Spending priorities for the Presidential candidates | Daily News


Spending priorities for the Presidential candidates

A previous article highlighted the dire state of the public finances and the need to bring public expenditure under control. Various promises are made at elections but none of them are actually affordable. At the same time there are two areas however where spending must increase, disaster management and health. Trying to manage increased expenditure at a time when public finances are already weak is a huge challenge that requires systemic reforms.

The spending priorities and necessary reforms are outlined below.

1. Disaster management

Sri Lanka was ranked as the second most affected country by the impacts of weather-related losses in 2017, according to the Global Climate Risk Index (2019). The country’s situation has worsened since 2016; floods and droughts are now almost annual events.

In May 2017 floods and landslides affected 15 of the 25 districts of Sri Lanka. The drought in 2016 and 2017 affected 1,927,069 people across 17 districts, many of them poor.

“Approximately 12 per cent of those affected were poor, nearly twice the national average of 6.7 per cent. In the case of the landslides, this is because the 11 affected Divisional Secretary (DS) Divisions tend to be poorer than the national average. Those affected by the floods overall were also disproportionately poor, with an estimated poverty rate of 8.7 per cent.” (World Bank)

If the poor are disproportionately affected by natural disasters it has a negative impact on poverty. A couple of more incidents where people lose their possessions and property will push those just above the poverty into poverty.

These events present risks that are too large to be managed at household or community level so a state lead intervention is necessary.

The problem needs to be tackled across three fronts:

I. Preventive measures that minimise the impact of disasters including floodplain zoning, wetland conservation and engineering measures to divert flood waters. Agriculture policy needs review and policies that encourage risky production choices in flood zones or increase vulnerability to droughts and floods should be avoided.

II. Early warning systems and evacuation plans that allow people to leave disaster zones to safer areas.

III. Managing the financial risks because they pose risks to the budget. Solutions include insurance, catastrophe bonds.

2. Ageing demography, looming health crises

Sri Lanka is one of the fastest ageing countries in the world. The share of the population over 60-years-old in 2001 was 9.2% which exceeded the average of all regions in the world except the OECD, Eastern Europe and the former Soviet Union. The population aged over 65 is expected to double, to 16.2% by 2035, a level comparable to Western Europe.

We have a rich country demography but a poor country economy, a disastrous combination.

This will lead to an increase in the numbers of chronically ill, the elderly, and those with severe disabilities. The informal social networks, family members who provide care in these instances are disappearing with migration and the break-up of extended family groups. In the absence of adequate social protection, the elderly, the ill and differently-abled have the potential to spiral into poverty. Urgent measures are therefore essential to tackle this impending crisis.

Additionally, a declining working-age population will generate less income for health and pension systems.

The response must include:

Supporting economic and social integration

Increases in labour force participation by older workers must be supported by increasing the retirement age and enabling flexible and part-time working, taking into account of changes in physical capacity with ageing.

Risk reduction

Measures that reduce the risk of disease and promote the maintenance of function, confidence and engagement can support healthy ageing and ease the pressure on health care systems. Disease prevention must target the main causes of morbidity including obesity, hypertension and mental health.

These measures should include physical exercise and social involvement from middle age onwards. The lack of social interaction is a risk factor for depression and cognitive decline – both serious and costly disabling conditions in older age – continued social engagement is seen as a priority preventive measure.

Building adequate systems of long-term care

The impact of increases in the older old population with disabilities will fall predominantly on the long-term care sector rather than the acute health sector. This necessitates an appropriate balance of settings for long-term care, including supported self-care and home-based services. Appropriate services for older people with chronic diseases are essential, requiring the integration and coordination of care across different service providers and between health and social care.

Sri Lanka’s health system has not changed, structurally from the system that was built in 1950. The current public healthcare system is ill-equipped to provide the long-term care associated with an ageing population, the treatment of NCDs, and it is unclear to what extent the government can meet the growing costs of treating them. Policy should focus on the long term, addressing these wider issues.

The two spending priorities highlighted above will place additional stress on the budget. With public finances already in disarray this is very difficult to achieve unless some systemic reform takes place.

Putting public finances on a sound footing

There are two reforms needed to bring the deficit under control and improve the investment climate; Medium Term Expenditure Frameworks (MTEF) and central bank independence.

1. Medium Term Expenditure Frameworks replace annual budgets with three to five year rolling plans. The important features of these are:

* Extends the time frame of budgeting from one year to 3-5 years.

* Projects the future cost of existing programmes and approved policy changes (baseline).

* Establishes hard spending limits – fiscal targets (ie deficit or total spending).

* Establishes a procedure for proposing any new policy initiatives.

* Rolls the MTEF forward each year, adding a year at the end.

The treasury works backwards from revenues, assuming no changes in the tax structure and the deficit target to arrive at the overall spending limit. Matching this with projected costs of current programmes will indicate if there space available in the budget for new policy initiatives. Fiscal space is the difference between baseline projections and the government’s spending target, if there is no space no new programmes can be accommodated unless some existing programmes are cut. The root of the problems is unplanned changes to spending. Ahead of the election random promises are made. No one has a clear idea of the long terms commitments that these promises entail or how they will be funded. Ad-hoc tax changes or borrowing follows which means constant changes in policy that add to uncertainty, hurting investment.

With longer plans and hard ceilings government spending becomes fixed and predictable. Specific processes must be followed to introduce new programmes. The overall spending limit is a ‘hard’ limit but within the overall limit reallocation can take place. This forces Cabinet to consider spending priorities - where should limited resource be allocated?

As spending becomes predictable, tax policy becomes predictable (ad-hoc changes are not required).

2. Central Bank reform

It is necessary to bring stability to both the exchange rate and inflation which requires reform of the Central Bank. Regular currency depreciation causes inflation which feeds into poverty. Expansion of monetary base is the cause of inflation that is reflected in the currency depreciation.

A reform option that could send a strong signal could be adopting the actual operating guidelines of, for example the German Bundesbank Law. This was done in some East European countries when they emerged out of the Soviet Union.

The important features should be:

1. A single mandate - to maintain price stability. (the current mandate includes stimulating growth which prompts various ad-hoc interventions; eg. directed lending, rate caps.)

2. Political independence with respect to tenure and remuneration of board. Members of the government should be excluded from the board (eg. secretary to the ministry of finance is a member of the monetary board).

3. Credit to government banned

The current Monetary Law Act allows the CBSL to provide direct provisional advances to the government expenditure from the consolidated account, but the amount must not exceed 10% of estimated government revenue for the financial year. The limit aims to avoid excessive monetization of fiscal deficits. In practice, however, the CBSL credit to the government exceeded the 10% limit continuously since 2000, often reaching 30%.

4. Autonomy in formulation and implementation of monetary policy.

The above set of reforms should improve predictability of the key macro variables: tax policy, exchange rates and interest rates; these are critical to attract investment.

None of these steps is easy or popular but unless the reality is faced Sri Lanka may be heading for multiple crises, financial, demographic and climate induced.

(The writer is an independent consultant.)


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