ECONOMYNEXT – Sri Lanka’s 2020 budget deficit could rise to 7.9 percent of gross domestic product from an earlier forecast 5.3 percent and 6.2 percent in 2019, the International Monetary Fund has said, the highest since 2015, when a so-called 100 day program of a newly elected administration de-stabilized state finances.
The IMF said the primary deficit of the budget – a measure that removes the effect of rate hikes giving the central bank a free hand allow rates to move up and avoid printing money maintain monetary stability – would rise to 1.9 percent from an project 0.7 percent surplus.
Sri Lanka has slashed value added tax, and a series of direct taxes, in a bid to ‘stimulate’ the economy, which was hit by the after effects of a currency collapse in 2018, coming from the island’s highly unstable soft-peg with the US dollar.
Spiking Deficit
Sri Lanka has a habit of running payment arrears during the last few weeks of the year in a bid to understate the deficit and repaying them early next year, sometimes with foreign market borrowings or printed money (provisional advances).
“Under current policies, as discussed with the authorities during the visit, the primary deficit could widen further to 1.9 percent of GDP in 2020, due to newly implemented tax cuts and exemptions, clearance of domestic arrears, and backloaded capital spending from 2019,” IMF mission chief Manuela Goretti said in a statement.
“Given risks to debt sustainability and large refinancing needs over the medium term, renewed efforts to advance fiscal consolidation will be essential for macroeconomic stability.”
Sri Lanka has not presented a formal budget for 2020, but is operating on a vote-on-account limited to the first four months of the year, when general elections are expected to bring in a new parliament.
Finance ministry has asked parliament to support a supplementary estimate of 155 billion rupees to support payment arrears amid the tax cuts. There were also foreign debt projects which were not provided for, parliament was told.
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By cutting taxes Sri Lanka has effectively jettisoned a policy plank of a three year IMF program that is now drawing to a close, based on so-called ‘revenue based fiscal consolidation, where many new taxes were imposed private citizens and the proceeds were given mostly as salary hike to state workers.
The projected deficit for 2020 at 7.9 percent would be the worst since 2015, when a newly elected administration ratcheted up subsidies, and hiked state salaries driving the deficit to 7.6 percent of GDP.
The central bank then cut rates and injected large volumes of money to keep overnight rates down, terminating term repo contracts triggering a currency crisis amid a strong recovery in domestic credit from an earlier collapse of the soft peg.
In 2018, the central bank cut rate and injected printed money to keep overnight rates down triggering monetary instability, despite new taxes bringing in more money and a freeze on state salaries, helping bring down the deficit steadily over two years to 5.3 percent of GDP.
The rupee then collapsed to 182 to the US dollar, triggering involuntary rate hikes and an output shock.
Economic output and revenues then fell, and election spending also went up. The IMF has said the 2019 budget deficit could rise to an estimated 6.2 percent of GDP, from a revised target of 5.7 percent, busting the final targets in a three year program.
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The central bank cut rates on January 30, to 7.5 percent from 8.0 percent, despite inflation hitting 5.4 percent, saying inflation will fall later.
Under a so-called highly discretionary ‘flexible’ inflation targeting’ framework the central banks cuts rates when inflation is low or high, but is then forced into involuntary rate hikes when the currency peg collapses.
State Credit
Private credit has so far been weak since the collapse of the soft-peg in 2018 from 153 to 182 to the US dollar, though a recovery is being seen.
Analysts have said that the economy tends to recover on its own about 18 month after each currency crises triggered by the soft-peg.
Sri Lanka’s Ceylon Electricity Board is going through a financial crisis, accommodating growing new demand with expensive thermal power, adding to losses at state enterprises.
President Gotabaya Rajapaksa has said he wants to make SOEs more efficient.
“The team welcomed the authorities’ plans to enhance the efficiency of state-owned enterprises, enabling them to operate on a sound commercial basis,” Goretti said.
“These plans would need to be supported by a visible commitment to strengthen governance and transparency, notably in the energy sector, and renewed efforts to tackle corruption.” (Colombo/Feb08/2020)