EIU risk update: Good rating for SL post-Budget, reforms urged
Saturday, 30 November 2013 08:29
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The Economist Intelligence Unit’s (EIU) latest risk briefing on Sri Lanka has rated the 2014 Budget and prospects well, while insisting reforms are key.
In its report titled ‘Sri Lanka Risk: Alert – Focusing on the right things,’ the EIU said: “For now, the country is rapidly becoming a success story, swiftly rebounding after more than two decades of war, a situation that has bolstered the standing of the president and Government…”
However, it noted: “Reform remains the key, however, and time will tell whether the Rajapaksa government’s program is sufficiently expansive and rigorous to effect fundamental change.”
Following is the full text of the EIU’s latest risk briefing on Sri Lanka:
The Government has presented the Budget for 2014, its fifth since the end of the civil war in 2009, pledging continued fiscal consolidation, higher growth, and moves to increase the size of the stock market. The Budget comprises a mix of small-scale concessions to key voters — the rural majority and bloated public sector — targets the banks for funds and seeks to keep international lenders onside with further attempts to draw down debt.Its reception was largely positive, although critics argue that the Government is placing too great an emphasis on GDP growth to support fiscal consolidation, and needs to implement medium-term plans to counter debt issues arising from the long-term cost of war and subsequent large-scale infrastructure spending through a program worth $ 21 b to 2015.
The Budget’s key provisions include:
nA pledge to reduce the Budget deficit to 5.2% of GDP (from 5.8% in the current fiscal year);
nGDP growth forecast of 7.5% for the next three years;
nThe imposition of a 2% Nation Building Tax (NBT, introduced in 2009 following the war’s end) on the finance sector;
nThe proposed merger of small financial institutions, and
nGreater funds provided for agriculture, education and health, as well as an increase in the cost of living allowance for civil servants.
The Government is aiming to raise approximately US$ 316 m in new tax revenue as a result of its decision to extend the NBT and VAT in supermarkets.
The telecommunications industry was also hit by tax hikes, with the telecoms levy increased from 20% to 25%.
In a bid to expand the stock market, President Mahinda Rajapaksa (also the Finance Minister), offered those companies that float in the next year a 50% reduction in corporate taxation (currently set at 28%) for three years. That said, it is unclear whether this will work, given that a previous similar attempt saw just two companies take up the Government’s offer during the course of 2013.
The Government has made progress in tackling the debt issue. It has brought down overall debt, currently aiming to reduce this down to 65% of GDP, from almost 80%. Clearly further work is required: Fitch, a ratings agency, highlights that the average debt percentage in the BB- sovereign rating band is 35%. In terms of the fiscal deficit, the Government is seeking to reduce this to 5.2%, which, if achieved, would mark its lowest value since 1977.
At this stage, organisations like the IMF have said that they do not view any immediate problems with debt sustainability, but over the medium term, there are question marks. More than 30% of this is foreign currency debt, posing a problem if the currency weakens.
Over the longer term, economists argue that the Government needs to pay more attention to the tax base. Some reforms in this area have been made, and, in this Budget, the Government has sought to target the banks rather than anger voters ahead of a potential early presidential election—there is talk that Rajapaksa may call polls next year in a bid to consolidate his position rather than wait till 2016.
Like with much of the region, however, the tax base remains narrow and compliance and collection methods require improvement. Thus, although taxation reform has been pursued since 2011, there has only been marginal positive change to date. Unless taxation revenue is significantly increased, moves to reduce the budget deficit may be compromised.
This situation highlights the importance of continued reform and high levels of GDP growth. For now, the Government is focused on pushing up growth figures in a bid to raise revenue. To this end, it ignored IMF advice not to reduce interest rates, cutting them by 50 basis points in October, in an attempt to spur on growth.
Much like other areas of policy, question marks dog the Rajapaksa administration. There was disquiet when Rajapaksa took on the role of Finance Minister, given his lack of economic experience (he is a lawyer by training). That said, Rajapaksa and his ministers have worked hard to prove their critics wrong. For now, the country is rapidly becoming a success story, swiftly rebounding after more than two decades of war, a situation that has bolstered the standing of the President and Government among the majority Sinhalese.
As the recent Commonwealth Heads of Government meeting highlighted, however, it is a situation blighted by controversy, from questions raised over suspected large-scale human rights abuses committed during the war, to press freedom and the nature of the democratic process. The economy isn’t impervious to the probing eye: critics question the veracity of the country’s economic data, which maintains strong economic growth and single-digit inflation.
The Government rebuffs criticism, pointing to the many successes notched up since the war ended. Reform remains the key, however, and time will tell whether the Rajapaksa Government’s program is sufficiently expansive and rigorous to effect fundamental change.
