ECONOMYNEXT – Sri Lanka’s 15 percent revenue target in 2025, can be achieved and the deficit may be better than expected depending on the rollout of capital expenditure, but in the long term remains challenging, Fitch Rating has said.
“Fitch believes the goal is achievable, given revenue-raising measures already announced and implemented,” the rating agency said in a statement.
“However, it will depend heavily on a smooth liberalisation of import restrictions, notably for vehicles.”
“There remains a risk that the authorities could look to slow that process if higher imports weaken Sri Lanka’s external stability, for example by eroding foreign-exchange reserves.”
Flawed OF
Sri Lanka has import control due to a flawed operating framework of the central bank and tendency to cut rates with inflationary open market operations, without regard to domestic credit or the balance of payments critics have pointed out.
Though foreign reserves are not expected to be used for trade, credit from liquidity injections lead to reserve erosion as the new money is used by banks to give loans without deposits triggering excess imports.
In December, imports soared to crisis level highs, without cars.
Analysts have also warned that a so-called single policy rate, has the same risks as the mid-corridor targeting did from 2025, where excess liquidity triggers re-finance credit through a so-called abundant (rupee) reserve system.
Analysts have called for the operation of a strict scarce reserve system so that Sri Lanka can meet IMF fx reserve targets and instead of selling down monetary foreign assets reserves through private imports made from credit re-financed by inflationary open market operations.
Meanwhile Fitch said the medium-term fiscal outlook for Sri Lanka remains challenging, and revenue growth is likely to slow sharply from 2026, unless additional policies are introduced.
“The deficit could be smaller than the government expects if implementing such a large capex increase proves difficult,” Fitch said.
Fich said Sri Lanka’s medium-term growth prospects would be impeded if public capex remains at the low levels seen in 2024 of about 2.7 percent of gross domestic product, despite several measures announced in the budget could lift private investment in export-oriented sectors and infrastructure.
The full statement is reproduced below.
In the longer term weak infrastructure could hurt growth.
The full statement is reproduced below:
Sri Lanka’s Revenue Raising Drive Key to Credit Profile
Wed 19 Feb, 2025 – 2:32 AM ET
Fitch Ratings-Hong Kong-19 February 2025: The Sri Lankan government’s budget highlights the authorities’ commitment to raising fiscal revenues as a share of GDP – an approach that, if successful, would alleviate a long-standing weakness in the sovereign’s credit profile, says Fitch Ratings.
Nonetheless, risks to the fiscal outlook remain significant, and plans to slow the pace of fiscal consolidation could weigh on prospects for debt reduction over the medium term.
The budget, unveiled on 17 February, is the first since President Anura Kumara Dissanayake of the Janatha Vimukthi Peramuna (JVP) was elected in September 2024, and provides greater clarity over the administration’s medium-term fiscal and economic reform agenda.
We view most of the budget announcements as being consistent with our assumptions made during our December 2024 assessment, when we upgraded Sri Lanka’s rating to ‘CCC+’, from ‘RD’ (Restricted Default). The provisional budget deficit outturn of 6.8% of GDP in 2024, for example, was in line with Fitch’s expectations.
The government’s goal of raising revenue/GDP to 15.1% in 2025, from 11.4% in 2023, would exceed our assumptions that the 15% threshold would only be achieved by 2026. The budget incorporates a 36.5% increase in revenue from taxes on external trade and a 13.1% increase in revenues from income taxes.
Fitch believes the goal is achievable, given revenue-raising measures already announced and implemented. However, it will depend heavily on a smooth liberalisation of import restrictions, notably for vehicles.
There remains a risk that the authorities could look to slow that process if higher imports weaken Sri Lanka’s external stability, for example by eroding foreign-exchange reserves. The medium-term fiscal outlook for Sri Lanka remains challenging, and we believe revenue growth is likely to slow sharply from 2026, unless additional policies are introduced.
Sri Lanka’s public finances remain fragile, and the budget projects a slowing of fiscal consolidation, with the deficit falling only to 6.7% of GDP in 2025. This reflects sharply higher spending on public capex (up by 61%), as well as increases in salaries and wages (up 12%) and subsidies (up 11%).
The deficit could be smaller than the government expects if implementing such a large capex increase proves difficult. However, we believe Sri Lanka’s medium-term growth prospects would be impeded if public capex remains at the low levels seen in 2024 (2.7% of GDP), even considering other measures announced in the budget that have the potential to lift private investment in export-oriented sectors and infrastructure.