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Friday, 22 November 2019 00:01 - - {{hitsCtrl.values.hits}}
Sri Lanka’s Presidential Election significantly increases policy uncertainty and could prompt loosening that exacerbates fiscal weaknesses and a rollback of reforms, Fitch Ratings says. However, whether these risks materialise remains to be seen, as a clear policy direction may only start to emerge after Parliamentary Elections.
The policy environment in Sri Lanka (B/Stable) had improved following the resolution of the 2018 political crisis, supporting the resumption of fiscal and economic reforms and of Sri Lanka’s IMF program.
“However, political tensions could resurface ahead of elections to parliament, where the UNP is the largest party. These are expected early next year. The new President’s constitutional reform plans could resurrect controversial proposals to enhance the Executive’s powers,” the report warned.
President Gotabaya Rajapaksa’s economic manifesto targets average growth of 6.5% or higher, compared with 3.2% in 2018 and a Fitch-forecast 2.8% in 2019, by promoting commodity and apparel exports, construction, and tourism. Strengthening growth and exports would be credit positive, but Fitch believes there is a risk of a more expansionary fiscal stance after the Parliamentary Elections.
Under Mahinda Rajapaksa’s presidency from 2005-2015, an aggressive infrastructure drive pushed up Government debt. President Gotabaya Rajapaksa’s manifesto targets a budget deficit below 4% of GDP and inflation below 5%.
“Although detailed economic plans are yet to be announced, we think achieving ambitious growth targets could entail stimulus measures that erode fiscal headroom, which is limited by high public debt (about 83% of GDP). This could undermine policy credibility, investor confidence, and potentially complicate relations with the IMF,” the report added.
“The new President’s manifesto suggests that the undermining of monetary policy credibility that was a feature of Mahinda Rajapaksa’s presidency will not recur. An important measure of this commitment will be the status of a planned Amendment to the Monetary Law Act, which would establish price stability as the Central Bank’s primary objective and support the shift towards flexible inflation targeting.”
President Gotabaya Rajapaksa’s commitments on social spending and public-sector wages and pensions could jeopardise deficit reduction unless Government revenue (which is low at just over 13% of GDP) increases. His manifesto includes plans to replace the Inland Revenue Act, a lynchpin of fiscal reforms under the IMF program, to unify VAT (currently 15%) and the Nation-Building Tax (2%) with a single VAT rate of 8% and cap personal income tax rates at 15%. If these lead to revenue losses, they could put Sri Lanka’s medium-term fiscal consolidation plan at risk.
“A 4% deficit may therefore prove challenging. We forecast the deficit to stabilise at about 5% of GDP in 2020-2021, as GDP growth recovers from the April bombings in Colombo.”
The report goes onto observe that contingent liabilities from major State-Owned Enterprises (SOEs) pose risks to debt sustainability. President Gotabaya Rajapaksa’s manifesto says that SOEs will not be ‘a burden to the exchequer’ but SOE reform has been difficult to achieve. A high share of foreign-currency debt could also pressure debt sustainability if investor confidence deteriorated and the rupee fell sharply.
The market reaction to the election has been mildly positive. The Sri Lankan currency has appreciated by about 0.5% against the dollar and the Colombo stock index rose by about 2%.
“A row-back on reforms could have implications for Sri Lanka’s IMF program, which has been extended to June 2020. The sixth review was completed in September and, coupled with $ 4.4 billion of sovereign bond issuance this year, has eased near-term external pressures. But external debt repayments are substantial at $ 19 billion in 2020-2023 (against reserves of $ 7.8 billion).”
