The importance of fiscal adjustment is well illustrated by the course of Govt revenue and expenditure over the last 10 financial years from 2015/16 to 2024/25. Govt fiscal data presented here consolidates the budget with special funds, and the figures for this financial year 24/25 are partially estimated.
Govt expenditure has been growing much faster than revenue (see Graph 1). Excluding three Covid-related years, Govt revenue rose from under 22% of GDP prior to 18/19 to 26% in 24/25, while Govt expenditure jumped from less than 25% of GDP to 35% (see Graph 2). The budget deficit increased more than three-fold from less than Rs20 bn prior to 18/19 to around Rs65 bn in 24/25 (see Graph 3), rising from less than 4% of GDP to over 9% (see Graph 4).
Govt interest payments were about 3% of GDP in 24/25, in line with fast-growing debt. The primary budget deficit, which excludes interest payments, is recognized as a key policy target for fiscal adjustment. The primary deficit stood at around 1% of GDP until 18/19, but rose markedly to a record level of over 6% in 24/25 (see Graph 4).
Bringing down the primary deficit from 6% of GDP over the coming years is crucial to contain fiscal debt pressures, and improve debt sustainability. In addition to the primary deficit, Govt loans to parastatal bodies and equity investments in public enterprises, averaging around Rs4 billion annually, or 0.5% of GDP, further raise Govt borrowing requirements. Although Govt loans and equity expenditures are typically intended for capital spending, they often represent disguised current spending to cover the operational expenses of parastatal entities.
The budget can be adjusted by reducing the primary deficit by 1.5% of GDP over the next 4 years, starting with Rs11 bn in 25/26. A combination of pension reforms and other reduced spending, combined with modest tax increases and cuts in tax exemptions, should provide adequate fiscal room for adjustment. Fiscal consolidation could have been initiated as from Jan 2025 t0 spread the budget adjustment over time more effectively.
Since the Chagos deal is expected to bring in an amount of Rs10 bn in the course of 25/26, budget adjustment could be deemed unnecessary. However, this would still imply a fiscal deficit well in excess of GDP growth, raising the public debt to GDP ratio above 90%. A potential country credit downrating to sub-investment grade in the light of a growing debt burden imposes a critical constraint on fiscal policy choices.
To lower the public debt ratio, a fiscal adjustment of over 2.5% of GDP is needed in 25/26, even with Rs10 bn from the Chagos deal. Budget adjustment measures of over Rs20 bn are necessary to almost halve the fiscal deficit, and set the country firmly back on the path of debt sustainability.
It is essential to build a broad consensus around a fiscal adjustment roadmap phased over several years, while maintaining a careful balance between fiscal responsibility and economic growth. Clear communication of the rationale behind budget adjustment would strengthen public understanding and support, especially if unbounded social spending for all income groups is also reviewed.
