Financial Deficit

"Why Financial Deficits Matter: A Glimpse into Sri Lanka's Economic Struggles"

Have you heard about the financial deficit?

Before understanding what a financial deficit is. it is important to first understand financial accounting.

Financial Statements are used to perform financial accounting.

These statements are

• Income statement
• Balance sheet
• Cash flow statement
• Retained earnings

Financial statements reflect a financial deficit.

A country's financial deficit occurs when the total spending of a government exceeds the amount of revenue it receives within a particular time frame, typically a fiscal year.

What are the causes of Sri Lanka's deficit?

1. Debt repayments                                                          
2. Public sector salaries and pensions
3. Subsidies and welfare programs
4. Defense and security
5. Public services and infrastructure
6. Administrative and operational costs 

Debt repayments are the main cause of the Sri Lankan deficit

The debts in Sri Lanka significantly contribute to the country's financial shortfall. As per the central bank data, because of continuous repayments and an attempt to accumulate reserves, the external financial account of the country was in a deficit of 610 million US dollars. Since the fourth quarter of 2022, Sri Lanka has already had to deal with its extraordinary debts as it has been trying to stabilize the economy. Without much inflow of capital, no government is left with options other than to depend on the domestic savings, either in the form of taxation or borrowings, to settle its payments and to save up its reserves. This is a scenario that lowers internal credit as well as the level of consumption, which exerts an extra burden on the economy. The crisis was intensified by the printing of money in huge quantities as they aimed at paying their debts and achieving the policy rate, which further worsened the current account. Analysts have stressed that an artificial reduction in interest rate creates losses in reserves, as experienced in the past years, such as 2012, 2015, and 2020, where a default may be experienced. Unless it has manageable monetary policies and structural reforms, the debt position will keep plunging the nation into recurrent financial crises, hence contributing significantly to the continuing deficit.

Stuck in the Debt Loop: How Sri Lanka continues Going in Circles

Years of struggling within a cycle of borrowing, paying back, and so on have left Sri Lanka with no breathing space. This cycle was highly evident ever since the last quarter of the year 2022, when the economy was stabilizing after the worst economic crisis experienced in the country, after the Central Bank made efforts to do this. However, in practice, this circle was created much earlier, cumulatively over several decades of bad financial administration, misapplied policies, and excessive reliance on foreign borrowings.

The deeper the debt causes Sri Lanka to go every time they borrow to pay old debts. In the Central Bank figures of this account, there was a deficit of $610 million, attributable principally to repayment of debts and reserve building, with little new capital arriving. The country instead had to find ways and means of raising savings at the domestic level through reduced consumption or taxation, just to ensure that interest and principal loans are paid at the stipulated time. And when there was not sufficient income in the form of taxation revenue or income through exports, there was the shortcut: money printing. However, the printing of additional rupees only increased the inflationary rate, and the rupee devalued further so that debt was all the more difficult to repay.

This trap is compounded by artificial suppression of interest rates, on the idea of macroeconomists that there is space to do so. However, as cautioned by the article, this fantasy has resulted in reserve losses and eventual defaults in 2012, 2015, 2018, and 2020- another recurring history that demonstrates that no lesson was taken. Analysts are still cautious that slashing rates too early, using old figures on inflation, would once again cost the country to follow the same path.

This has been a controversial issue among classical economists scholars such as Friedrich Hayek and Bertil Ohlin, who cautioned that although printing money unchecked causes inflation at the local level, it also causes trade deficits and external imbalances. However, Sri Lanka had been under the influence of the Keynesian-style thinking, as its surplus on current account was considered key-without, however, realizing the actual problem, which was the policy of irresponsible money printing.

This means that for more than ten years, Sri Lanka has been in this vortex that creates financial chaos. International borrowing, which started as a foreign dependence, has turned into an addiction. It is not more loans; more subsidies, but a total face lift in the management of money, determination of interest rates, and growth. Until this time, the circle of payment will be going on-not only the money of the people will be going, but their future.

Is it possible to get Sri Lanka out of the Debt Loop?

The big question that is haunting every citizen of Sri Lanka is-will Sri Lanka ever come out of this vicious circle of debts and fiscal crisis? Arguing yes, but not unreservedly, not without regulations, not without reform, not without a long-term view.

The only way out of this loop is by ensuring that Sri Lanka has to stops relying on short-term solutions such as printing money or more debt to clear some old debts. It has the actual way out, which is to reorganize its financial routine as well as its economy. It implies an increase in domestic revenues by having better tax policies, enhanced exports, foreign direct investment, and a reduction in the wasteful expenditure of the government. State-owned enterprises with our loss-making enterprises, and politically motivated subsidies have been sucking the public funds without adding any actual value to them, long enough.

The other important thing is to safeguard monetary stability. As the article explains, there is nothing beneficial about printing money to artificially reduce interest rates, as it only incites inflation and results in lost reserves. They should rather be replaced by the interest rates based on the actual market. The actual market interest rate will be lower, thus leading to an increase in savings, stabilization of currency, and the country will become more creditworthy.

Above all, Sri Lanka should earn international credibility and trust in the financial system. That implies remaining faithful to reform, bringing transparency to it as well as making the environment business-friendly. Capital inflows will once again take place in Sri Lanka once the foreign investors have confidence in the economic direction of this country, and hence, less borrowing will be required.

This is not going to be easy and not overnight. With political will power, ethical leadership, and intelligent economic planning, Sri Lanka can slowly come out of the debt cycle and make a stable and self-sufficient future. The past was tough-the future is not rewritten yet.

Conclusion

The financial narrative, as it emerges behind the balance sheet, does not only involve numbers-it is a history of little foresight approaches, policy mistakes, and the responsibility of paying off its debt burden, which has placed the country in a cycle of crisis. Reorganizing an economy that is straining with excessive borrowing into a disaster of devouring the printing of money, the effects have been disastrous: inflation, depreciation, and rampant dissatisfaction of the populace

There is a ray of hope somewhere in this dark pattern, however. The way out is not lined with quick temporary solutions, but with the reorganization of the structure, responsible fiscal policy, and a high level of sticking to a long-term plan. Sri Lanka can finally change its economic story when it leaves behind its strategy of reliance on quick money tricks and instead adopts a strategy of transparency, efficiency, and investor confidence

The country should keep in mind that the deficit might control the present, yet through strength, sound judgment, and long-term reform, this does not need to be the definitive legacy. The balance sheet cannot speak of a shortage of money, but rather an excess of vision.

Reference

economynext.com

Written by A.Sawmiya

Index no: 236120V