Fiscal Policy

Should we abolish the budget?

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In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning


By Aneetha Warusavitarana

On the 5th of March 2019, the Ministry of Finance presented the much-delayed budget for 2019. The budget is a tool of extraordinary influence, which is used to affect government revenue, expenditures and national policy. That being said, our budgets don't appear to be exerting that influence, or creating the impact they could. According to Verité Research’s budget tracker only 8% of projects from the budget 2018 are progressing, with a staggering 59% lagging behind in implementation.

Everyone has come to expect the budget, but what purpose does it serve? Why does it exist? During the rest of the year the government continues to make decisions on policy, pass legislature and try to run the country. The allocations made during the budget to specific ministries are not set in stone. The reality is that these allocations are moved around government in a manner than bewilders all involved, and when a year passes and the next budget is announced, it is found that budget promises have not been met, and very little has actually been implemented.

Budgets by definition should focus on revenue and expenditure. In the case of Sri Lanka and the mountain of debt that we need to contend with, this is all the more important.

Results focused budget

When looking at this year’s budget, a wide variety of topics have been touched on. The Ministry of Finance has revised taxes on multiple fronts, with a focus on reducing the indirect tax base and increasing direct taxes. However, the budget has not limited itself to detailing expenditure and revenues. There has been a substantial amount of general policy which has been included, bringing up the question of whether there is a point to their inclusion in the budget. Surely these general policies would be better suited in a national policy document or election manifesto?

The policy decisions in the budget 2019 have ranged from establishing a national pension plan, increasing government servants’ salaries, to amending labour laws, and this is where the problem lies. Increasing government servants’ salaries would technically be the duty of the Ministry of Public Administration and Disaster Management (an apt ministry to handle the government sector) and salary revisions should follow a system, and not be dependent on ad hoc decisions. A national pension plan, while much needed is not an endeavor that can be completed in a year. The same reasoning applies to amending labour laws. These two in particular will in all likelihood take at least a few years to be finalized and implemented.

The alternative?

The alternative to the current budgeting process is following a medium-term expenditure framework (MTEF). This framework integrates policy, planning and budgeting for the medium term, combining a top-down resource envelope with a bottom-up estimate of the current and medium-term cost of existing programmes. The result is the alignment of macroeconomic stability and broad policies with more specific programmes. It is essentially a three to five year rolling budget, which sets fiscal targets and allocates money for that time frame. This system addresses the reality that very few projects can be successfully implemented within one year and allows the government to acknowledge this and act accordingly.

What does a Medium-Term Expenditure Framework mean for policy?

MTEF

Within this framework, policy proposals are considered in the medium to long term context. Spending agencies have a stronger voice, as they have significant input into the design of sector strategies and some flexibility in managing their resources to meet their objectives. New projects are undertaken dependent on whether they are affordable and implementable in the medium term, allowing the government to have a very clear and mostly accurate statement of fiscal policy objectives, fiscal deficit and debt management.

At a project level, this framework creates two main wins. First, both policy and funding are more reliable and predictable. Second, it allows for policy to drive funding, as opposed to the reverse. This in turn means that budgeting is linked more strongly to results, as focus shifts to specific outcomes and what resources are required to achieve them.

What happens to the annual budget?

The annual budget will be announced, but it will simply reflect what is achievable in the short-term, within the larger three to five-year framework. This is beneficial, as spending will be more specific, and tied to clear targets. Funding is not allocated for an entire project, but only for the section of the project that can be reasonably achieved during the next twelve months. The entire budget is more focused on results, and less on broad policy statements. Given the low levels of implementation mentioned earlier, it is evident that a greater degree of specificity, combined with a results-focused approach to the budget is required.

What needs to be done?

Interestingly, even now a substantial amount of planning follows the structure of a three-year rolling plan. The Public Investment Programme or the PIP, is a three-year rolling document which details government expenditure of projects and programmes. The Ministry of Finance also publishes an annual medium-term fiscal strategy which establishes the general direction or objectives of fiscal policy for the next three years. According to the Ministry of Finance website, budget estimates are prepared in the larger context of a medium-term budgetary framework.

It appears that the key components of an effective medium-term expenditure framework already exist. The next step would be to align the annual budget more clearly with these components. Allocations should be made more specific, with clear ties to the three-year plan. New projects and programmes should be introduced taking into account a three-year resource envelope and fiscal objectives. In other words, the budget in its current iteration should be completely overhauled and refined.


Aneetha Warusavitarana is a research analyst at the Advocata Institute and her research focuses on public policy and governance. She could be contacted at aneetha@advocata.org or @AneethaW on Twitter. Advocata is an independent policy think tank based in Colombo, Sri Lanka which conducts research, provides commentary, and holds events to promote sound policy ideas compatible with a free society in Sri Lanka.

Bringing sanity to public finances

Originally appeared on Echelon

By Ravi Ratnasabapathy

Ad-Hoc policies have created unsustainable long-term spending commitments. A medium-term expenditure framework can discipline policymaking.

Sri Lanka has experienced a large and persistent budget deficit, averaging over 7.7% of GDP since 1990. The deficit has been met partly by borrowing, which is why the debt-to-GDP ratio has averaged 89.1% during the same period, almost double that of our peer group. The government has attempted to close the deficit through painful and unpopular tax increases; but amid the rising cost of living, public patience for this has already worn thin.

With elections looming and the popularity of the government sinking, there is a danger they will revert to giveaways without considering the impact this will have in the longer term. Giving jobs or salary increases to state workers is a popular short-term gimmick, but involves long-term commitments: salary payments over the life of the employee, often followed by a pension. With 1,358,589 people already on the State payroll and a further 600,000 drawing pensions, this is no longer sustainable. Salaries and pensions alone consume half of government revenue.

The accumulated ills of various shortsighted measures have taken the country to the brink of default. There is an unprecedented ballooning of foreign debt repayments over 2018-22 amounting to a massive $14.9 billion. To put this in context, the current IMF facility is only $1.5 billion.

The maturing debt is too large to be repaid, so must be rolled over, which means we need to borrow to repay. In order to do so, we must maintain investor confidence. Failure to do so will lead to higher borrowing costs – something we cannot afford. Moody’s ranks Sri Lanka among the countries most exposed to an interest rate shock. Interest payments already consume around 36% of government revenue, an increase in rates will put severe pressure on the budget.

The accumulated ills of various shortsighted measures have taken the country to the brink of default. There is an unprecedented ballooning of foreign debt repayments over 2018-22 amounting to a massive $14.9 billion

Moody’s warns, “Persistently high government liquidity and external vulnerability risks continue to pressure Sri Lanka’s credit profile, and specifically measures to build reserves and smooth the profile of external payments may be insufficient to stem imminent government liquidity and balance of payments pressures starting in 2019, when large international debt repayments come due and Sri Lanka’s three-year International Monetary Fund Extended Fund Facility programme concludes."

This is why the Finance Ministry has pushed through unpopular tax hikes and increased fuel prices. Foreign lenders will look at the country’s finances to assess its ability to repay; so in the short term, there is no sensible alternative but to collect more taxes. The real problem, however, is not tax but runaway spending; over 2000-16, total spending grew at a compounded annual rate of 12% (from Rs335,822 million to Rs2,333,883 million), with the deficit following suit (Rs119,396 million to Rs640,326 million). Foreign financing of the deficit grew from Rs495 million to Rs429,130 million in the same period. It is government spending not taxation that ultimately determines the total burden of government activity on the private sector. Although spending may be financed by borrowing or printing money (instead of taxes), all government spending is ultimately a call on resources that have alternative uses, or involves transfers from one group of society to another.

Debt is simply taxation postponed, with interest added. Money printing can tide over in the short term, but ultimately results in inflation and currency depreciation. The need, therefore, is to reign in expenditure, which must start with a proper plan.

Large businesses routinely plan for 3-5 years, but the government relies on an annual budget, which is produced by a bottom-up approach – i.e. the various departments submit their estimates of expected expenditure, which are then amended and collated centrally. Planning and policy is geared to the annual budget cycle, and little attempt is made to prioritize spending.

Debt Balloon and Yawning Deficit.png

Planning must move away from annual budgets to a Medium-Term Expenditure Framework (MTEF), three-to-five year rolling plans, the important features of which are as follows:

  • Extends the timeframe of budgeting from 1 year to 3-5 years.
  • Projects the future cost of existing programmes and approved policy changes (baseline).
  • Establishes hard spending limits – fiscal targets (i.e. deficit or total spending).
  • Establishes a procedure for proposing any new policy initiatives.
  • Rolls the MTEF forward each year, adding a year at the end.

The Treasury can work backwards from revenue, assuming no changes in the tax structure and the deficit target to arrive at the overall spending limit. Matching this with projected costs of current programmes will indicate if there is space available in the budget for new policy initiatives. Fiscal space is the difference between baseline projections and the government’s spending target; if there is no space, no new programmes can be accommodated, unless some existing programmes are cut.

The overall spending limit is a ‘hard’ limit, but within the overall limit, reallocation can take place. This forces the Cabinet to consider spending priorities – where should limited resources be allocated? The Cabinet can determine soft ceilings for ministries that need to ‘win’ competitively on the basis of plans submitted.

Although spending may be financed by borrowing or printing money (instead of taxes), all government spending is ultimately a call on resources that have alternative uses, or involves transfers from one group of society to another

The Treasury needs to reward credible plans, so those that provide performance measures, specify outcomes, outputs and costs should receive more funding. Performance measures help make the case for budget allocation and enable monitoring of programmes. Performance measures are based on the following parameters:

  • Inputs: Measures the resources used to provide government services, such as personnel, operating expenses and capital.
  • Activities or output: Measures what an agency does, the number of applications processed, the number of passengers carried and kilometers of roads paved.
  • Efficiency: Measures the cost per unit of activity such as cost per patient, cost per student or cost per child vaccination.
  • Outcome: Measures how well objectives are met. These are usually the ends of government such as safety, health or educational improvement.

Expenditures must be driven by policy priorities, but disciplined by budget realities, which means sudden and unplanned announcements cannot be made. The result is greater policy predictability, a focus on outcomes, priorities and expenditure management.

Conceptually, this is simple, but implementing it in practice is a daunting task involving a lot of political negotiation (to get ministers to agree to spending limits) and administrative work in estimating future costs, revenues and measuring performance.

The trickiest political negotiation involved is in allocating the spending limit according to priorities. This exercise is the most important – with an annual incremental budget, no one is forced to question the ‘base cost.’ With a hard spending limit to be allocated among departments, questions on priorities come to the fore. The other obstacle is weak capacity within the government, both the bureaucracy and among ministers, which means that external technical support is needed to implement this, which is fortunately available through donor programmes.

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More than 16 African countries have adopted an MTEF, with Ghana and Malawi pioneering it in 1996. Since then, other countries in the region have followed. Implementing may be done in stages, starting with key spending units. In Malawi, the deficit contracted from 15% of GDP in 1994/5 to 5% by 1998/9, partly due to the MTEF. According to the World Bank (2013), by the end of 2008, more than two-thirds of all countries had adopted an MTEF. To work, the MTEF must become the government’s budget process and control the details of spending. Expenditure limits are agreed to by incoming governments giving intra-party policy consistency.

Properly planned expenditure means little need for periodic, ad hoc adjustments to taxes, which are witnessed at every budget, and even in between budgets through gazette notifications. Unexpected tax changes wreck havoc with the plans of businesses and households alike. Greater visibility will increase overall levels of confidence among lenders and investors.

When an MTEF is implemented well, public expenditure is limited by the availability of resources, budget allocations reflect spending priorities, and public goods and services are delivered cost-effectively. MTEFs, therefore, offer the prospect of achieving the three high-level objectives of public expenditure management: aggregate fiscal discipline, allocative efficiency and technical efficiency. Reaching this is an incremental process, but with good technical support, it is possible. The earlier this is adopted, the better.