMF is confident the government could reach the budget deficit of seven percent for 2009, data is yet to come in for analysis.

According to available data for the first nine months of 2009, the budget deficit has grown by 30 percent to US$ 322.6 billion, which works out to 6.5 percent of GDP.

The deficit for the corresponding period of 2008 was Rs. 246.9 billion, 5.6 percent of GDP. By the end of 2008, the deficit reached Rs. 340 billion and 7.7 percent of GDP. The original estimate for the budget deficit was Rs. 293 billion, 7 percent of GDP.

On the positive side, during the first nine months of 2009, revenue collection had improved by 12 percent but recurrent public spending increased by 19 percent, while capital spending on long term infrastructure declined by 2.7 percent.

Going into 2010, the Central Bank warned that the fiscal position was in a precarious position and the government should therefore desist from increasing public sector wages and reckless spending.

Analysts warn that since public sector wage increases are captured in GDP figures economic growth may not be real.

They said 2010 would be a difficult year with parliamentary elections to be held next.

"It is unlikely we will have fiscal stability this year irrespective of who comes in to power," an analyst told the Island Financial Review.

Infrastructure development and integration of the North and East to the rest of economy would require more government spending while expenditure on public health, education and other subsidies are expected to continue.

"If we are not careful about the budget deficit we could have problems financing the deficit. Now that we are a Middle Income country, concessionary loans may be hard to come by which means the country would have to borrow at market rates. Inflation is waiting in the sidelines to catch up with us if we are not careful and so is the spectre of high interest rates," a dealer told the Island Financial Review.

Dealers said investors remained uncertain in the run up to the presidential election and domestic borrowings had also dried up.

Public debt has increased to Rs. 4,154 billion in 2009 compared to Rs. 3,578 billion the previous year.

According to the Central Bank, government debt was 105 percent that of the country’s Gross Domestic Product (GDP) in 2002. In 2004 it came down to 102.3 percent and has since declined gradually to reach 81.1 percent in 2008.

In 2004, the outstanding debt stock amounted to Rs. 2.139 trillion with the domestic debt stock amounting to Rs. 1.143 trillion. In 2008, the outstanding debt stock reached Rs. 3.578 trillion.

However, the government’s debt stock increased to 84.4 percent of GDP in 2009. The estimated outstanding debt stock amounts to Rs. 4.154 trillion with the domestic component reaching Rs. 2.407 trillion.

If MR wins a second term...

The Citigroup report said Rajapaksa’s election manifesto focuses on developing employment generating infrastructure projects in key areas such as ports, aviation, energy, roads and housing.

It said Rajapaksa also proposes to conform to the devolution of power to the provinces under the 13th Amendment.

"A victory for President Rajapaksa would in our view bring two key benefits: (1) policy continuity, and (2) infrastructure development," Citigroup said.

Economists and analysts speaking to the Island Financial Review agreed that this would be the case, but warned that infrastructure development alone would not help unless there was more fiscal discipline.

Some dealers said they expected the exchange rate to remain stable throughout the year while inflation is expected to reach around 8 percent for 2010.

Economists and analysts said despite winning the war and placing the country on the trajectory for strong economic growth, the government’s recklessness in some areas of public spending (such as the upkeep of a large number of ministers and some infrastructure projects a few analysts termed ‘ego projects’) and corruption levels could put pressure on sustainable and equitable development.

If SF wins...

"On the other hand," Citigroup said, "Fonseka’s pledges suggest he would: (1) help weed out the causes of profligacy in public finances through improved governance and an independent audit commission, and (2) take more conciliatory measures towards appeasement and resettlement of the Tamil minority, which would go down well with the international community."

Economists and analysts agree that ending corruption and implementing the 17th Amendment would go down well with the economy, some suggesting it would be a prerequisite for sustainable inclusive development.

But uncertainty behind the UNP-JVP coalition is the biggest drawback and this could delay investments until such time the alliance proves itself.

Some dealers said UNP economic policies could lead to a depreciation of the rupee leading to double digit inflation.

"If this happens Central Bank’s independence would be validated and they would have to tighten its monetary policy to curtail inflation and then interest rates would increase once again," a dealer said.

Economists found it difficult to explain the economic implications of a Fonseka victory.

"The UNP and JVP have not indicated how they plan to run the economy. Fighting corruption and executive presidency is top on their list. While ending corruption is crucial, diluting powers of the president is debatable. There is uncertainty about the economic implications as the Fonseka camp has not been very clear on this," an economist said.

According to Citigroup, this gives Rajapaksa a slight edge.

"At this juncture, it appears that Rajapaksa may be marginally better positioned to deliver on promises. This is because Fonseka’s coalition government has varying ideologies (the JVP is generally know to have leftist leanings while UNP is more pro-market), which could make implementing reforms more difficult," it said.

An analyst summed the presidential election tomorrow in these terms: "On the face of it, the choice is between corruption and chaos. Voting has much to do with trusting and hoping."

Note from the Business Desk…

The comments from economists and analysts were gathered over a period of time since the presidential election was announced last year. None of them wanted to be quoted saying they were free to express their views on condition of anonymity.

~ The Island ~


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