By W.A. Wijewardena
Huge hole created by CEB
President and Finance Minister Ranil Wickremesinghe, addressing the recently concluded Sri Lanka Economic Summit 2022 hosted by Ceylon Chamber of Commerce, posed a threatening question to private sector bastions packed shoulder to shoulder in a too small auditorium for that large crowd. Briefing them of his new economic model for the next 25 years, he warned them that year 2023 is to open with a huge hole in government financing caused by unsound financial policies of the government monopoly of electricity generation, Ceylon Electricity Board, amounting to some Rs. 300 to 400 billion.
He asked the private sector bastions who are already overburdened by high taxes, galloping inflation, cost increases, forex scarcities, and slowing economy whether they would want the Government to fund the hole by running printing presses.
His reference to ‘running printing presses’ is related to the popular slogan among many Sri Lankans today, money printing by the Government to finance the budget causing inflation. His suggestion was that this option should be avoided because it was evil and those who use electricity should be required to pay the cost on the principle that the user should pay and not the general public.
But according to the World Bank’s collection of development indicators, by 2020, Sri Lanka had had a near 100% of population having electricity connections. Hence, the general public and the electricity users in Sri Lanka are one and the same. As such, there is no difference whether it is the public that pays or the electricity users who pay. It is the same group.
But the bigger hole is in the Budget 2023
What President Wickremesinghe omitted to disclose was that the so-called hole created by the deficit in CEB is nothing compared to the bigger hole in the Government budget. The Consolidated Fund, the constitutional provision for recording all inflows and outflows of the Government and hence, naturally balance itself, is overdrawn to the extent of Rs. 1,000 billion as at end of 2021. Rs. 850 billion of this overdrawn amount is funded through a temporary overdraft facility from state banks and another Rs. 150 billion by a provisional advance from the Central Bank.
On top of this, the Budget 2023 has a much bigger hole on a gross basis. According to the budget numbers, the gross expenditure of the Government in 2023 will amount to Rs. 7.9 trillion including the long-term debt to be repaid by reissuing to the market as against a gross revenue base of Rs. 3.4 trillion. However, this gross expenditure does not include the reissue of the maturing Treasury bills within 360 days amounting to Rs. 3.8 trillion. When this amount is also added to the gross expenditure announced in the budget 2023, the overall total amounts to Rs. 11.7 trillion.
What this means is that the budget deficit on a gross basis will amount to Rs. 8.3 trillion or 28% of the estimated GDP of Rs. 30 trillion for the year. The Government has taken out the reissue costs from the budgetary numbers but the actual burden to be borne by the public constitutes the whole of this expenditure as explained later in this article. The gap in CEB estimated at Rs. 300-400 billion is nothing compared to this huge gap in the overall budget.
Ricardo-Barro Equivalence: No difference between bond financing and tax financing
When a government spends money, it is generally believed that it is the taxes which the current population should pay that will constitute the burden to be borne by them. Therefore, if the government borrows money to pay for the expenditure, it was not considered a burden because it is only a redistribution of the financial assets from taxpayers to bondholders. Therefore, when the bonds are repaid, people will pay taxes to repay them, but it is only a transfer of money from taxpayers to bondholders. Therefore, it does not involve a burden because one section of population owes it to another section of the population. This led to the popular slogan relating to the domestic debt of the government that ‘we owe it to ourselves’. This was changed by the 19th century English economist, David Ricardo, who argued that there is no difference between the tax financing and the debt financing.
When people pay taxes today, they bear a burden today by transferring their resources to the government sector. It reduces their spendable income known as the disposable income and force them to curtail both consumption and money available to lend to their private sector peers. When the government charges higher taxes to repay what it has borrowed in the past, the people must pay higher taxes. Hence, debt financing is simply the postponement of the current tax liability to the future. This is known as Ricardian Equivalence, and it was further developed by Harvard Economist Robert Barro who argued that when the government spends one rupee here there is a reduction of one rupee spent by the private sector elsewhere. Therefore, this theory is now known as Ricardo-Barro Equivalence.
Foreign borrowing is more burdensome
This analysis presumes that the Government borrows only from domestic sources to finance the budget. It becomes much more alarming when foreign borrowing for financing the budget is allowed. At the time of making the foreign borrowing, there is an inflow of resources increasing the welfare of the people. However, when it is repaid, there is an outflow of resources more than the initial inflow because the country should now repay the principal along with interest. But it is the people who should curtail their consumption to provide for resources for repayment of the foreign borrowing. Therefore, the crucial requirement for meeting the foreign debt of the Government is not just having domestic savings. The nation should have foreign exchange to convert the domestic savings to usable mode of repayment.
If it does not have, it runs in to a new problem in the form of being taken hostage by foreign creditors who will insist that the available foreign exchange resources should be used to repay their debt before meeting the nation’s normal import requirements. If foreign debt is defaulted, unless a speedy resolution is arrived at, the door for refinancing the maturing foreign debt plus payment of interest will be closed for the Government. It makes the gross expenditure of the government not just a book entry but a threatening reality. This is the issue which Sri Lanka is going through today.
Money printing leads to inflation
Then, what about running the printing presses as warned by the President to meet the holes in the budget? It does not impose an immediate burden on the people, and therefore, there is a tendency to believe that it does not inflict a burden on people. Instead, people will be benefitted by the higher liquidity they now enjoy due to the increase in the cash balances. However, if money is printed over and above the safe levels, that is, much more than the increased liquidity requirements arising from the real economic growth, the excess money leads to both domestic inflation and the pressure for the exchange rate to depreciate. This is because the increases in excess money will increase the aggregate demand above the short-term aggregate supply and if imports cannot be increased to meet the increased amount of aggregate demand, it leads to domestic inflation on the domestic front and to balance of payments difficulties on the external front. With inflation, the country will lose its competitive edge, fail to realise much from international trade, and there will be pressure for the exchange rate to depreciate. Therefore, exchange rate depreciation is not the cause of inflation but the result of inflation. Therefore, money printing over and above the safe levels will cause inflation and inflation is a tax which is being paid by all.
Inflation is a tax on people
But how does inflation become a tax? Suppose the Government pays the salary of a teacher by getting the Central Bank to print a new 5,000 rupee note. The teacher sacrifices, say, 8 hours of her real labour to get that 5,000 rupee note. But the Government spends only the printing cost of the note and therefore, there is an unequal exchange between the Government and the teacher. Why should a teacher agree to such an unequal exchange? Because she is told by the Government that when she goes to the market with that 5,000 rupee note, she can buy, say, a kilogram of rice. But when she goes to the market, she finds there are others who also have got 5,000-rupee notes and are about to exchange for rice.
When the demand goes up, prices go up and assume that they have increased to Rs. 10,000 per kilo. She can buy only half a kilo of rice now and the lost quantity of a half a kilo is a tax she pays to the Government. Since this reduction in the consumption level has arisen due to inflation, it is called due to the inflation tax.
Contd.....
Huge hole created by CEB
President and Finance Minister Ranil Wickremesinghe, addressing the recently concluded Sri Lanka Economic Summit 2022 hosted by Ceylon Chamber of Commerce, posed a threatening question to private sector bastions packed shoulder to shoulder in a too small auditorium for that large crowd. Briefing them of his new economic model for the next 25 years, he warned them that year 2023 is to open with a huge hole in government financing caused by unsound financial policies of the government monopoly of electricity generation, Ceylon Electricity Board, amounting to some Rs. 300 to 400 billion.
He asked the private sector bastions who are already overburdened by high taxes, galloping inflation, cost increases, forex scarcities, and slowing economy whether they would want the Government to fund the hole by running printing presses.
His reference to ‘running printing presses’ is related to the popular slogan among many Sri Lankans today, money printing by the Government to finance the budget causing inflation. His suggestion was that this option should be avoided because it was evil and those who use electricity should be required to pay the cost on the principle that the user should pay and not the general public.
But according to the World Bank’s collection of development indicators, by 2020, Sri Lanka had had a near 100% of population having electricity connections. Hence, the general public and the electricity users in Sri Lanka are one and the same. As such, there is no difference whether it is the public that pays or the electricity users who pay. It is the same group.
But the bigger hole is in the Budget 2023
What President Wickremesinghe omitted to disclose was that the so-called hole created by the deficit in CEB is nothing compared to the bigger hole in the Government budget. The Consolidated Fund, the constitutional provision for recording all inflows and outflows of the Government and hence, naturally balance itself, is overdrawn to the extent of Rs. 1,000 billion as at end of 2021. Rs. 850 billion of this overdrawn amount is funded through a temporary overdraft facility from state banks and another Rs. 150 billion by a provisional advance from the Central Bank.
On top of this, the Budget 2023 has a much bigger hole on a gross basis. According to the budget numbers, the gross expenditure of the Government in 2023 will amount to Rs. 7.9 trillion including the long-term debt to be repaid by reissuing to the market as against a gross revenue base of Rs. 3.4 trillion. However, this gross expenditure does not include the reissue of the maturing Treasury bills within 360 days amounting to Rs. 3.8 trillion. When this amount is also added to the gross expenditure announced in the budget 2023, the overall total amounts to Rs. 11.7 trillion.
What this means is that the budget deficit on a gross basis will amount to Rs. 8.3 trillion or 28% of the estimated GDP of Rs. 30 trillion for the year. The Government has taken out the reissue costs from the budgetary numbers but the actual burden to be borne by the public constitutes the whole of this expenditure as explained later in this article. The gap in CEB estimated at Rs. 300-400 billion is nothing compared to this huge gap in the overall budget.
Ricardo-Barro Equivalence: No difference between bond financing and tax financing
When a government spends money, it is generally believed that it is the taxes which the current population should pay that will constitute the burden to be borne by them. Therefore, if the government borrows money to pay for the expenditure, it was not considered a burden because it is only a redistribution of the financial assets from taxpayers to bondholders. Therefore, when the bonds are repaid, people will pay taxes to repay them, but it is only a transfer of money from taxpayers to bondholders. Therefore, it does not involve a burden because one section of population owes it to another section of the population. This led to the popular slogan relating to the domestic debt of the government that ‘we owe it to ourselves’. This was changed by the 19th century English economist, David Ricardo, who argued that there is no difference between the tax financing and the debt financing.
When people pay taxes today, they bear a burden today by transferring their resources to the government sector. It reduces their spendable income known as the disposable income and force them to curtail both consumption and money available to lend to their private sector peers. When the government charges higher taxes to repay what it has borrowed in the past, the people must pay higher taxes. Hence, debt financing is simply the postponement of the current tax liability to the future. This is known as Ricardian Equivalence, and it was further developed by Harvard Economist Robert Barro who argued that when the government spends one rupee here there is a reduction of one rupee spent by the private sector elsewhere. Therefore, this theory is now known as Ricardo-Barro Equivalence.
Foreign borrowing is more burdensome
This analysis presumes that the Government borrows only from domestic sources to finance the budget. It becomes much more alarming when foreign borrowing for financing the budget is allowed. At the time of making the foreign borrowing, there is an inflow of resources increasing the welfare of the people. However, when it is repaid, there is an outflow of resources more than the initial inflow because the country should now repay the principal along with interest. But it is the people who should curtail their consumption to provide for resources for repayment of the foreign borrowing. Therefore, the crucial requirement for meeting the foreign debt of the Government is not just having domestic savings. The nation should have foreign exchange to convert the domestic savings to usable mode of repayment.
If it does not have, it runs in to a new problem in the form of being taken hostage by foreign creditors who will insist that the available foreign exchange resources should be used to repay their debt before meeting the nation’s normal import requirements. If foreign debt is defaulted, unless a speedy resolution is arrived at, the door for refinancing the maturing foreign debt plus payment of interest will be closed for the Government. It makes the gross expenditure of the government not just a book entry but a threatening reality. This is the issue which Sri Lanka is going through today.
Money printing leads to inflation
Then, what about running the printing presses as warned by the President to meet the holes in the budget? It does not impose an immediate burden on the people, and therefore, there is a tendency to believe that it does not inflict a burden on people. Instead, people will be benefitted by the higher liquidity they now enjoy due to the increase in the cash balances. However, if money is printed over and above the safe levels, that is, much more than the increased liquidity requirements arising from the real economic growth, the excess money leads to both domestic inflation and the pressure for the exchange rate to depreciate. This is because the increases in excess money will increase the aggregate demand above the short-term aggregate supply and if imports cannot be increased to meet the increased amount of aggregate demand, it leads to domestic inflation on the domestic front and to balance of payments difficulties on the external front. With inflation, the country will lose its competitive edge, fail to realise much from international trade, and there will be pressure for the exchange rate to depreciate. Therefore, exchange rate depreciation is not the cause of inflation but the result of inflation. Therefore, money printing over and above the safe levels will cause inflation and inflation is a tax which is being paid by all.
Inflation is a tax on people
But how does inflation become a tax? Suppose the Government pays the salary of a teacher by getting the Central Bank to print a new 5,000 rupee note. The teacher sacrifices, say, 8 hours of her real labour to get that 5,000 rupee note. But the Government spends only the printing cost of the note and therefore, there is an unequal exchange between the Government and the teacher. Why should a teacher agree to such an unequal exchange? Because she is told by the Government that when she goes to the market with that 5,000 rupee note, she can buy, say, a kilogram of rice. But when she goes to the market, she finds there are others who also have got 5,000-rupee notes and are about to exchange for rice.
When the demand goes up, prices go up and assume that they have increased to Rs. 10,000 per kilo. She can buy only half a kilo of rice now and the lost quantity of a half a kilo is a tax she pays to the Government. Since this reduction in the consumption level has arisen due to inflation, it is called due to the inflation tax.
Contd.....
