Sri Lanka sails towards fiscal consolidation

[sashimaalTop contributor]

Sri Lankan Government is set to prune capital expenditure of state institutions amounting to Rs. 626 billion while re-working the 2016 budget aimed at fiscal consolidation in the wake of an agreement with the IMF on a 36-month Extended Fund Facility (EFF) for 185 per cent of Sri Lanka’s quota in the IMF (about SDR 1.1 billion or US$1.5 billion), state policy makers revealed. The IMF is now working on the staff report for the Executive Board to get their approval towards disbursing the EFF in installment basis to Sri Lanka commencing from next month, IMF sources in Washington said.

The Treasury is facing a major task of tackling weak income generation with tax revenues down considerably while the budget deficit in 2015 has gone up to 7.2 per cent of GDP from 6 per cent in 2014. Amendments to revenue proposals have disfigured the 2016 budget beyond identification, an economic expert in the state policy think tank who wished to remain anonymous said. The IMF EFF will boost the countries dwindling foreign exchange reserves which has dropped to US$ 6.2 billion in March from $6.3 billion in January this year, he said adding that tax reforms are not possible at the moment due to low economic growth and missing budget targets.

Sri Lanka should take prompt action to improve tax administration, broaden the tax base and eliminate a range of tax loopholes as suggested by the IMF during negotiations for the EFF, he pointed out. The Central Bank is likely to issue sovereign bonds to the tune of $2.2 with the clinching of the IMF bailout facility by Sri Lanka. Economist Professor Sirimal Abeyratne expressed the hope that an IMF programme will bring short term temporary benefits, raising the confidence of investors and businesses that government finances will be put on a more stable path. He told the Business Times that the bailout facility would help to treat the country’s economic ills for two or three months and thus the government should take prompt action to tackle the current situation.

The government’s action of tax hike increases revenue will help to reduce the budget deficit, he said adding that like spending cuts, it could cause lower spending and lead to a fall in economic growth. One of the best ways to reduce the budget deficit as a percentage of GDP is to promote economic growth. With economic growth, people pay more VAT, companies pay more corporate tax (tax on profits), and workers pay more income tax. High economic growth will reduce the budget deficit as there is a need to raise tax rates or cut spending, he disclosed. Meanwhile Fitch Rating said Sri Lanka’s IMF programme eases near-term balance-of-payments risks but will require sustained commitment from the authorities to address long-standing weaknesses in external and public finances.

Fitch said therefore it has no immediate impact on Sri Lanka’s ‘B+’/Negative sovereign rating. The downgrade resulted from rising refinancing risks, a decline in foreign reserves, and weakening public finances. But refinancing risk remains high. Sri Lanka has large external debts to refinance, with over $3 billion of external debt due in 2016 and an external liquidity ratio far below the ‘B’ and ‘BB’ category medians, the rating agency said The programme sets ambitious fiscal targets that may be hard to achieve. It aims to slash Sri Lanka’s fiscal deficit to 3.5 per cent of GDP in 2020 from a recently restated 7.4 per cent last year, partly through comprehensive tax system reform.

Persistently low government revenue, which has dropped to around 12 per cent of GDP, is a key contributor to fiscal weakness, and implementing reforms to the tax system could be challenging (last November’s budget did not outline any major tax reforms), Fitch Ratings said. Meanwhile Moody’s said the IMF programme will ease Sri Lanka’s liquidity pressures but ‘not its fiscal challenges”. In a media statement on Thursday, the rating agency said that the IMF programme will have a credit-positive effect on liquidity, but will only marginally affect government credit metrics, unless fiscal policy implementation is much smoother than “we expect”.

The IMF programme has three potential benefits for Sri Lanka’s external financing profile. First, programme disbursements, together with $650 million of forthcoming multilateral and bilateral loans, according to the IMF, will increase liquidity. Second, the IMF financing will be at more favourable terms than Sri Lanka can get through the market. Third, the agreement may help restore market access, Moody’s said. “However, we expect bumps in the sovereign’s fiscal consolidation path because of difficulties in implementing robust revenue raising measures. We forecast a further increase in the government’s debt burden and debt/GDP ratio this year and next, leaving Sri Lanka vulnerable to a shift in financing conditions.”

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[Ethical TraderTop contributor]

Thanks Shashi.