By R. M. B. Senanayake Courtesy The Island

Statesmen and public interest organizations expected much from the UNP government under Ranil, which came to office on January 8th last year. They have been in office for over a year, but have carried out the same irresponsible populist policies; and done nothing to ensure sound government and fiscal rectitude. They have done nothing to stop the haemorrhage of public funds from loss making State Corporations, seem to be no longer committed to sound fiscal management, and have failed to explain to the people the unsound fiscal and monetary policies of the previous MR government.

Our governments don’t like to restrict public expenditure. They use the dispensation of public funds as a means to win the votes of the people, never mind the contribution to increase the GDP. Of course, the government is always keen to spend other people’s money in the name of development. But we often ignore the fact that if the government has not sought to rectify the revenue and expenditure policies.

The government obtains money to fund its expenditure from taxation or from running government owned public enterprises. But they don’t like to tax people and they are unable to run the public enterprises profitably, because of the need to dispense favours from such enterprises to their supporters. So, they don’t recruit the most suited for any vacancies but only their favourites, from political supporters who are invariably not suited for the jobs. As for income for the government, it must come from taxation. But taxation of the people makes them unpopular and thence they try hard to avoid it. But what other source of income or rather funds, does the government have? It can borrow from both domestic sources or from abroad. The domestic sources could be the people who are savers or from the financial institutions. But the latter do not always lend the savings of the people deposited with them. They can and do create new money to be lent to borrowers, and such new money when spent adds to the Aggregate Expenditure. Aggregate Expenditure must equal Aggregate Income. All private sector spending units can spend only what they earn as income. Of course they can borrow, but lenders will not lend ad lib to private sector borrowers without adequate security, and any private sector unit which borrows more than what it can repay is heading for financial trouble.

But it is not so with the government, which can obtain its income not only from taxation, and it must borrow taking into account the capacity to repay. Generally, revenue from taxation will increase more or less at the similar rate as that of the growth of the Gross National Income or GDP, apart from borrowing of course. Lenders in the private sector will look at the income of a borrower when lending to it. But there is the general presumption that the government will not default on its debt and people believe it. Since they control the government owned banks and financial institutions, they are able to borrow without limit. But economists say there are prudential limits to government borrowing.

Firstly, when the government borrows the savings of the people it reduces the availability of national savings for the private sector, which is often proclaimed as the engine of growth by politicians. But the engine of growth requires money to invest, which alone can provide the necessary growth. Economists talk of Investment as necessary for growth. How much investment? They have calculated the Capital/Output ratio which is considered as 4.5 or four and half times the capital invested produces one unit of growth. The higher the ratio the greater is the amount of capital required to be invested to produce growth. But capital must first be generated before it can be invested. Capital can be created only by savings, and savings to economists means the foregoing of spending on consumption. So savings in money terms must translate to Real savings where there are restrictions on consumption, at least on the freezing of consumption, so economists stress that a country that wants to speed up its investment must also save more in real terms. Our national savings is only about 21% of GDP. But we manage to invest about 29% of GDP because we borrow from foreign sources through direct foreign investment, as when a foreign party sets up a new industry here or from portfolio investments where foreigners by or subscribe to local borrowings by companies or the government. Much foreign borrowings take the form of foreigners buying government securities either in the primary market when they are issued for the first time, or in the secondary market when they are traded by the original subscribers to other investors.

Is there a limit?

Is there a limit to government borrowings? When the government borrows from domestic lenders it merely has to repay the borrowing in rupees, and the government need not be short of rupees for debt repayment since it can borrow afresh to repay the maturing debt. But when government borrowing keeps on increasing, the public may demand higher and higher interest rates. So when the Central Bank conducts public auctions to issue securities for new borrowings, lenders or subscribers to them want higher and higher rates of interest. But the Central Bank, which manages the public debt on behalf of the government, is faced with a conflict of interest. It must seek to reduce the rate of interest on new borrowings to reduce the interest burden on the government. But monetary policy may sometimes require a tightening of interest rates. What matters however is not the nominal rate of interest, but the Real rate of interest which is the nominal rate of interest less the rate of inflation. Inflation has come down in the recent years, but as the demand for government borrowings keeps on increasing, the government as a borrower will have to pay higher and higher rates of nominal interest which translate into higher real rates of interest as well. Higher real rates of interest become a burden on the borrowers. But the lenders will want higher rates of interest. So the government as borrower may then prefer to borrow from the Central Bank and the banking system, but that means the creation of new money, adding to the Money Supply, which then leads either to higher and higher prices or higher deficits in the current account of the balance of payments. So the Central Bank rejects tenders at public auctions where the lenders demand higher rates of interest. But the alternative is for the Central Bank and the banking system to either pay higher interest rates or be the major subscribers to the issue of government securities in the primary market, without raising the interest rates. But borrowings from the Central Bank and the banking system are highly inflationary and/or detrimental to the balance of payments since the banks may create new money to subscribe to them (unless it has savings not invested).

Supply of funds

The supply of funds in the banking system is also not unlimited, and hence when the government takes more of the national savings there is less available on offer to the private sector, which is recognized as the more productive sector of the economy and the engine of productive growth.

Our governments have borrowed vast sums of money to spend on welfare services instead of investing such borrowings to expand the productive capacity of the economy. Normally, such borrowings must be invested to produce a return from which the interest on the borrowings can be repaid. When the borrowings are used to provide welfare services to the people there is no return on such investments, and no possibility of recovering even the borrowings. This is the problem that our governments have since Independence created for themselves – borrowing to spend on welfare services instead of investing. If they have invested they have failed to obtain an adequate return on them. We have constructed expressways but have not seen to it that the beneficiaries pay the cost by way of a fee, so that the investment provides a sufficient return. It is true that tolls are now levied on the use of expressways. This should be the pattern for all future constructions of roads and highways. The principle should be extended from the highways to even the less important roadways, which should of course be built according to modern standards. The same should apply to the construction of new bridges. The principle should be extended to the Provincial Council and Pradeshiya Sabha investments in overheads, such as in the construction of roads and bridges which are presently used by people with much hardship. The people will appreciate the work involved and pay up willingly.

IMF vs. Irresponsible values

The Government is said to be in talks with the IMF for balance of payments support to tide over a looming crisis. All our governments have disregarded the prudential rules of fiscal management. They come to office hoping to spend money that is not there, and fail to address their minds to stop the losses in the commercial undertakings of the State Corporations. They have no commitment to run the public sector with economy and efficiency. They have adopted the irresponsible values of providing benefits without recovering the costs. Plato would have quoted this as the inevitable result of mass democracy. What future is there for a State which is run by such an irresponsible bunch. They only want to expand public expenditure. They turn a blind eye to the colossal losses incurred by State Corporations and are not interested in doing anything to turn them around for they themselves are the cause. There is a Sinhala folk saying about asking the rogue’s mother about the whereabouts of the stolen property. So they will continue to incur losses which have to be reimbursed by the Treasury, which in turn must borrow and pay interest or create money.

The IMF is the only hope to compel our irresponsible governments to reform the public sector. The IMF must insist that the government commit itself to reform of the public sector enterprises to stop the haemorrhage of public money. The problem of losses in State Corporations are caused by the members of the government themselves. They appoint unsuitable political nominees with no expertise or experience in running enterprises and who are knaves.

Sri Lanka recorded a Government Debt to GDP of 75.50 percent of the country’s Gross Domestic Product in 2014. Government Debt to GDP in Sri Lanka averaged 90.83 percent from 1990 until 2014, reaching an all time high of 103.20 percent in 2001 and a record low of 75.50 percent in 2014. Government Debt to GDP in Sri Lanka is reported by the Central Bank of Sri Lanka. But this reduction in the ratio is due more to the increase in government income to fund its expenditure rather than to any decrease in borrowing.