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Monday, January 24, 2022

Sri Lanka Post-Budget review: MoD plus employ 25% of public sector; devours 50% of the salary bill

By Rehana Thowfeek.

Sri Lanka is in crisis. The chickens, as they say, have come home to roost.

Sri Lanka’s post-war economic growth, fuelled largely through debt-financed infrastructure projects and increasing public expenditure, has proven to be a costly endeavour, and the country is now staring down the barrel of overwhelming external debt repayment obligations to the tune of $ 4-5 billion every year till 2025.

Ever-growing fiscal deficits

On top of ever-growing fiscal deficits, Sri Lanka also contends with balance of payments deficits. Credit rating downgrades have locked Sri Lanka out of international finance markets. Coupled with lower tourism earnings and worker remittances, foreign exchange reserves have depleted to record lows. In order to preserve what is left of its reserves, the country now faces strict import restrictions, impeding business operations, as well as increasing cost of living.

While we may be tempted to blame Covid for this mess, Sri Lanka has been on a precipice of its own making long before. The economy is at a critical juncture – a time for reform: To check unchecked public spending, prune the excess, and usher Sri Lanka into a better state of being or risk permanent and lasting damage.

In this context, everyone looked on in anticipation at the newly minted Finance Minister’s maiden budget with bated breath. The second reading of the Budget was passed last week with a majority. In this article, I provide my analysis of whether adequate steps have been taken to address the matter of the perennial fiscal deficit (commonly referred to as the budget deficit).

2020: Spate of tax reductions

As Finance Minister Basil Rajapaksa rightly said, the Sri Lankan Government has run on a deficit since the 1950s (except in 1954 and 1955). This pace was amped up in 2009 for post-war economic growth. While the government’s budget deficit has been tumbling downhill over the years, its revenue position deteriorated most disastrously in 2020 following a spate of tax reductions brought on soon after President Gotabaya Rajapaksa’s electoral victory in November 2019. Government revenue fell by nearly a third in comparison to 2019, causing the 2020 budget deficit to hit a record high of Rs. 1.6 trillion (1).

There appears to be an attempt to right this wrong: The Finance Ministry has announced steps to increase government revenue in the upcoming year through a variety of new taxes: A one-time tax surcharge, a Social Security Contribution tax, increasing VAT (Value-Added Tax) on financial services, increasing cigarette and excise taxes, and a rather bizarre motor vehicle accident tax.

The budget deficit for 2022, however, is still massive (8.8% of projected GDP), which would have to be funded by even more loans (this time, domestically, I suppose). According to its Fiscal Management Report, the Government hopes to bring the deficit down to 4.8% of GDP by 2025, not by pruning its expenses but by increasing its revenue. This brings me to the first structural issue I wish to speak about.

  1. Taxes that burden the poor

One of the many structural ills of the government’s revenue collection is the unfair burden it places on the poor and middle-class income groups through its overdependence on indirect taxes (taxes on imports and exports, taxes on goods and services). In 2019, there was an attempt to shift it slightly, and the share of tax revenue, which came from income taxes, increased to 28% from 20% in 2018.

One of the main purposes of taxes is to redistribute wealth. Budget 2022 has restored the composition back to 2019 levels with 26% of tax revenue expected from income taxes, but it fails to reduce the burden on the poor and middle class by shifting the brunt of the tax burden to the higher income earners.

The Government’s plan till 2025 appears to be much the same; the share coming from income taxes as a percentage of GDP is expected grow by 0.4% points from 2022 to 2025, while on the other hand, the share coming from taxes on goods and services as a percentage of GDP is expected to grow by 1.4% points in the same period. Therefore, there is little effort to address this issue.

In my previous post (“The 2022 Budget: What we know so far”) covering the expenditure allocations in the Appropriations Bill, I categorised the expenses based on ministries. In Figure 4, I have gone one step ahead and categorised based on the sector. The values within denote the allocations as a share of programme expenditure (Rs. 2.5 trillion, which does not include debt service expenditures).

Accordingly, the single largest programme-wise allocation is made for defence, with Rs. 373 billion allocated for defence activities. Rs. 106 billion is allocated for public security. National and provincial (2) allocations for education amount to Rs. 319 billion. On healthcare and pharmaceuticals (3), Rs. 300 billion has been allocated. Highways receive Rs. 270 billion. Civil pensions receive Rs. 309 billion, the third largest programme-wise allocation in the Budget. This brings me to the next structural issue I want to raise: Overstaffing in the public sector.

Sri Lanka currently has some ~1.5 million public sector workers (including military and police), which means ~1 in 5 of the country’s labour force is employed by the government, and there is one public sector worker for every 13 citizens in the country. This is a ridiculously large public workforce for such a small country.

  1. The public sector: Overstaffed and inefficient

A significant portion of government expenditure goes towards paying public servants their salaries and pensions. It is best illustrated with Figure 5. In 2021, the government’s salary and pension bill amounted to a whopping Rs. 950 billion, which was 73% of government revenue for the year.

Given that there were 1.8 million beneficiary families receiving Samurdhi, the average monthly Samurdhi benefit per beneficiary family was ~Rs. 2,400. On the other hand, the Samurdhi Department employs 25,485 staff members. Therefore, the average monthly salary per Samurdhi staff member was ~Rs. 55,650.

This overstaffing results in lower salaries across the board (since there are so many salaries to pay). Sectors which are human resource-intensive, like education and health, which depend heavily on their staff to deliver quality outcomes, therefore, undoubtedly struggle to pay competitive salaries. But this is not the case for every state entity. Take a look at Samurdhi, for example.

Cost vs. benefit – the Samurdhi programme is the country’s flagship social assistance programme. In 2021, Rs. 70.9 billion was allocated to the Samurdhi Department, out of which Rs. 53.5 billion was paid out to beneficiaries. This means 25% of the allocation is channelled to meet administrative costs which are largely salaries and perks to employees: Rs. 17 billion was allocated for salaries and perks, to be exact.

Given that there were 1.8 million beneficiary families receiving Samurdhi, the average monthly Samurdhi benefit per beneficiary family was ~Rs. 2,400. On the other hand, the Samurdhi Department employs 25,485 staff members. Therefore, the average monthly salary per Samurdhi staff member was ~Rs. 55,650. The outcomes expected from the Samurdhi programme are not human resource-intensive, as it is a cash transfer programme for poverty alleviation. Therefore, such a disproportionately high salary bill is unjustified and begs the question, then, of its efficiency.

In 2021, the government’s salary bill amounted to Rs. 634 billion, out of which Rs. 204 billion was spent on Defence Ministry salaries while Rs. 113 billion was spent on Public Security Ministry salaries. In combination, the Ministries of Defence and Public Security employ around ~350,000 people.

2.1. Excessive military and police force

The more we investigate, the clearer it becomes: It is not merely just an issue of public sector overstaffing; it’s also an issue of military and police overstaffing.

To illustrate this, consider the following figures: In 2021, the government’s salary bill amounted to Rs. 634 billion, out of which Rs. 204 billion was spent on Defence Ministry salaries while Rs. 113 billion was spent on Public Security Ministry salaries. In combination, the Ministries of Defence and Public Security employ around ~350,000 people.

Therefore, despite employing only ~25% of the total public sector workforce, the Ministries of Defence and Public Security account for ~50% of the government’s salary bill. Again, this impacts sectors like education and health which are desperately in need of more funds to invest in capital and pay more competitive salaries. Does the Minister indicate any move to address this matter of public sector overstaffing?

Despite the Finance Minister’s statement to the media claiming no respite for public sector workers from the 2022 Budget, in his budget speech, he says two things which contradict this: (1) Give permanent government jobs to 53,000 graduate trainees, allocating Rs. 35 billion for it, and (2) extend the retirement age to 65. The extension of the retirement age is a good idea, as it would reduce the pensions bill somewhat, but if the government simultaneously stacks the other side with younger recruits, the purpose is lost, as it will only lead to an increase in the salary bill.

Trimming the defence and public security cadre would be a good first step to trimming the entire public sector; it can immediately reduce the government’s salary bill significantly and free up much-needed money to invest in sectors like education and healthcare – to pay teachers more competitive salaries, for example.

An interesting way to think about this is by framing the public sector salary bill in the context of the government’s tax revenue composition. Even though all public servants do not contribute income taxes (some do, like employees of state-owned enterprises and those earning more that Rs. 3 million per annum), nor make contributions for future pensions, they do pay taxes in the form of taxes for goods and services (like VAT). Recall the tax composition in Section 1: Public sector workers are, in effect, subsidising the government for their own salaries (to an extent). Imagine that – paying your employer to pay you.

2.2. Affordability of a non-contributory pension scheme

Pensions by themselves are a serious drain on public funds. Sri Lanka is an aging society (changes in the age composition of a population such that there is an increase in the proportion of older persons) with long life expectancy, and a non-contributory pension scheme such as the civil pensions scheme is just not a sustainable solution anymore.

The pension bill (similar to the salary bill) is paid entirely through tax revenue and borrowings. The pensions bill for 2022 is 10 times greater than it was 20 years ago; in another 20 years, how much more could it be? And more importantly, can the public coffers continue to support this unaided?

Changing to a contributory pension scheme would be suitable, but the Sri Lankan Government has a bad history with those too. The Farmers’ and Fishermen’s Pension Scheme (FFPS), for example, was set up in 1987 to provide pensions for the farming and fishing community. Enrollees were expected to contribute regularly to the fund and at the age of 60 would become eligible for a monthly pension.

The programme, however, was administered terribly: Contribution amounts were too small to support the promised monthly pension, contributions were never increased over time to account for inflation, contributions were not collected on time (some never contributed more than a few times), there were no clearly defined exit rules (to kick non-contributors out), etc.

By 2013, the fund had collapsed. Since 2005, when FFPS pension expenditures overtook contributory incomes for the first time, the government has continued to channel funds to bridge the ever-increasing gap through Treasury allocations. They did not stop enrolling more beneficiaries either. The programme has become, in effect, another burden on the public coffers – hence it is not merely a matter of changing the modality of the pension programme, but its proper administration.

The crowding out effect

The issue with having such massive amounts of funds trapped in contractual obligations like public sector salaries is that it crowds out investments which would be made into more productive sectors like education and healthcare. Sri Lanka spends far less on education than its regional and income peers. Investments to improve the quality of education and education outcomes are something education specialists have urged for decades.

It also leaves little wiggle room in case of an emergency, like Covid, which suddenly placed a massive strain on the existing resources of the state healthcare system, but rapid investment into building capacity would not be possible in the case the funds are trapped in obligatory payments.

It is also problematic from a labour market perspective; there is a huge pool of the country’s labour force trapped in unproductive jobs, all the while the more productive private sector is faced with labour shortages. Whereas a young person may be contributing to economic growth through entrepreneurship or a job in, for example, tourism, he/she is instead a drain on scarce public resources, stunting the country’s potential.

  1. Reforms for an efficient public sector

State-owned enterprises (SOEs) are a key source of public sector inefficiency. While there are undoubtedly some institutions which deliver efficiently, the best way to illustrate this issue is to look at the losses made by SOEs between 2006 and 2017:

  • The Ceylon Petroleum Corporation (CPC) made net losses amounting to Rs. 177 billion
  • The Ceylon Electricity Board (CEB) made net losses amounting to Rs. 187 billion
  • SriLankan Airlines made net losses amounting to Rs. 156 billion
  • Sri Lanka Transport Board (SLTB) made net losses amounting to Rs. 58 billion

They also borrow heavily, and these are mostly government-guaranteed debts, which means the government is duty-bound to honour them. In 2020, total SOE debt amounted to Rs. 1.2 trillion – we simply cannot afford to keep bearing these losses and the mounting debt.

In his speech, the Finance Minister acknowledged these issues and proposed several measures to improve the efficiency of SOEs: Instilling financial discipline, utilising underutilised assets, suspending construction of new office premises, and preventing requests for supplementary estimates for 2022. He also proposed several measures to improve the efficiency of the overall public service, including the introduction of a client charter (this is not something new, by the way) and key performance indicators.

Take SriLankan Airlines, for example – there is little merit in asking it to be more financially disciplined when it costs the Treasury Rs. 99 million a day to maintain.

There is talk among ruling party MPs on reinstating the fuel pricing formula to plug the losses the government (and by extension, the people) absorb to make the CPC profitable. Energy Minister Udaya Gammanpila was right when he said it is the poor who pay for these losses (recall the tax revenue composition); therefore, such reform would shift the burden away from the poor.

While we are at least not in denial anymore, these measures are too little too late for some SOEs. Take SriLankan Airlines, for example – there is little merit in asking it to be more financially disciplined when it costs the Treasury Rs. 99 million a day to maintain. Therefore, the discussion should really be around restructuring, shutting down, or selling off some of these debt-riddled, loss-making SOEs (although no one would likely buy the debt, we would have to keep that, but at least we will not be adding more).

If Sri Lanka was not in crisis mode, this year’s Budget would really have been quite fine, but since we, willingly or not, are in crisis, my opinion is that it does not adequately address the matter of curtailing the fiscal deficit nor the issues within that have plagued the Sri Lankan economy. It is a problem that is affecting us all – looking at the state of public finances, there is nowhere left to go except to undertake drastic, unpopular, and bitter reforms.

A bitter pill to swallow

What we should really do is swallow a bitter pill: Increase direct taxes, reduce public sector employment, and get rid of debt-riddled, loss-making SOEs. This is likely to win no public favour, probably because the common man does not comprehend the size of this massive macroeconomic problem which affects him too.

Internationally, we do not appear well (the credit ratings are a good indicator), and unless we take steps to address the immediate debt repayment crisis and put in place measures to permanently address the structural issues that have led us here, we will not inspire much confidence around the world that we are serious about reforming ourselves.

What should ideally have been done over many years would now have to be done in a short span of time. However, if we fail to do so, no matter how bitter, we risk alienating Sri Lanka from global economic gains for generations, destroying generations of Sri Lankan lives and their hopes and aspirations in the process.

Footnotes:

  1. Projected based on the Central Bank of Sri Lanka’s projection for economic growth for 2021 and Asian Development Bank’s projection for economic growth for 2022
  2. Based on 2021 allocations to provinces
  3. Healthcare and pharmaceuticals include allocations for the Ministry of Health; the State Ministry of Primary Healthcare, Epidemics, and Covid Disease Control; and the State Ministry of Production, Supply, and Regulation of Pharmaceuticals. The provincial allocations to departments of health are estimated based on previous year’s data

(The writer is an economic analyst with experience working for leading Sri Lanka think tanks on a variety of social and economic issues. She is formally qualified in economics from the University of London and the University of Warwick. This article was originally published on her blog)

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