There are three ways to finance the fiscal deficit. They are government debt, money creation, and
taxes. Government debt and money creation impact on economic growth adversely.
(Amirthalingam 2013) The fiscal deficit is a chronic problem of Sri Lanka and other developing
countries. [Table 1].The average fiscal deficit was 13.14 percent of GDP from 1977 to
1990. It was 9.3% from 1991 to 2000. But it was 7.7% from 2000 to 2015. (Central Bank
Report) Anyway a high amount of figure, fiscal deficit to GDP ratio is not good for macro-
The economic environment of Sri Lanka, because the fiscal deficit is financed by government debt. It is
a very popular way to finance the fiscal deficit in Sri Lanka. When fiscal deficit increases, it
causes to increase the government debt. If our country tax system is efficient, the fiscal deficit would
have financed from tax revenue. Thereby government debt could have reduced. But tax revenue
to GDP ratio has been decreasing from 1977 to 2013. [Table 1, Graph 1]. The average tax
revenue to GDP ratio was 18% from 1977 to 1984. But it was 17% from 1985 to 1995. Then
it was 16% from 1996 to 2005. But it was 13% from 2006 to 2015(Graph 2). (Central Bank
Report). But Kaldor (1963) argued that a country should impose taxes at 25 – 30 percent of GDP
to achieve economic growth. Kaldor's’ target needs to Sri Lanka to disentangle the debt
trap (Amirthalingam 2013).
The fluctuation of government debt up to 1977
Government debt has two parts. They are domestic debt and external debt. Household debt is the
debt which borrows from the local market (non- banking or banking or issuing Treasury bill or
Treasury bond) to finance the fiscal deficit. External debt is the debt which borrows from international organizations and foreign countries to finance the fiscal deficit. Domestic debt
surpassed external debt from 1977 to 1986. But external debt had surpassed domestic debt in 1987
To 1996. After that, household debt has exceeded external debt from 1997 to 2016. [Table 3 &
Graph 3]. Anyway, domestic debt and external debt cause their own problems. The obligation to GDP
ratio has reached a peak point in 1989. It was 108.7%. This rate was the highest debt to GDP
ratio in the debt history in Sri Lanka. This had happened because of the deflation of the rupee value
in 1989. When deflating rupee value, it causes to increase the cost of production. Oil and other import
production have to be paid than earlier. It causes to undermine foreign resources, and external debt
services also have to be paid more than earlier. On the other hand, due to the JVP confusion
economy had collapsed in Sri Lanka and the government had to borrow money from the foreign market,
because of domestic savings had undermined during the JVP conflict period. The GDP to external
debt ratio was 62% in 1989. This was the highest foreign debt to GDP ratio in Sri Lanka. As well
as the Mahaweli development project had implemented from 1986 to 1989, therefore, Debt to
GDP ratio had increased by 28.5% from 1986 to 1989. As well as debt to GDP ratio has declined
by 9.5% from 2004 to 2005. The reason behind that was Tsunami disaster. Many of Sri
Lankan’s creditor nations granted debt write off and interest-free periods on loans to assist the
reconstruction process during that period. (Wijeweera, Dollary & Pathaberiya 2005).Debt to
GDP ratio has decreased by 14.6% from 2009 to 2010. The reason was that the war was
finished by 2009. The war which had been three decades in Sri Lanka. (1983-2009).The aim was
behind that government had to borrow a lot of military items to defeat the LTTE. Therefore ending
war caused to decrease the government debt.
Comparison of Government debt from Asian Countries
When comparing debt to GDP ratio among Asian countries, Sri Lanka has recorded the highest debt
to GDP ratio in 2015. The figure is shown that inability of debt management in Sri Lanka. When
comparing Bangladesh and Sri Lanka. Government debt had been kept sustainable level by
Bangladesh. It was 34% in 2015. But it was 77.6% in Sri Lanka. According to the table
Indonesia, Malaysia, the Philippines, and Thailand had maintained a sustainable level in 2015.Debt to
GDP ratio was 67.2% in India, but it was reasonable they had achieved 8% GDP growth rate in
2015. But the GDP growth rate was 4.8% in Sri Lanka [Table 4]. Therefore the government should keep
GDP to debt ratio as below the threshold level. Research has concluded that the threshold level
for public debt is 59.42% of GDP. Above this level, public debt makes a negative impact on
GDP per capita growth (Cooray & Heemantha, 2013).
Composition of Domestic debt and External debt
Domestic debt has two parts as banks and non -bank sector. As well as external debt has two
parts. They are concessional loan and commercial loan. At the same time, the government can
borrow from banks or non- banks or can get a business loan or concessional loan. .Government
has borrowed debt from the non-banking sector than debt from the banking sector during 1985to2016
(Graph 4). Government has acquired concessional loan than commercial loan during 1980 to
2016. (Graph 5) But the commercial loan has been increasing from 2008 to 2016. The reason was
previous government had issued Treasury bill for foreign investors, and they had invested heavily
in Treasury bond. Second sovereign bond had released in 2009. After graduating from a lower-middle-income country, it made difficulties to borrow concessional loan (Amirthalingam 2012).
Government debt can be defined broadly and narrowly. But the debt to GDP ratio sets using
a narrow definition (Central Bank Reports). Total central government debt is called a narrow
definition of government debt. It doesn’t include contingent liabilities. A contingent liability is
a liability which government entities borrow from the market with the guaranteed issued by the
government. If government entities will not be able to pay off debt, the central government has to take
responsibility of government entity borrowings. They are Ceylon Electricity Board, Ceylon
Petroleum Corporation, Road Development Authority and Sri Lankan Airlines. The narrow
definition misleading since it does not show the actual indebtedness for which the tax players are
responsible. Therefore both of direct borrowings and contingent liabilities should take to the debt
management process.
Consequences of domestic debt and external debt
Household debt and foreign debt cause an economic problem. When the government borrows money lot
from the local market, it causes to increase the interest rate. Thereby impede the private sector
investment. This is called crowding out effect. When decreasing private sector investment, it
impacts on economic growth adversely. Increase in government borrowing may also cause
inflation through the expansion of the money supply. External debt causes to undermine the creditworthiness in Sri Lanka. Foreign currencies should be demanded when paying off international debt
services. This procedure causes to deflate the rupee value. Deflate the rupee value causes to
wane the balance of payment (BOP).
On the other hand, deflating the rupee value causes to
increase the competitiveness of export items. But our export items less than import items and
export items don’t have the strength to earn a lot. That’s why in such a situation, BOP is going to
undermine. Debt service payments are a severe financial burden to the Sri Lankan economy. Debt
repayments as a percentage of revenue have increased from 1980 to 2016. It was 98% in 2016.
Debt repayments as a percentage of exports also have increased from 1980 to 2016. It was 92%
In 2016 (Table 06). Therefore debt service payment compels a country to abandon or postpone
investment on essential development projects. Government expenditures are (Education,
Health) necessary to develop the country. As an example, before developing Singapore
had expended a lot to education. Therefore human capital development is significant to
develop the country. But the Sri Lankan situation is unfortunate. Government has to spend to interest
payment than education expenditure. This is the opportunity cost of debt servicing. In 2015
Interest payment was 22%from total expenditure. But education & welfare expenditure were
10%, Health expenditure was 8% (Table 06). Therefore the government was unable to spend
sufficiently on most important sectors which are very useful to develop the country.
Finally, I suggest procedures to reduce government debt. Fiscal deficit should finance by
tax revenues. Then the tax system should be simple, and politicians should not intervene in the tax
system what businessman evade the taxes. On the other hand, after 2005 there are lots of
corruptions and frauds had recorded. These kinds of crimes also caused to increase the
government debt. As an example, the southern high way project also has recorded corruptions. Then
debt was not enough to implement a plan, and the government had to borrow debt back to finance
the project. Therefore if we want to strengthen as a nation, we should stop corruption and
inefficient things. As well as the government would earn sufficient revenue from exports, the fiscal
deficit could have financed by export revenue, and it will cause to increase the foreign assets in
Sri Lanka. Anyway, the present government has been implementing some strategies to improve tax
compliance. Ultimately they aim to reduce the government debt. Plans are (a) “broadening
the tax base to ensure tax revenue of around 15-16 percent of GDP (b) rationalizing the tax
system while minimizing tax exemptions, tax holidays and special tax rate that are detrimental to
fair and effective tax administration (c) strengthening public financial management, particularly
commitment control and financial planning and discipline (d) eliminating unproductive
expenditure (e) Improving efficiency of State-Owned Business Enterprises.” Restructuring
process, increasing transparency of money transaction and increasing accountability are used to
increase the efficiency of State-Owned Business Enterprises. (Central Bank Report 2016).
