Abstract:
In the past three decades a number of developing countries have experienced major
episodes of financial crises that were brought in by unsustainable fiscal deficits. As in the
case of a number of other developing countries, the fiscal deficit in Sri Lanka too has been
high for a long period. Though the fiscal deficit was at its peak at 23 per cent in 1980, it
averaged 13 per cent during 1977-1991 and 9 per cent during 1992-2007. However, even a
9 per cent deficit could be a dangerous phenomenon as it could act as a catalyst to
financial instability in the country. When government revenue is insufficient to offset its
expenditure, the country is forced to depend on foreign and domestic sources to bridge the
fiscal deficit. As a result, government’s debt as a percentage of GDP increases. However,
high level debt will increase the pressure on the government’s ability to meet its other
expenditure commitments. This is of particular concern when these commitments involve
essential and development oriented expenditure. It also tends to reduce resource
availability to the private sector in addition to increasing the interest rate in the domestic
markets. This will increase the cost of borrowing by the private sector and thereby crowd
