Economy

Impact of Fluctuations in Fiscal Policy During Election Seasons in Sri Lanka

If both Fiscal Policy and Monetary Policy imbalances are becoming increasingly volatile in any economy, this situation will inevitably place extra strain on that economy. Fiscal policy is simply defined as how a government manages its budget to accomplish its ultimate goals and ensure the nation’s sustainable growth. This involves the formulation of robust policies and the maintenance of favourable macroeconomic conditions to sustain the instruments of taxation, public expenditure, and public borrowing as tools for economic management. J. M. Keynes also argued that the involvement of the government in the economy through the fiscal policy perspective may assist in stabilising the economy in the short and medium terms (Alimi, et al., 2015). However, some economies fail to maintain a sustainable fiscal policy due to actions governments are taking to fulfil their election promises and stabilise long-term political dominance during election periods, rather than focusing on economic stability.

Considering the background outlined above, this study aimed to identify the inconsistency of fiscal policy, especially in tax revenue and public expenditure in Sri Lanka during all 13 general and presidential election periods (from 1955 to 2020), and its impact on overall economic conditions in the long and medium terms. Before we get to the main topic, we can look at the overall performance of the fiscal sector in Sri Lanka since its independence. Figure 1 illustrates that there was no large disparity between government expenditure and revenue from 1955 to 1977. Due to this context, there were no high-capacity financing scenarios as well. But since 1980, the story has changed dramatically, and that change has been much faster since 1994. The accelerated Mahaweli development program, launching significant social welfare schemes namely, Janasaviya and Samurdhi, establishing programmes such as providing free school books and the Mahapola scholarship, Gam-Udawa rural housing scheme program, and establishing export processing zones have generally affected the rapid change of government fiscal context during these periods.  Following that, large scale infrastructure development schemes have been implemented since 2005, which have created another evolution in government expenditure and the overall government fiscal context.

Figure 1: Overall Behaviour in the Fiscal Sector in Sri Lanka 1950-2020 (Rs. Million)

Source 1: Central Bank Annual Report (2022), Special Statistical Appendix 

Nonetheless, this review focuses on the patterns of government expenditure and tax revenue during general and presidential election years from 1950 to 2020, as well as the impact of this on current and future economic structures. Against this backdrop, we can identify 24 general and presidential election seasons when considering the above timeline. For ease of analysis, this whole period has been separated into two parts: ’Before’ and ‘After’ with regard to open economic policies”. When we look at the five important general elections between 1955 and 1977, we can see that, apart from the 1977 election season, the other four periods saw a significant percentage increase in government spending rather than a significant growth in tax collection. In keeping with Figures 2 and 3, apart from 05 of all 13 election years, recurrent expenditure, especially transfer and goods and services payments, has increased by a significantly higher percentage in the year following the election year (yellow highlighted) than in the election year, compared with the previous year.

Figure 2: Behaviour of Fiscal Operations Change in Governments from 1956-1977 (Rs. Million) 

Source 2: CBSL Annual Reports (1950-1971); Election Years: 1956, 1960, 1965, 1970, 1977
Black Percentage mentioned: the increases in recurrent expenditure during the election year and after the election year compared with the previous.
Red Percentage mentioned: the increases in tax revenue during the election year and after the election year compared with the previous

However, since 1956, the tax revenue has not provided adequate support to cover at least recurrent expenditures after any election periods.  “The food subsidy program was one of the key expenditure heads during the period 1948-77.” (Central Bank of Sri Lanka, 2000, p. 225). As displayed in Figure 2, “transfer payments”, including food subsidy expenses and “goods and services costs”, have been the most impactful expenditure category throughout the election season, particularly during the election and also after the election year. 

Figure 3: Behaviour of Fiscal Operations Change in Governments from 1982-2020 (Rs. Million)

Source 3: CBSL Annual Reports (1981-2022); Election Years: 1982, 1988/89, 1994, 99/2000, 2004, 2010, 2015, 2019
Percentage mentioned: the increases in recurrent expenditure during the election year and after the election year compared with the

Against the backdrop described above Figure 2 and 3, when there was a change of government in most election periods namely; 1970, 1977, 2000, 2004, and 2019, recurrent expenditure in the year following the election increases by a greater percentage than the election year. Also, in 1956, 1960, 1982, 1988, and 2010, which have been identified as election years during which there was no change in government, the recurrent expenditure of the election year and after the election year increased almost at the same percentage (Figure 2 & 3) compared with the previous year. Furthermore, the boost in recurrent expenditure in those years has been much higher compared with the election years in which the government changed. Before the 2005 election, transfer payments and goods and services costs were the most significant expenditure categories for the rapid growth of recurrent expenditures throughout election periods, and those expenditures seem to have become more sensitive and reactive. Because these types of expenditures had a vast impact on political survival in Sri Lankan history, it is clear that a crucial percentage increase has occurred in election years and after each election year as a result of election promises or hopes of election victories. Following the 2005 election, because all governments had relied extensively on foreign debt, there has been a rapid increase in the category of interest payments, which reflect recurrent expenditures that cannot be met by tax revenue. Considering the backdrop outlined above, transfer payments, goods and services costs, and interest payments have increased by around 4100.5 times, 1807.1 times, and 46034 times respectively, from 1955 to 2022.  

Taxes are one of the most sensitive subjects, particularly among those living in low and middle income countries, as if taxes remain high when individual earnings are low, it will boost social unrest and impact  the political dominance of any government. Under this scenario, almost all governments in Sri Lanka have also tried to ensure their political hegemony over a long period by making unnecessary adjustments to public expenditure rather than implementing effective tax hikes. An increase in direct taxes is a better way to address budget deficits, but none of the governments in Sri Lanka have given it due consideration. Given the backdrop outlined above, when it comes to 2022 from 1955, tax revenue has increased by only around 1867.9 times, and taxes on net income and profits have also increased by only around 1780.9. That tax revenue cannot be regarded as a sufficient increase at all. However, let us further examine whether the expenditure has been managed, especially in relation to the insufficient rise in tax revenue.

 Figure 4: Behaviour of Household Transfer and Public Salary Costs During the Election Period (Rs. Million)

Source 4: CBSL Annual Reports (1981-2022); Election Years: 1982, 1988/89, 1994, 99/2000, 2004, 2010, 2015, 2019
Percentage mentioned: the increases in payments during the election year and after the election year compared with the previous year.

Since independence in Sri Lanka, the “Welfare Beneficiary Schemes,” which include the Food Subsidy Program (1948–1977), Food Stamp Scheme (1978–1989), Janasaviya (1989–1994), Samurdhi (1994–2023), and Aswesuma (2023), have posed significant challenges during election periods. Furthermore, the government of Sri Lanka has renewed those beneficiary schemes three times since 1978, and overall transfer payments, especially in household transfers (payment amounts or beneficiary groups), have increased (Figure 4) during election periods, mostly as election promises and election victories. Furthermore, public salary and wage costs have also generated a crucial influence on recurrent expenditure (Figure 4) during election periods, prior to and post-election years, rather than non-election periods. That’s because, since the post-independence era, nearly all governments have tended to provide additional government employment possibilities or salary increments during election years. In a comprehensive analysis of all election years from 1982 to 2020, apart from 2010, the two expenditure categories revealed in Figure 4 have grown by a remarkable percentage of over 15% during the election year compared to the prior election year. In keeping with this, those fluctuations in transfer payments and salary and wage costs during election seasons would put additional pressure on fiscal operations for a long time. This is because, under the “Sticky Wage Theory,” which was introduced by John Maynard Keynes, increased wages will never be cut again in the future. On the other hand, the most notable element is that these welfare plans address a particularly sensitive subject for people, and the exit ratio from those programs was quite low. “Only 17% of those who received Samurdhi benefits have exited the programme.” (LIRNEasia, 2023, p. 56). 

Consequentially, many governments in Sri Lanka had to rely on domestic and international loan facilities to finance the recurrent budget deficit and meet capital expenditure. Similarly, every government since 2005 has prioritised international loans at high interest rates to finance budget deficits rather than domestic loans. Due to the continuous reliance on loans, interest payment costs have skyrocketed since 1995, and that has been a major cause of the current economic crisis as well. As illustrated in Figures 2 and 3, we haven’t been able to use our tax revenue to cover even recurrent expenditure. That has limited the ability to move forward with sustainable capital expenditure, which has adversely impacted sustainable long-term economic growth as expected in numerous election policy reports, such as “Regaining Sri Lanka, Vision 2025, and Vision of Prosperity.”. Additionally, that would have a side effect on the exchange rate as well, which means the increases in international debt repayments and interest payments would raise the demand for foreign reserves and devalue the rupee.

Considering the clarification so far, we have a good understanding of the real impact of the volatility of fiscal policy operations during election years on sustainable economic development in Sri Lanka. Then, we should have to focus on short-term and long-term “Policy Based Solutions” to overcome those critical states. (1) The top priority task should be the effective management of recurrent expenditures, in parallel with increasing direct tax revenue. Within this framework, we should prioritise the most pressing expenditure swiftly, such as identifying the most vulnerable groups for welfare schemes, prompt privatisation of state enterprises that have become a burden to the government, or privatisation of at least their management to minimise the goods and services expenditure. (2) Secondly, capital expenditure should be concentrated, with a focus on productive areas where foreign exchange can be generated, in order to ensure long-term sustainable economic development. (3) When initiating enormous capital expenditure-based projects, it is better to place more emphasis on “public-private partnerships” rather than maintaining a government monopoly and weight on the government. (4) All governments must prioritise effective economic policies and the long-term economic stability of the country rather than maintaining long-term political power throughout any election period. (5) Finally, urgent policies and appropriate adjustments should be made for sustainable budget financing with the advice of local and international economic expertise and the support of the private sector as well.

Conclusion

As citizens of Sri Lanka, our top priority should be to ensure the nation’s economic growth over the long term. As previously highlighted, prudent fiscal policy management is one of the most prominent components of fostering sustainable economic development in the country. We are still going through hardship caused by the economic crisis and require additional policy-based operations to recover from current circumstances. In keeping with this, all governments must place a greater emphasis on permanently abandoning the economic missteps previously observed, especially those occurring in the context of electoral periods. Then, we must seriously consider the behaviour of fiscal policy, especially during the upcoming election period, because if earlier incidents during elections repeat themselves, it could significantly impede the nation’s developmental trajectory.

References

Alimi, O. Y., Yinusa, O. G., Akintoye, I. R., & Aworinde, O. B. (2015). Macroeconomic Effects of Fiscal Policy Changes in Nigeria. Journal of Accounting and Management, 5(3), 85-94.

Central Bank of Sri Lanka. (1960; 1970; 1990; 2000; 2010; 2015; 2022). Annual Reports. Colombo: Central Bank of Sri Lanka.

Central Bank of Sri Lanka. (2000). Economic background of Independence Sri Lanka. Colombo: Central Bank of Sri Lanka.

LIRNEasia. (2023). Social Safety Nets and the State of Poverty in Sri Lanka. Colombo: LIRNEasia. Retrieved from https://lirneasia.net/wp-content/uploads/2023/07/LIRNEasia-Social-Safety-Nets-and-the-State-of-Poverty-in-Sri-Lanka-4.pdf

By H.K.G. Dilan Janitha
Intern – Economics Intelligence Unit
The Ceylon Chamber of Commerce

Reviewed By : Sanjaya Ariyawansa
Economist 
The Ceylon Chamber of Commerce

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