By Mandana Ismail Abeywickrema

The government has said it has no option but to print money to fund its defence expenditure as well as to pay the new recruits to the public sector. The statement came just a week after passing the most controversial budget ever presented to parliament.

The statement made by a senior government minister stands testimony to the loose fiscal polices followed by the government that has resulted in the country's economy being pushed to the edge.

Consumer Affairs Minister Bandula Gunawardena, a qualified economics teacher, speaking to the BBC's Sinhala language Sandeshaya programme has said it has now become necessary to print money because the government had recruited 250,000 persons and defence expenditure was increasing.

Different scenario

He has also said that between the years 2002 and 2003, the total government service had been trimmed and vacancies of 120,000 had not been filled, and that the scenario now was quite different leading to mounting expenses.

Following are the comments made by the Minister in response to questions posed by the news service.

BBC: Is the government trying to pay for all this expenditure by printing money?

Minister: Yes. There is no alternative.

BBC: The government has no alternative but to print money resulting in higher inflation?

Minister: Yes. In that event the government will have to stop state recruitments with immediate effect, stop the war, stop welfare expenditures, stop fertiliser subsidies, stop school mid-day meals. However, the government is not prepared to move into an expenditure limiting programme because the government believes it is politically bad for the country.

Printing money

Gunawardena's comments were met with much criticism by economists who said that Gunawardena being an economist should know better than to say that printing of money was the only option for a cash strapped government.

"If he says the only option is to print money, then he ceases to be an economist. The consequence of such an act is very clear - inflation would increase even further," Economist Dr. Harsha de Silva said.

Gunawardena has also blamed the high oil prices for the country's record inflation level and has said it was a global problem as massive amounts of money were being spent on oil imports, resulting in "imported inflation."

However, economists have argued that although global oil prices have an impact on inflation, it did not have as much of an impact as the government has made it out to be.

"Global prices do have an impact, but it is not as much as they make it out to be," said Dr. de Silva.

Low inflation

Other countries in the region, which are also affected by the high global oil prices, have managed to maintain single digit levels of inflation.

Sri Lanka's closest neighbour India, with massive oil imports, has recorded 3% inflation - a figure more or less common to many other countries in the Asian region including Thailand.

"Sri Lanka has one of the highest levels of inflation," Dr. de Silva said.

He also pointed out that till the government stops printing money, the country would continue to record a high rate of inflation.

Analysts have pointed out that the government had printed Rs. 45 billion from May to September this year and was borrowing vast amounts from the state banks to fund its survival, causing high inflation.

The Colombo Consumer Price Index (CCPI) recorded a 4.4% increase between the months of October and November.

Increase in expenditure value

The CCPI for the month of November was posted at 5976.2, which is an increase of 253.2 index points higher than that recorded in October, the Census and Statistics Department said.

"This is an increase of Rs. 512.08 in the expenditure value of the Market Basket when compared to October 2007," the department said.

Meanwhile, the countrywide consumer price index, the Sri Lanka Consumer Price Index (SLCPI), was at 24.1% in October this year, the highest recorded by the index since 2005. The SLCPI's previous high was 18% recorded in January 2005, soon after the government printed Rs. 65 billion to fund its fuel and fertiliser subsidies in 2004.

Analysts have also charged that after printing large amounts of money the government had also proceeded to borrow vast sums of money from foreign banks at commercial rates of interest further accelerating the country descent into 'debt ridden nation' status.

The government's first sovereign bond of US$ 500 million was issued in October.

Paying a higher amount

One of the country's long standing donors, the World Bank said that although Sri Lanka's bond issue was oversubscribed, the country was paying a much higher interest rate than what was currently being paid by the emerging markets.

The bank said that Sri Lanka's offering rate was higher than even that offered in the US market.

"Sri Lanka has offered 380 basis points, which is higher than the US market. For an emerging market, it is usually around 200 basis points," the Bank's Managing Director, Graeme Wheeler said.

Treasury Secretary Dr. P.B. Jayasundera in November said that Sri Lanka might sell about US$ 300 million of bonds in its second offering to overseas investors to help repay debt.

This according to him was expected to 'reduce pressure on domestic debt markets in 2008.'

Dr. Jayasundera had reportedly told a business forum that the government was looking at bonds that would mature in seven to 10 years to change the structure of its foreign debt portfolio.

He had said that the government was looking at US$ 200 to 300 million for debt rollover.

Central Bank Governor Ajith Nivard Cabraal was reported last month saying that Sri Lanka's overseas debt sales are aimed at easing local rates and reviving the nation's war-ravaged economy.

Public debt distress

Meanwhile, the International Monetary Fund (IMF) warned of the significant risk faced by Sri Lanka with regard to public debt distress due to its heavy reliance on dollar denominated, short term commercial debt.

Issuing a statement at the conclusion of the IMF Directors' Article IV consultations with Sri Lanka recently, the IMF directors called on the local authorities to improve debt management.

"Directors noted the significant risk of public debt distress in Sri Lanka, arising from heavy reliance on dollar-denominated, short-term commercial debt. They stressed the need to lengthen and smoothen the maturity profile of the debt to reduce rollover and liquidity risks, including through capital market refinancing, and to improve debt management in general," the IMF statement said.

Be that as it may, the country's economic issues have been further compounded by the 2008 budget, which has also been termed as a "war budget" by economic analysts.

The legislators on December 14 gave the final nod to the 2008 budget, which has made the highest allocation for defence in the country's history.

Analysts say that with the addition of other indirect costs, the defence expenditure for next year would definitely be far greater than that presented by President Mahinda Rajapakse in the 2008 budget.

It is predicted that defence expenditure could rise up to Rs. 200 billion in 2008.

Higher allocations for defence

Since 2006, there has been a significant variance with regard to the estimated sum for defence and actual expenditure.

In 2006, the government estimated to spend a sum of Rs. 96 billion on defence when the actual amount spent amounted to Rs.111 billion.

In 2007, the initial estimate of Rs. 139 billion for defence funding increased to Rs. 156 billion by end November.

In 2008, the government is expected to spend a sum of Rs. 166 billion, which is Rs. 456 million (US$ 4 million) per day on defence and public security, which is huge for a lower middle-income country.

However, going by the earlier defence spending since 2006, the government estimation of Rs. 166 billion for next year would undoubtedly see more billions added by the end of the year.

According to analysts, if the additional costs such as pensions and disability expenditure on service personnel and instalment payments for military procurements are also taken into consideration, defence expenditure for 2008 will easily exceed Rs. 200 billion.

At the conclusion of the last budget, government members walked down the corridors of parliament singing what were termed 'patriotic' songs. However, at the going rate with funds hard to come by and expenses soaring, the very same legislators may soon have to sing for their (government's) supper.