Budget 2016 and education and health

expenditure: Playing numbers games

isnt in accord with good governance
principles

Chief of the IMF Mission to Sri Lanka, Todd Schneider, has questioned the accuracy
of some of the figures presented in Budget 2016 - AFP
Controversy over education and health numbers

Monday, 14 December 2015

A controversy has arisen relating to

the education expenditure vote in Budget 2016. A section of
Opposition Parliamentarians has accused the Minister of
Finance of adding some fictional numbers to the budgetary
expenditure under the education vote.
University academics too have questioned the validity of
increased expenditure on education in terms of the countrys

total output, known as Gross Domestic Product or GDP. According to critics,

there has been an unusual number-inflation game in the education vote.
However, the same game, if it can be called a game, has been played with
the health vote as well, though on a smaller magnitude, unknown to critics.
This has led to a similar inflation of the estimates of the non-tax revenue
too in the Budget.
Having failed to understand why and how non-tax revenue has shot up
phenomenally, openly questioning whether Sri Lankas fiscal house is in
order, the Chief of the IMF Mission to Sri Lanka, Todd Schneider, has
expressed doubts about these impressive numbers in Budget 2016
(available at: http://www.ft.lk/article/504661/Is-Sri-Lanka-s-fiscal-house-inorder?).
In such a background, good governance principles require the Ministry of
Finance to issue a clarification on the issues raised by Parliamentarians and
independent analysts. With the absence of such a clarification, the public
has become confused whether to believe or disbelieve budgetary numbers.
Hence, it is necessary to examine the issues involved from an economic
point to disabuse the minds of the concerned public.

Global standards in presenting budget numbers

Two clarifications are in order before proceeding with the examination of the
issue at hand. One is that Government statistics, including those in the
Budget, are to be prepared by following international best practices which
have been codified in an IMF publication titled Government Finance
Statistics Manual, updated and released periodically.
The other is that the expenditure on education or health or any other
function of the Government cannot be ascertained from the approved votes
in Parliament. They are just raw numbers that have not classified
expenditure either by function or by economic purpose. Hence, they have
to be reworked by following, again, the recommendations of the
Government Finance Statistics Manual and that would be a subsequent
exercise to be completed by the Central Bank.
Budget is related to other macroeconomic numbers
A governments budget does not stand alone from the rest of the
macroeconomic sectors in the economy. It has a relevance to and a bearing
on the national accounts which calculate a countrys GDP, balance of

payments that records its position with other countries and financial and
monetary statistics that compile money supply numbers. All these statistics
are compiled by following the double-entry book keeping principles just like
preparing the accounting statements of a private company. Hence, any
expenditure in the budget, say payment of salaries and wages to
government employees, is an income in the national accounts.
Similarly, any expenditure on a capital item by the government should be a
part of the capital formation in the national accounts.
When the Government raises a foreign loan, it is a part of the financial flows
in the balance of payments and any repayment of a foreign loan is an
outflow in the same account. Likewise, when the Government borrows
money from the Central Bank to finance the Budget, it is a part of the
domestic credit expansion in the money supply statistics. Therefore, all
these macroeconomic accounts are interrelated and should be prepared in
conformity with each other.
To prevent the individual governments from using their own standards and
methods and thereby coming up with confusing sets of statistics which are
not internationally comparable or domestically in conformity, the
international community has agreed on establishing a set of common
standards when preparing these accounts.
Accordingly, national accounts are to be prepared by following the System
of National Accounts or SNA released by the United Nations. The IMF has
taken action to prepare a comparable set of standards for the other three
macroeconomic sectors. Accordingly, budgetary numbers are to be
prepared in terms of the Government Finance Statistics Manual or GFSM,
external sector numbers in terms of the Balance of Payments Manual or
BPM and money supply numbers in terms of Monetary and Financial
Statistics Manual or MFSM, all released by the IMF.
GFSM: prepare a balance sheet and record items on an accrual
basis
The latest GFSM has been issued by the IMF in 2014 which has updated its
earlier edition released in 2001. Sri Lanka is not fully compliant with even
the 2001 version of GFSM. The Ministry of Finance has disclosed in its
Annual Report for 2014 that the accounting methodology of keeping
government accounts has been the Generally Accepted Accounting
Principles relating to public sector entities. But for analytical purposes,
budgets should be presented in terms of GFSM.
There are two major novelties introduced in GFSM. One is that, like in

private companies, government flows should be recorded on an accrual

basis meaning that what should be recorded for a particular year is what is
relevant only to that year. Thus, if some payments are in arrears, they
should be added to and if there are payments in advance or payment of
arrears, they should be removed from the annual flows.
At present, Sri Lanka records all its budgetary flows not on an accrual basis
but on a cash basis. The second is that the Government should, like a
private entity, prepare a comprehensive balance sheet recording both
assets and liabilities and showing the net-worth of the Government.
Sri Lanka has so far not ventured into doing this and has been releasing its
Government statistics on a cash basis, though it has prepared a truncated
balance sheet recording only the financial assets and financial liabilities.
Hence, on both counts, there is a long way which Sri Lanka has to go in
order to make itself compliant with GFSM.
Functional classification of
Government expenditure
The second qualification is that, in order
to derive the expenditure on education,
the relevant statistics should be
extracted from all ministry votes and not
necessarily from the Ministries of
Education or Higher Education.
The numbers relating to education,
extracted from all ministry votes should
be presented in a separate table called
functional classification of government
expenditure. In terms of GFSM,
education expenditure consists of both
direct and collective expenditure incurred
by the Government on behalf of pupils.
Pupils include all those who are in the
primary, secondary, tertiary and
vocational streams.
Direct expenditure items include those
that directly benefit the pupils such as
salaries paid to teachers, facilities
provided to students to carry on learning
such as free textbooks, free meals, free
uniforms, etc. Collective expenditure

items include those items that are beneficial to pupils as a whole such as
expenditure on revising syllabuses or conducting examinations, etc. All
other expenditure items in the ministry votes are classified as general
administration or procurement of services.
Accordingly, salaries paid to educational officers and those in the ministry
are not for education purposes but for general administration. As such, not
all the expenditure items presented in the Ministry of Education or the
Ministry of Higher Education votes are considered as those incurred for
education.
The table that has represented government expenditure in terms of
different functions is published by the Central Bank in its Annual Report.
Hence, until this table is published, it is not possible to ascertain how much
has been spent on education by the Government. What it means is that it is
misleading to consider the votes of the Ministries of Education, Higher
Education and Vocational Training as the expenditure incurred by the
Government on education.

Unusual treatment of the use of capital in Budget 2016

The Finance Ministry has done something unusual in the Budget 2016
relating to both education and health services. That is, it has assessed the
implicit rent value of the lands and buildings owned by the Government and
used for providing education and health services. Then it has presented
such notional rent values in the budgetary estimates as recurrent
expenditure on education and health services terming them Capital
Carrying Cost of Government Lands and Buildings.
This is a departure from the practices it had followed in the past where
expenditure recorded under each head had been only those actually
expended by payment of cash from the Treasury or incurring a debt by the
Government.
The rationale for changing the system only in respect of education and
health has not been disclosed in the draft estimates. The amount so
reported as expenditure on education and health has amounted to Rs. 139
billion, made up of Rs. 121 billion for education and Rs. 18 billion for health.
The estimates say that the Ministry expects to expend the same amount on
the same count in each of the next two years, namely 2017 and 2018 as
well. The total of such notional rent income from lands and buildings
amounting to Rs. 139 billion has been added as Non-Tax Revenue in the
revenue estimates of the budget for 2016 as well as in the two subsequent

years. This practice has inflated the Non-tax Revenue number in Budget
2016 causing even IMF Mission Chief to question its validity.

Why is this practice unsavoury?

This practice is unsavoury on five counts. First, it is not in accord with the
recommendations in GFSM which provide the best international practice in
presenting government statistics. Second, it has implications on the
compilation of national accounts since such expenditure reported in the
Budget is not an income of any party in the economy or the revenue
attributed to the Government is not a leakage of income from the economy.
Therefore, it is inconsistent with national accounts.
Thirdly, it inflates both the education and health expenditure and the
revenue of the Government recording more favourable ratios in terms of
GDP and thereby misleading the public, international agencies and
analysts.
Fourthly, it is a selective application of a new principle ignoring all other
Government entities with lands and buildings and such selective
application, representing a weird cherry picking is not prudent and does
not go well with good economic policy governance. Fifthly, it creates a gap
between the Governments cash flows and flows reported in the budget
making budgetary numbers unreliable.

Depreciation reduces net worth

However, it is a universal fact that when capital assets are used for carrying
out ones activities, there is a cost attributable to such usage. In private
usage, this is known as depreciation and such depreciation is taken out of
the income by charging it to the profits and loss account. The end result is a
reduction of the net worth of the person to the extent of the depreciation
involved. In the case of governments, the use of capital is still taken into
account as provided for in GFSM. But the treatment method is different
from the treatments made in private accounting.

In government accounting, capital consumption is a direct

reduction of net worth
When the Government incurs a capital expenditure such as acquisition of

lands or construction of buildings, such capital expenditure is reported as

an expense in the Budget for which the Government has to find money for
its financing.
Since such acquisitions enhance the net worth of the Government, they are
shown as physical assets owned by the Government in its balance sheet.
They are reported at historical costs in terms of the Generally Accepted
Accounting Principles relating to government sector accounting which the
Government of Sri Lanka too is following. They may be brought to market
value by revaluing at later stages but the revaluation profits are directly
added to the net worth of the Government without distorting governments
revenue flows.
The use of such capital assets in producing government services is known
as capital consumption in GFSM as well as in the System of National
Accounts. The way to calculate it is to assess the remaining lifespan of the
asset and divide it by the number of years involved.
For instance, if a school building is valued at Rs. 1 million and it has a life
span of 10 more years, the annual capital consumption is just Rs. 100,000.
This is a cost but that cost is not presented as an expense of the
Government by showing it under the expenditure votes. It is directly
deducted from the net worth of the Government since its ultimate effect is
to reduce the net worth. The reason for treating it as a direct reduction of
the net worth without distorting government budget is related to the way
countries calculate their domestic outputs, known as GDP. They calculate
GDP before charging depreciation, the charge of which results in generating
net domestic product or NDP.
If the Ministry of Finance desired to reckon the capital consumption used for
producing educational and health services, the appropriate procedure
would have been to charge it directly to the net worth of the Government
and not to present it as an expenditure item in the Budget. But since the
governments balance sheet does not contain physical assets, that
procedure would not have been possible.
Given this background, the Ministry of Finance should have ignored this
capital consumption part altogether as it had done in the past. When it has
been arbitrarily brought into the budgetary numbers, it has created room
for critics to attack both the budget and the Minister of Finance. Hence, the
current wave of criticisms against the budget and the Minister of Finance is
a creation of the Ministry of Finance itself.
Ministry of Finance has opened room for discrediting the Budget

However, it will not distort the budgetary figures for analytical purposes,
since the Central Bank, when representing budgetary numbers in terms of
Functional Classification of the Expenditure of the Government later, will
disregard this notional rent reported in the Budget 2016.
As such, it has only discredited Sri Lankas Budget and its budget-making
causing the Government to lose its reputation as a practitioner of good
economic policy governance.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank
of Sri Lanka, can be reached at waw1949@gmail.com).
Posted by Thavam