SL’s 2025 Budget positive though several challenges exist: SCB Global Research

Standard Chartered Bank (SCB) Global Research has said Sri Lanka’s 2025 Budget is positive, though there are several challenges.

In a report following the presentation of the 2025 Budget by President and Finance Minister Anura Kumara Dissanayake on Monday (17), the SCB Global Research in its report released on 18 February also provided an issuer recommendation of ‘overweight’ for Sri Lanka.

“The 2025 Budget, the new Government’s first since winning the Presidential and Parliamentary Elections in 2024, was in line with market expectations: the focus is on continued fiscal austerity while at the same time public investment spending has been increased. The Budget broadly sticks to International Monetary Fund (IMF) fiscal targets; that said, revenue growth targets appear somewhat ambitious to us. High interest costs remain a drag,” the report said.

SCB Global Research also said the following. 

The 2025 Budget projects total revenue at 15.2% of GDP (2024: 13.6%) and a primary balance surplus of 2.3% of GDP (2024: 2.2%), broadly in line with IMF targets set in June 2024. However, the 2025 fiscal deficit is projected wider at 6.7% of GDP (vs. the IMF target of 5.2% of GDP; 2024: 6.8%) on higher interest expenses. 

That should not be a concern as the IMF focuses mainly on primary surplus and revenue targets.

The Government has Budgeted 24% growth in tax revenues in 2025 on nominal GDP growth at 9.5% (vs. our estimate of 8.5%), which seems ambitious to us. However, Sri Lanka, to its credit, surprised positively on overall tax collection in both 2023 and 2024 and might do so again in 2025.

Revenue growth projections are not very broad-based and are heavily reliant on taxes to be levied on motor vehicle imports (imports were liberalised from 1 February 2025). The Government raised import duties to 200-300% of the vehicle’s value, depending on the engine type, versus 50-100% in 2019 when imports were last allowed. While we expect strong car imports, given pent-up demand due to the restrictions of the last six years, such high import taxes could dampen demand, posing a downside risk to the 2025 revenue targets. The IMF estimated in June 2024 that higher vehicle import taxes could contribute additional revenues of c.0.7% of GDP in 2025.

As well as import taxes, the Government expects improvements in tax administration to support ongoing tax buoyancy; in addition, the introduction of VAT on digital services and higher corporate tax on liquor, cigarette, and gaming companies should support overall revenue growth in 2025.

Public investment is Budgeted to increase to 4% of GDP in 2025 (2024 (prov): 2.7%). While this is positive for growth, we see a risk of public investment being cut during the year if the Government misses its revenue targets.

Higher interest expenses remain a key drag, with an interest-to-revenue ratio of c.60% in 2025. Interest expenses jumped sharply to 9% of GDP in 2024 and are likely to remain at similar levels in 2025. The IMF had projected total interest payments at 7.5% of GDP in June 2024.

While most investors we talked to expected the 2025 Budget to be in line with IMF requirements, the Budget announcement is still positive for Sri Lanka and should support the curve at current levels. While the SRILAN curve has rallied strongly, most other comparable credits have also rallied year-to-date (YTD). At current yields (assuming upside scenario 2 for the macro-linked bonds materialises), the SRILAN curve still offers value when compared with peers like Ghana, Egypt, and Pakistan.

The new SRILAN curve has rallied strongly YTD, with the macro-linked bonds (MLBs) (SRILAN 30, 33, 36 and 38) up 4.75 to 6.5 points; in contrast, the governance-linked bond (GLB) SRILAN 35 is 2.75 points lower YTD. At these cash prices and assuming upside scenario 2 plays out, which is our base case, the MLB SRILAN 36 and 38 are trading at a 10.13% yield. This is just 73bps wider than the yield on the GLB SRILAN 35 (assuming 75bps reduction in coupon) and only 28bps wider than the SRILAN 35 in case there is no coupon reduction.

While we are confident of upside scenarios being triggered (we see a 90% probability that this happens), at spread differentials below 75bps (between MLB SRILAN 36/38 and GLB SRILAN 35) we prefer owning the GLB SRILAN 35 over the MLBs.

The 2025 fiscal deficit target of 6.7% of GDP translates into a net financing requirement of Rs. 2.2 trillion, a c.8% increase from 2024’s revised estimate of Rs. 2.04 trillion. In 2025, the Government has Budgeted to finance Rs. 2.125 trillion via domestic sources, mainly non-bank borrowing. We assume that this will be split between T-bills and T-bonds in the ratio of 10%:90%, resulting in a net issuance of Rs. 213 billion of T-bills, and Rs. 1,913 billion of T-bonds. In 2025, we estimate LKR bond redemptions to be Rs. 969 billion, resulting in a gross LKR bond issuance of Rs. 2.9 trillion.

Based on our estimates of demand from various market participants, we think the overall demand-supply balance in T-bonds is likely to remain unfavourable. Although demand from domestic savings institutions (pension/provident funds) is likely to remain strong, demand from cyclical investors (banks) may wane amid limited further monetary easing. Therefore, we expect demand for bonds to fall short of the supply and maintain our Neutral outlook on LKR bonds.