Bleak fiscal prospects

February 26, 2013, 9:08 pm

The budget deficit, targeted at 5.8 percent of GDP this year, the lowest since 1977, is likely to be overshot by the government with revenue as a percentage of GDP expected to fall further this year as economic challenges mount and expenditure exceeds targets, a research report shows.

A research report released by CT Smith Stockbrokers has forecast the budget deficit would overshoot the government’s 5.8 percent of GDP target this year, reaching 6.5 percent of GDP with aggressive revenue and expenditure targets unlikely to be achieved.

The report said revenue targets would not be met due to slower growth in income tax and external trade. Revenue as a percentage of GDP is expected to fall sharply to 14.7 percent this year (2013), down from 16.8 percent in 2000.

Earlier this month, the International Monetary Fund (IMF) raised concerns about falling revenue after tax revenue fell to 11.5 percent of GDP last year from the 12.2 percent target on slower economic growth and tax concessions.

CT Smith believes the government would overshoot its target for recurrent expenditure this year and was likely to cut down on capital expenditure to avoid an excessive fiscal deficit.

The IMF has indicated that the government would slightly overshoot the 6.2 percent of GDP budget deficit target for 2012 with capital expenditure being differed or cut.

Although authorities said no programme would be pursued with the IMF and despite the government not making allowances for foreign commercial borrowings this year in the 2013 budget, the research report said the government was likely to issue another foreign bond this year.

Also, DFCC and NDB are expected to raise US$ 500 million (13 percent of the budget deficit) from external sources for SME development. These funds would be invested in government securities temporarily, CT Smith said.

With the government expected to finance the bulk of this year’s deficit from domestic non-bank borrowings, there would be a degree of crowding out of the private sector and possible upward pressure on interest rates during the second half of this year, a point economists have already warned about as reported in these pages.

The public debt-to-GDP ratio which increased to 81 percent in 2012, from 78 percent the previous year, was likely to inch downwards to 80 percent this year.

According to the IMF, inflation and interest rates could be under pressure if the government failed to stick to its fiscal targets and bring down too high debt levels.

According to the 2013 budget proposals the government will not seek foreign commercial loans this year after borrowing Rs. 109.5 billion in 2011 and Rs. 128 billion in 2012.

With the budget deficit estimated at Rs. 507.4 billion this year, the government hopes to raise Rs. 86 billion from foreign sources to finance the deficit, a sharp decline from Rs. 205.6 billion estimated for last year, while domestic borrowings are estimated at Rs. 421.4 billion, almost doubling from 259.6 billion in 2012.

Non bank domestic borrowings are expected to carry the weight of the deficit financing, surging to Rs. 289.4 billion this year from 84.6 billion in 2012.

According to CT Smith, benchmark Treasury bill yields are expected to decline by 100bps by the third quarter of this year, however, government deficit financing would push rates up by 50bps by the fourth quarter.

With the government prioritising growth over inflation, CT Smith believes monetary policy rates would be cut by 50 to 75bps this year. Inflation is expected to range within 7 to 10 percent this year, it said.