Fiscal policy changes include increasing public spending and boosting tax collection

Myanmar is in the midst of a historic transformation of both its public sector and fiscal policy towards international norms. The country traditionally had a very small civilian government and many large state enterprises, all overseen by a politically and commercially powerful military. State enterprises have traditionally accounted for most public revenues, while central bank printing of kyat banknotes provided much of the financing for the government as tax collection remained very light.

That traditional arrangement is changing, most visibly with the growth of the civilian government and its decreasing dependence on direct central bank financing. Tax collection is also on the rise and the government appears to be asserting firmer control over state enterprises. In July 2014 Myanmar was accepted as a candidate member of the Extractive Industries Transparency Initiative (EITI), pledging to begin publishing detailed accounts of public revenues from exploitation of natural resources.

BEATING INFLATION: The transformation can be seen in public sector accounts published by the IMF, based on data provided by the Myanmar government. In the 2007 fiscal year, the government spent only 9.3% of GDP, including 1.6% of GDP on the military’s current expenditures and 5.8% of GDP on other sectors, mostly on construction of the new capital at Naypyidaw. That left just 1.9% of GDP for the operating expenditures of the civilian government.

Government funding came from taxes at 3.7% of GDP, other central government revenues at 0.6% of GDP, transfers from state enterprises at 2.9% of GDP and central bank financing at 2.7% of GDP, which went partly to state enterprises. That amount of central bank financing was enough to drive a 21% increase in broad money supply in FY 2007/08, and because a history of high inflation had taught people to spend their kyat quickly, that translated directly into consumer price inflation, which ran at 31% according to the IMF. Fiscal years start on April 1 of the same-numbered calendar year. The first big fiscal improvement came with the 2008-09 global financial crisis, which led to a steep drop in global food prices and put a strong damper on inflation. That set off a change in savings behaviour, as people and companies began to use bank deposits in order to earn interest rather than spend or invest their kyat in real assets as quickly as possible. The result was a sharp slowdown in the velocity of money, which itself put a strong damper on inflation. The process became self-sustaining even after commodity prices bounced back, with moderate inflation drawing in more bank deposits leading to a further slowdown of money velocity, defined as the ratio of final spending to the sum of bank deposits and circulating currency. The velocity of broad money fell from 5.3 in FY 2007/08 to 3.4 in FY 2011/12, according to the IMF’s calculations.

Lower inflation also allowed the government to finance itself by selling bonds, which are mainly held by banks as liquid interest-earning assets against their client’s deposits. Government expenditures rose to 11.3% of GDP in FY 2011/12, including 5.9% of GDP on capital investment, 2.9% of GDP on military current expenses and 2.5% of GDP on civilian government current expenses. Funding came from taxes at 3.9% of GDP, other central government revenues at 0.4% of GDP, transfers from state enterprises at 2.3% of GDP, central bank financing at 1.8% of GDP and other debt financing – mostly bond sales – at 2.8% of GDP.

Yet even with a public deficit of 4.6% of GDP and a 26% increase in broad money supply, inflation in FY 2011/12 ran at only 2.8%.

STRONGER PUBLIC SECTOR: With the lifting of international sanctions, the civilian government has been able to take advantage of increased financial inflows from the rest of the world to substantially grow in size. The government’s FY 2014/15 budget, as reported to and published by the IMF, called for spending of MMK10.3trn ($10.3bn), or 16.3% of GDP, as projected by the IMF. That is a similar public sector share of GDP to the Philippines, according to World Bank data. The corresponding figures in Thailand and Malaysia are in the low 20s, while in most advanced economies the public share of GDP is around 40%.

FINANCING PUBLIC SPENDING: The public sector’s budgeted 16.3% of GDP in FY 2014/15 included 5.9% of GDP on capital investment, 3.7% of GDP on military current expenses, and 6.7% of GDP on civilian current expenses, which is an increase in the share of GDP allocated to civilian public current spending of some 3.5 times since FY 2007/08.

The increased civilian public spending is crucial to improving education and health care, and boosting both civilian and military public spending is also vital to reducing corruption and the traditionally powerful role of the military in commercial activity. While the military’s public budget during the sanctions era was small, the military controls large commercial interests that are believed to have provided additional income outside the budget. Military units in remote border regions are also suspected of accepting informal payments from smugglers and illegal businesses.

Financing of FY 2014/15 public spending was budgeted to come from taxes at 7.7% of GDP, other central government revenues and grants at 1.1% of GDP, state enterprise transfers to government of 0.8% of GDP and deficit financing of 6.6% of GDP. However, the IMF projected a deficit of 5.5% of GDP, due mainly to higher income from sales of mobile telecoms licences, and a consolidated public sector deficit of 4.5% of GDP, after counting expected retained earnings of state enterprises. Still, the relatively large public deficits are a cause of concern to the IMF. The IMF forecast that external financing (development aid loans) would finance 1.1% of GDP worth of deficit in FY 2014/15, while the central bank would finance 1.3% of GDP and the rest of the deficit would be funded from domestic debt financing.

The velocity of broad money, meanwhile, has continued to decline as money continues to pour into bank savings deposits. Velocity fell to 2.6 in FY 2012/13 and an estimated 2.2 in FY 2013/14, and was projected to drop to 1.9 in FY 2014/15, according to the IMF. Thus inflation was expected to remain relatively moderate despite the continued central bank financing of government and emerging expansion of commercial bank credit to the private sector. Inflation came to 5.7% in FY 2013/14 and was forecast by the IMF to reach 6.6% in FY 2014/15, although dropping global commodities prices in 2014 were likely to improve results.

BRINGING TRANSPARENCY: Joining the EITI is a major step in bringing some transparency to public finances, as natural resources represent a large portion of public revenues. The government is obliged to publish its first EITI report by January 2016.

Relatively little resource revenues reach the government budget, as most are consumed within the large network of state enterprises.

For example, the public share of earnings from offshore gas accrue mainly to the Myanmar Oil and Gas Enterprise in the form of a share of output, which is allocated to other state enterprises including public electric power generators. The public enjoys very low electricity prices for households, but little in the way of budget revenues.

According to data provided by the government to the IMF, state enterprises earned MMK7.3trn ($7.3bn), or 15.3% of GDP in FY 2012/13, but spent MMK5.5trn ($5.5bn) and retained earnings of MMK1.1trn ($1.1bn), transferring only MMK800bn ($80m) to the state budget. According to budget figures provided to the IMF, state enterprises were expected to earn MMK8.7trn ($8.7bn) in FY 2014/15, but they were expected to spend MMK7.9trn ($7.9bn) and retain earnings of MMK300bn ($30m) while transferring only MMK500bn ($50m) to the state budget.

TAXATION: The main way the state budget receives earnings from natural resources is through corporate income tax, the personal income taxes of resource business owners and the commercial tax, a levy similar to a value-added tax charged on producers, traders and exporters of certain goods.

Natural gas is taxed at 8%, precious stones at 30% and hardwood at 25% or 50% if exported. However, the taxes on precious stones are largely avoided, and some hardwood lumber also avoids the tax.

Most goods and some services are taxed at a 5% rate, while higher rates apply to alcohol (50%), cigarettes (100%), automobiles (25%) and petroleum fuels (10%). According to the Central Statistical Organisation, total commercial and service taxes came to MMK1.2trn ($1.2bn) in FY 2012/13 and MMK1.6trn ($1.6bn) in FY 2013/14, while personal and corporate income taxes totalled MMK1.4trn ($1.4bn) and MMK1.6trn ($1.6bn), respectively.

Income tax revenues are low because most people and small businesses pay little to none, and foreign investors receive attractive tax holidays. But the government has announced plans to switch to a value-added tax by 2018, which usually improves collection because companies must enforce it on each other.