Fiscal deficit swells to record high of 11.1% in 2020

• CB says near-term risks to fiscal sector remain elevated due to low revenue mobilisation and large foreign currency debt service requirements
• Warns persistent deviations of budget deficit and elevated level of outstanding Central Government debt warrant a firm commitment towards fiscal consolidation 

The country’s fiscal deficit as a percentage of GDP in 2020 had swelled to high of 11.1% from 9.6% in the previous year.

Last year’s figure is also unprecedented considering the fact that the average between 2016 and 2018 was around 5%.

The previous highest budget deficit in recent history was 10.8% in 2001 whilst in 2009, which saw the end of the 30-year conflict, the figure was 9.9%. The country recorded a high budget deficit of 15.6% in 1988.

In absolute terms the deficit of Rs. 1.66 trillion in 2020 was entirely financed most by domestic sources.

In its Annual Report for 2020, the Central Bank said at the turn of the year 2020, fiscal policy was focused on reviving a stagnant economy. However, with the economic fallout from the COVID-19 pandemic, the fiscal outcome deviated from expectations, as reflected in the decline of the Government revenue and a rise in Government recurrent expenditure, thereby widening the budget deficit and raising the outstanding Central Government debt. 

“Heavy reliance on domestic sources in financing the budget deficit in 2020 reflected the impact of extremely challenging global market conditions that limited access to foreign financing, and the expressed preference of the Government to reduce the reliance on foreign financing,” it added. 

The Central Bank also said going forward, near-term risks to the fiscal sector could remain elevated due to low revenue mobilisation and the large foreign currency debt service requirements. Persistent deviations of the budget deficit and the elevated level of outstanding Central Government debt warrant a firm commitment towards fiscal consolidation as envisaged in the National Policy Framework of the Government.

As per the Government’s medium term fiscal framework, a budget deficit of 9.4% has been forecast for 2021 and to be progressively reduced to 7.5% next year, 5.6% by 2023, 4.7% in 2024, and 4% by 2025.

In detailing the revenue performance, the Central Bank 2020 Annual Report stated that Government revenue declined in 2020, both in nominal terms and as a percentage of GDP, reflecting the combined impact of subdued economic performance due to the COVID-19 pandemic, the tax revisions implemented from late 2019, and the tax concessions granted to businesses and individuals affected by the pandemic. 

Accordingly, total revenue declined by 27.7% to Rs. 1,368 billion in 2020 from Rs. 1,890.9 billion in 2019. Tax revenue declined by 29.9% to Rs. 1,216.5 billion in 2020 from Rs. 1,734.9 billion in 2019, mainly due to low revenue from income tax, VAT, NBT, CESS and excise duties. 

The relative share of revenue from direct taxes declined to 22.1% in 2020 from 24.7% in the previous year, mainly reflecting the impact of subdued incomes of businesses and individuals amidst the pandemic. The share of revenue from indirect taxes accounted for 77.9% of total tax revenue in 2020. 

Non-tax revenue declined marginally by 2.9% to Rs. 151.4 billion, reflecting the reduction in revenue collection from fees and charges and profit transfers of SOBEs. As a percentage of GDP, total revenue declined to 9.1% in 2020 from 12.6% in 2019, reflecting the reduction in tax revenue to 8.1% in 2020 from 11.6% in 2019, while non-tax revenue collection remained unchanged at 1% in 2020.

Government expenditure and net lending in 2020 were adjusted by the Ministry of Finance by shifting a sum of Rs. 422.6 billion to 2019 in view of accounting for the payment of arrears spilled over from 2019. Accordingly, of the recurrent expenditure incurred in 2020, a sum of Rs. 123.4 billion was shifted to 2019, and of the capital expenditure and net lending in 2020, a sum of Rs. 299.2 billion was shifted to 2019.

With these adjustments, Government expenditure and net lending in 2020 declined to 20.3% of GDP (Rs. 3,041 billion), from 22.2% of GDP (Rs. 3,337.9 billion) in 2019. The decline in Government expenditure and net lending was attributed to the notable reduction in capital expenditure and net lending to 3.3% of GDP (Rs. 492.6 billion) in 2020 from 6.1% of GDP (Rs. 913.3 billion) in 2019. In contrast, the recurrent expenditure increased to 17% of GDP (Rs. 2,548.4 billion), compared to 16.1% (Rs. 2,424.6 billion) in 2019.

The Central Bank in its 2020 Annual Report said that major fiscal challenges that needed to be addressed by the Government included the persistently low revenue, rigid recurrent expenditure, rising gross financing needs and the resultant elevated debt level, as well as the need to improve the financial performance of SOBEs. 

It also noted that tax revenue mobilisation has been impeded by various tax exemptions/holidays, tax evasion and weak tax administration for decades.

It said certain tax reforms introduced by the Government were aimed at addressing these issues, despite the near-term setback due to the COVID-19 pandemic. The adverse near-term impact on tax revenue collection due to the fiscal stimulus measures is expected to be offset by the envisaged rebound of economic activity in the period ahead. 

It is imperative to enhance Government revenue by improving the tax base and simplifying documentation requirements in the tax system, while strengthening the capacity for risk based revenue administration to improve tax compliance, within a simple, efficient, and equitable tax system as envisaged by the Government.

Meanwhile, the rising share of non-discretionary fiscal expenses, such as interest payments, salaries and wages, and pension payments, continues to add pressure on fiscal operations, thereby challenging the expenditure rationalisation plans of the Government. 

Relatively large Government expenditure, given the low revenue mobilisation and tightening financial conditions, has resulted in high budget deficits, necessitating effective management of Government expenditure to avoid significant stresses in the period ahead with increasing borrowing requirements, coupled with large debt service payments of the Government falling due in the near to medium term. This underscores the need for deficit financing through non-expansionary sources in the period ahead. 

Past efforts towards fiscal consolidation by phasing out the relatively high fiscal deficit and Government debt have fallen short of expectations. Against this backdrop, the Government needs to strike a fair balance between firming up fiscal consolidation and continuing the facilitation of the envisaged economic recovery and growth in the period ahead.