Budget 2025: Methodological error

While achieving these targets the Government has deviated in regard to absolute figures that ensure debt sustainability

This year’s Budget is crucial. By adjusting the Budget or preparing the Budget the Government can manage economic stability, control inflation, reduce unemployment, ensure debt sustainability and promote sustainable growth, making it a crucial part of fiscal policy. 

Therefore, after submitting the Budget what is written elsewhere specially in the NPP’s election manifesto in regard to the fiscal policy, directly or indirectly has economically no relevance for argument. In analysing the Budget, however if any parliamentarian or economist needs a reference document to compare with then the best document is the IMF’s review report published in June 2024, because considering the debt sustainability and putting the economy back on a growth trajectory Sri Lanka’s monetary authorities have basically agreed on what Budget 2025 should look like.

Superficially, it seems that the Government has taken extra care to fulfil the expectation of IMF’s main criteria but has significantly deviated with some expectations and principles, possibly due to methodological errors of the Budget preparation. 

Two key parameters of the IMF report are Primary Balance and the Revenue to GDP ratio. The IMF insisted that the primary balance should be 2.3% of GDP and Revenue to GDP ratio must be 15.1% of GDP in 2025. In the Budget the Government has achieved these targets. Hence, the Government’s concern to go with the IMF’s targets is commendable.

Key principle in ensuring debt sustainability

The problem is while achieving these targets the Government has deviated in regard to absolute figures that ensure debt sustainability. These parameters are overall balance or budget deficit and financing of the same. The IMF’s expectation is to reduce the overall balance or budget deficit while achieving the required primary balance. This is a key principle in ensuring debt sustainability and this Budget has ignored this principle. This means that the primary balance is a relative target, achieving this target has no meaning if the overall balance is increased on a continuing basis. The IMF might call, let us say, an explanation on this point.

How can the Government highly concerned with the IMF’s fiscal policy targets miss such an important principle? I would say it could be a methodological error. 

Let me explain it briefly. Backward calculation could be the culprit.

There are a few known parameters or variables in preparing the Budget. Revenue is known, Primary balance is fixed by IMF, interest payment is known, and GDP has been estimated. Total expenditure is still unknown. Then anybody can calculate the total expenditure by using the equation to calculate primary balance. Primary balance is the revenue surplus after deducting expenditure excluding interest and when the answer is divided by GDP and multiplied by hundred, we will get it as a ratio. The IMF wants this ratio to be 2.3% in 2025.

Widening deficit

Therefore, the equation of calculating primary balance can be written as follows.

Primary Balance = [Total Revenue – (Total Expenditure – Interest)/GDP] * 100

In the above equation the unknown parameter is the total expenditure. So, you may calculate what the total expenditure should be while achieving the primary balance of 2.3% by doing this backward calculation. The figure for total expenditure so calculated arrived at Rs. 7,190 billion. With these figures we have achieved primary balance of 2.3% and Revenue to GDP ratio of 15.1% but overall budget negative balance (deficit) increased by Rs. 419 billion than the IMF target. A widening deficit means that the Government is spending significantly more than it is earning. Total expenditure has increased by Rs. 292 billion or 1.5% of GDP, compared with IMF’s targets. 

Overall impact of these figures requires the Government to increase domestic borrowing by over Rs. 904 billion than estimated by the IMF for the year 2025. This is a staggering amount. This will badly affect debt sustainability. Also, this means that the Government is to borrow enormous amounts of money to finance its tax concessions, salary/wage increases, various subsidy increases and for increased capital expenditures. Once the total expenditure is matched to the primary balance of 2.3% of GDP, this mistake which can negatively affect debt sustainability, cannot be avoided. 

However, the Government intends to increase the demand ensuring growth by putting more money in people’s wallet, which can in turn tend to increase the private credit growth. If this happens it is certain that there will be a negative impact on the national current account which could contribute to destabilising the rupee. This means the Government and the Central Bank must contain private credit growth proactively. I hope that constructive criticisms are welcomed by the Government.

(The writer can be reached via [email protected].)