Analysis on Government Debt and Debt Financing in Sri Lanka (1948 to 1977)

01. INTRODUCTION

In generally Government debt is referred to the debt owed by a central government of a
country. Government debt also referred to as public interest, national debt, and sovereign debt.
In Sri Lanka, Public debt can be defined as a debt owed by both the central government and other
public entities. According to the above definition, other public entities included government
corporations, government statutory boards, government academic institutions, government
banks, etc.

01.1. OBJECTIVES OF PUBLIC DEBT IN SRI LANKAN GOVERNMENT
Generally, the government borrows funds from internal sources and external sources to
meet three main goals.
➢ To meet the budget deficit.
➢ To meet the expenses of war and other extraordinary situations.
➢ To finance development activities.

01.2. SOURCES OF GOVERNMENT DEBT FROM 1948 TO 1977
When considering government debt sources in Sri Lanka from 1948 to 1977, those debts
references can be divided into two main categories.

➢ Internal Debt Sources / Domestic Debt Sources
The funds borrowed by the central government of Sri Lanka and other public institutions from
lenders within Sri Lanka. Those lenders include commercial banks, other financial
institutions, the general public, etc.
Treasury bills and Rupee loans were primary domestic debt sources from 1948 to 1977 in Sri
Lanka. Treasury bills are short-dated securities issued by the Sri Lankan government to
finance budget deficit or to finance projects. Rupee loans refer to loans denominated in Rupees.
➢ External Debt Sources
The funds borrowed by the central government of Sri Lanka and other public institutions of Sri
Lanka from foreign lenders. Those foreign lenders include foreign commercial banks,
governments, or international financial institutions.
When considering foreign debt in Sri Lanka from 1948 to 1977, external debt can be divided into
three main categories project loans, non-project loans (commodity loans), and sterling loans.

02. OVERVIEW OF GOVERNMENT DEBT FROM 1950 TO 1977

In 1950 total outstanding government debt was Rs. 654 million. It was included Rs. 529
Million domestic obligations and Rs. 125 million foreign debts (Figure 01). In 1950 domestic debt
was 13.70% of GDP while external domestic debt was 3.2% of DGP (Figure 02). When
considering internal debt sources, 14.93% represent treasury bills, 82.42% represent rupee
loans, and 2.65% represent other debt sources.
In 1977 total government debt was Rs.24, 985 million. It was included 14, 392 million
domestic obligations and Rs. 10, 593 million foreign debts (Figure 01). It was 26.20 times
improvement of domestic debt when compared with domestic debt in 1950 and 83.74 times
development of external debt when compared with external debt in 1950. As a result of this debt improvement caused to increase domestic debt to GDP ratio up to 39.50% and foreign
debt to GDP ratio increased up to 29.10% (Figure 02). When considering local debt
sources, 17.4% represent treasury bills, 72.2% represent rupee loans, and 10.4% represent
other debt sources.

From 1948 to 1977, Sri Lankan economy can be divided into 4 main stages based on
political regimes and economic policies executed by various political governments. Therefore this
analysis is done based on these 4 stages.

02.1. From 1950 – 1955 (LIBERAL MARKET ECONOMY)
In 1950, the United National Party won power, and from 1950 to 1955 Sri Lankan Government
executed liberal market economic policies. In 1950 total government debt was Rs. 654
million. (Figure 03) It was represented 16.90% of GDP. (Figure 04) According to Central
Bank of Sri Lanka, from independence to today there were colossal budget deficit except 1954
And in 1955. In 1954 the government budget surplus was Rs. 24 million and in 1955 the government
budget surplus was Rs. 117 million.
From 1953 to 1954, government tax revenue was increased by approximately 8%, government
non-tax revenue is increased by 7%, and grants were increased by 5 times. From 1953 to 1954
Total government recurrent expenditure was decreased by approximately 15%, and total
government capital expenditure has been reduced by about 14%. As a result of above
increased in government revenue and decreased in government debt was caused to
the government budget deficit in 1954. As a result of this government budget deficit in 1954,
total outstanding debt was being reduced by approximately 7%.
In 1955, multilateral donors (United Nations Agencies, the European Investment Bank, and
the International Fund for Agricultural Development (IFAD)) and bilateral donors (China,
Japan, India, South Korea, Iran and etc.) began to provide assistance to finance development
projects in Sri Lanka. As a result of this grants from 1954 1955 total government grants were
increased by approximately 40%. As well as government total tax revenue was increased by
around 14% while non-tax revenue was increased by about 13% when
compared with 1954. Even though recurrent government expenditure was increased, total
government capital expenditure was decreased by approximately 13%.
As a result of this increase in government revenue more than government expenditure, from
1954 to 1955, the government budget surplus increased by approximately 4 times. Due to the huge
government budget in 1955, the total outstanding government debt was decreased by
approximately 4%. From 1950 to 1955, 79% of total government debt was financed by
domestic debt sources, while 21% of government debt was financed by foreign debt sources
because domestic credit was more readily available than foreign credit.

02.2. From 1956 to 1964 (CLOSED ECONOMY)
From 1956 to 1964 the Sri Lankan economy was a closed economy. Up to 1956, the Sri Lankan
economy was highly depended on a few exports, and the private sector could not
undertake huge capital investment. Therefore new government started to play a major role in
the economy and ten years planning project was started to implement in order to uplift living
standard. Development policy was embedded with this 10 years plan. New government
implemented the previous government strategy of agricultural imports substitution also to
industries. Due to new economic policies implemented by the new government in 1956
government budget deficit was increased up to Rs. 42 million. Due to the increase of government
budget deficit, debt was increased up to Rs. 1208 million. It was 7.20% increase in
government debt within one year. Ten years of the development plan was implemented from
financial year 1957/58. Therefore capital expenditure was started to increase.

Within this period, the most significant incident was the government of Sri Lanka began
obtaining loans from the World Bank in 1959. It was profoundly affected to increase foreign debt
from 1960 to 1965. At the beginning of 1960, the government was facing a critical problem
concerning external reserves position. Even though more than sixty percent of the imports
were represented essential consumer items, to solve this problem in the budget of 1960 by
sharply increasing the duties of cars, petrol, liquor, and tobacco. But government expenditure
was increased more than government tax revenue from 1960. Therefore the government budget
deficit was increased from 1960 to 1965. Thus total government debt was gradually
increased from 1960 to 1965. Due to the flood in 1964, the entire government recurrent expenditure
was increased by approximately 15%. As a result of this increase in this total outstanding debt
was increased by approximately 12%.

02.3. From 1965 to 1969 (PARTIAL OPEN MARKET ECONOMY)
From 1965 to 1969 the Sri Lankan economy was a partial open market economy. In 1965 total
government debt was Rs. 4435 million and debt to GDP ratio is increased up to 54.80%.
Due to increasing government debt, the Aid Group for Sri Lanka was established in 1965 to
provide financial assistance for the Sri Lankan government. In 1966 “Walawe Ganga” project
was started. Therefore capital expenditure was increased gradually and for financed this
project had to borrow funds and it was caused to increased total outstanding debt from 1966
to 1969. As well as the drought was caused to increase total outstanding debt at the end of
1969.

02.4.CLOSED ECONOMY (1970-1976)
From 1970 to 1976 the Sri Lankan economy was again closed economy. In 1970, 20% of
recurrent government expenditure was expenditure on welfare activities. Therefore it was
caused to increased government budget deficit as well as increased in outstanding debt. In
1970 to reduce imports, the government increased tariff on imports. From 1970 to 1974, total
government expenditure and total government revenue gradually increased. But in 1975
government total expenditure was increased by approximately 25% when compared with 1974.
Therefore it was caused by increased government debt.

03. Consequences of increasing government debt
If an increase in government expenditures (recurrent and capital expenditure) or decrease in
government tax revenue and non-tax revenue lead to government budget deficit. This
government budget deficit should be financed from internal debt sources or external debt
sources. Then interest on public debt is started to increase gradually when finance budget
deficit in every year by borrowings. It also caused to decrease in private investment. This
process is called crowding out effect of government borrowings.
The growing public debt in Sri Lanka from 1950 to 1977 and its servicing costs were a significant
burden on the Sri Lankan economy. It had adverse effects on long term economic
development of Sri Lanka Because, if the government have to considerable expenditure on debt
serving, the government have to fewer resources which can be used for the development process.
Borrowing funds from both internal and external sources don’t necessary implies economic
growth of a country if the government borrows funds from domestic debt sources, it caused inflation in an economy. From 1950 to 1977, 58% of total government debt was financed by
domestic debt sources. It caused to increase in the cost of living, especially it was caused to fixed-wage earners and pensioners. It also caused an increased cost of production.