The 2016-17 Budget: A Pleasing but Perilous Path

The 2016-17 budget has the potential to provide a stronger impetus to the economy,
but a pronounced attention to social development is not financially
sustainable in the absence of fiscal reforms

The 2016-17 budget aspires to be growth-friendly by rebooting public investments, and further strengthens social spending, but falls short of its own strategic aim to consolidate public finances. Its economic impact is likely to be modest, since the tough policy decisions required to ensure fiscal sustainability are being postponed to the following years.

In the following text, the current and expected fiscal outcomes are reviewed, and budget performance assessed against stated strategic goals. The urgency of fiscal reforms is also highlighted.

Consolidated accounts

A technical issue needs to be cleared first. For a proper analysis of budgetary performance, the budget should be consolidated with special extra budgetary funds in line with IMF practice. Five of these funds were closed in June 2015. Two remaining funds, namely, the National Resilience Fund, and the Build Mauritius Fund, will still account for a significant amount of off-budget outlays of close to Rs5bn in 2016-17, in addition to a petroleum levy of Rs1.6 bn. Furthermore, in accordance with IMF standards, capital spending should reflect only fixed investments, namely, the net acquisition of non-financial assets.

2015-16 Budget outcome

The consolidated budget deficit, i.e., including the two special funds, showed a significant improvement from 4.3% of GDP in 2014 to 3.1% of GDP in 2015-16, or by 1.2 percentage points. A lower deficit was achieved by offsetting extra social spending with a sharp contraction in capital expenditure, and with a boost from exceptional revenues.

Operating expenses surged by 1.1 percentage points, to 22.6% of GDP, especially owing to higher pensions and wage compensation, including the new PRB award. Capital spending was however drastically reduced to half of the 2014 level, or by 2 percentage points, to a record low of 1.6% of GDP. As a result, total expenditure declined by 0.9 percentage point, to 24.2% of GDP.

Revenue rose slightly to 21.1% of GDP, propped up by an additional petroleum levy, and by some exceptional items. These included transfers of Rs1.4bn as surplus from the State Trading Corporation (STC), and of Rs1 bn from other extra budgetary funds.

Although investments by public enterprises, such as the CEB, CWA and WMA, continued to increase, total public investments did not pick up sufficiently to offset the steady decline in private investments. The domestic investment rate thus dropped further to around18% of GDP in 2015-16, well below the initially budgeted estimate of 24.8% of GDP. The curtailment of capital expenses has undoubtedly contributed to a dampened GDP growth of only 3.4% in 2015-16.

2015-16 Fiscal Strategy

The 2015-16 budget strategy aimed at fiscal consolidation and debt reduction. Bringing the budget deficit down in 2014 was a notable achievement, even though revenue was shored up by some exceptional transfers. But, the failure to stabilize public indebtedness was striking, especially in view of the statutory public sector debt target of 50% of GDP in 2018.

Public sector debt rose instead to 55.6% of GDP in June 2016, and, on the basis of the international definition, to 65% of GDP. Additional public financing included a line of credit of Rs3.5 bn from the Bank of Mauritius to repay BAI policyholders and investors, and equity injections of Rs3bn in Maubank, a merger of MPCB, and NCB (ex Bramer Bank). The public debt level would have been even higher without an exceptional transfer of Rs1.5 bn from the cash reserves of the Build Mauritius Fund.

Despite higher social spending to accommodate electoral promises, last year’s budget managed to keep total expenditure under control and to partly correct the overall deficit, mainly through sizeable cutbacks in capital spending. The scope for expansionary fiscal policy was stifled in the hope that sizeable private investments would galvanize the economy. It is now abundantly clear that the heavy reliance on the private sector to bolster investments and growth, chiefly through smart cities and property developments, and SMEs, was misguided.

2016-17 Budget Estimates

Reversing the previous year’s fiscal stance, the 2016-17 budget proposes to boost both capital and total expenditures, and allow the overall deficit to worsen again to 4.4% of GDP, close to the levels prevailing in 2013 and 2014.

In 2016-17, capital spending will more than double to 3.3% of GDP, and expenses will rise to 23.8% of GDP. Total expenditure will increase to a high of 27.1% of GDP, or by 2.9 percentage points over the previous year.

Revenue will rise by 1.6 percentage points to 22.7% of GDP, more on account of higher external grants than of the hike in the excise duty on tobacco and alcoholic products. New Indian grants alone are estimated at Rs 4 bn, or 0.9% of GDP. Another exceptional transfer from the STC will add Rs 1.7 bn to revenue.

Taxes will remain fairly stable, at around 19% of GDP. The gamut of popular tax measures relating to relief on customs duty, VAT, property taxes, and income taxes represent only 0.2% of GDP, or less than Rs 1bn.

A more active fiscal policy is expected to generate greater economic momentum. However, despite a robust recovery, capital spending will not exceed the 2013 level. The forecast of a 4.1% increase in GDP in 2016-17 may thus prove over-optimistic without a strong turnaround in private investments, which have been declining since 2013.

2016-17 Fiscal Strategy

The fiscal strategy of the 2016-17 budget is to enforce “greater fiscal discipline and financial prudence, in view of the recent rising trend in public debt”, and a focal aim is to “contain the rising trend in recurrent spending, and rationalize subsidies and social transfer programmes”. Assessed on its own strategic goals, the 2016-17 budget is not designed to deliver.

Social benefits, expenses, and the budget deficit, will all be significantly higher in 2016-17, relative to GDP. Revenue is too dependent on exceptional one-off revenues, including grants. A grant shortfall of over Rs 2 bn was recorded in the previous year, which could well recur. The Indian grants are mostly project-tied, and quick disbursement may be difficult.

Unlike the previous budget, the 2016-17 budget makes no direct mention of debt reduction, and refers instead to financial prudence. The public sector debt is estimated to remain steady at 55.6% % of GDP in June 2017, with a small decline to 54.9% of GDP in June 2018. A repayment of Rs1.8 bn by the CEB in 2016-17, will contribute to the stabilization of public debt. Retiring debt is a sound utilization of the windfall from low oil prices, in contrast to the use of the STC surplus to fund current expenses.

From the budget’s debt forecasts, compliance with the statutory public sector debt ceiling of 50% of GDP by 2018 appears to have been abandoned. Last year’s budget had projected the public sector debt ratio at 50.3% in June 2018. In the right conditions, a review of the self-imposed public debt constraint may be acceptable, even it seems like moving the goal posts.

Public sector debt, on the international definition, will decline more significantly to 62.8% of GDP in June 2017, and to 61% in June 2018. However, these debt figures may be underestimated due to unaccounted outstanding obligations to BAI policyholders, the doubtful classification of (non participating) redeemable preference shares as equity instead of debt for the funding of public projects, and potential contingent public liabilities arising from BOT projects.

In a reversal of last year’s trade-off, heavier capital spending and a wider deficit in 2016-17 will impart a new stimulus to the economy, but will heighten the risks to fiscal stability as well. The budget speech’s claim of “maintaining strict fiscal discipline” is in dissonance with its own target estimates for 2016-17.

Medium Term Fiscal Strategy

The budget is formulated in a macro-economic framework covering a 3-year period, and the indicative budget estimates for the years 2017-18 and 2018-19 are far better aligned with a strategy of fiscal soundness and consolidation.

Over the following two years, 2017-18 and 2018-19, revenue would rise by Rs14 bn, whereas total expenditures would increase by only Rs3 bn, and the capital budget would be downsized again. Under this dream scenario, the budget deficit would be more than halved to Rs8.4 bn, or 1.6% of GDP, and all major budgetary aggregates would record trend reversals. Expenses would be sharply rolled back to 21.1% of GDP, lower than in 2014. Social benefits would be pared down to 5% of GDP, or back to the level prevailing in 2014. Employee compensation too will fall to under 6% of GDP, or below the 2013 level.

However improbable, it is hoped that these estimates are based on a credible medium term plan to restore fiscal discipline. Bold policy measures will be required to implement the steep adjustments in public expenditures.

Fiscal reforms

The need for fiscal reforms has become ever more compelling, to ease the rising burden of public indebtedness, and to revive growth, which remains persistently below the economy’s potential. The public sector reform measures announced in the 2016-17 budget are a welcome start to a full-fledged programme for a better delivery of public services, and an improved cost effectiveness of public health, education and pension expenditures. A restructuring and liberalization of state-owned airline and telecoms services canprovide considerable opportunities for a more competitive, globally-connected and productive economy.

A critical measure for enhanced efficiency and accountability in public financial management would be to reintroduce programme-based budgeting (PBB). Public expenditures should be viewed in terms of programmes rather than single items, and outcomes rather than inputs, and evaluated on rigorous performance criteria. The jettisoning of PBB and a return to single item budgeting since last year was a retrograde step, which threatens to undermine the strength of our institutional public management framework and our standing vis a vis rating agencies and development partners.

A key role of fiscal policy is to address economic imbalances stemming from domestic structural weaknesses or the vulnerability to unexpected external shocks. The Indian tax treaty amendment and Brexit will further aggravate the challenges to economic stability. The external accounts already reflect a relatively large deficit in the net exports of goods and services, amounting to 10% of GDP, and the financing of the balance of payments is subject to the volatility of capital flows, relating mainly to transactions of Global Business Companies.

In conclusion, the 2016-17 budget has the potential to provide a stronger impetus to the economy, but a pronounced attention to social development is not financially sustainable in the absence of fiscal reforms. The promise of a new era of development rests not only on a rekindling of investments, but also on creating the fiscal space for social and development spending.

Sushil Khushiram

This article is an extended version of a presentation to Epsilon Think Finance. The author is a former Minister of Economic Development and Financial Services.

Add a Comment

Your email address will not be published.