The primary driver of post-independence Sri Lanka’s macroeconomic instability has been consistently poor fiscal discipline. Fixing this permanently requires a combination of legislative reform, governance reform, and a fundamental change in the public mindset.
There are two pieces of legislation that could contribute to a transformative shift in Sri Lanka’s macroeconomic management. It is necessary to revise the Monetary Law Act in order to remove the ability of the Central Bank to directly finance the government fiscal deficit.
Over the years, weak fiscal policy has been buttressed by monetary financing, directly contributing to inflation and inadvertently creating the space for an expansion of public debt. Removing this power will automatically force greater fiscal discipline since the fiscal authorities will know that there is no monetary bailout in case of budget underperformance.
A new Monetary Law legislation should also reduce the space for fiscal dominance by removing the ex-officio position of the Secretary to the Treasury on the Monetary Board. The resulting enhanced independence of the monetary authority should be coupled with ensuring accountability of the Central Bank to the legislature.
In parallel, it is also necessary to introduce comprehensive Public Finance Management legislation. Such legislation should subsume and improve upon the existing Fiscal Management Responsibility Act by building in time-bound escape clauses and supermajority requirements for certain amendments.
The legislation should also include disciplines on public sector recruitment to ensure depoliticization and fiscal neutrality. It should require quantification of pension liabilities, and require measures to de-risk and finance the liability. PFM legislation should also provide legal force to enhance checks and balances in public finance governance such as an independent budget office and legal provisions for the parliamentary committees on public finance, public accounts, and public enterprises.
Fiscal governance would also be improved by the PFM bill requiring enhanced fiscal transparency in terms of fiscal performance (including SOEs), budget execution, public debt and arrears.
Initial drafts of both pieces of legislation were developed in 2018, with a revised Monetary Law Act being gazetted to be tabled in parliament, but both were abandoned subsequently. It is heartening to note that both pieces of legislation are now back on the agenda. However, legislation alone is not sufficient to drive meaningful change.
The Fiscal Management Responsibility Act of 2003, largely observed in the breach, is a testament to this. Achieving change requires a change in the public mindset. It is convenient to blame successive groups of politicians for Sri Lanka’s macroeconomic malaise. However, politicians respond to the demands of the electorate.
As a collective citizenry, Sri Lankans over the years have demanded state sector jobs, demanded utilities at below market cost, demanded exemptions from taxation. Politicians have simply responded to these demands and financed them by borrowings that steadily accumulated into an unsustainable burden.
Accordingly, in 2022 public sector salaries and pensions accounted for 67% of government revenue, CPC and CEB interest-bearing debt alone was 6.5% of GDP, and by the end of 2021, only 325,007 individuals out of a population of 22 million were registered for personal income tax. The crisis we are facing at present is the collective cost of several decades of diyaw diyaw culture. Unless there is a shift in that culture and mindset, we will likely repeat the cycle.
In 2022, public sector salaries and pensions accounted for 67% of government revenue, cpc and ceb interest-bearing debt alone was 6.5% of gdp, and by the end of 2021, only 325,007 individuals out of a population of 22 million were registered for personal income tax