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Sunday March 26th, 2023

Sri Lanka budget 2022: 9.8-pct of GDP deficit to be funded locally, repeats windfall taxes

ECONOMYNEXT – Sri Lanka is planning to finance a 9.8 percent of gross domestic product budget deficit or 1,807 billion rupees domestically and has continued a policy of deadly retrospective windfall taxes started by the failed 2015 administration in a budget for 2022.

The budget also returned to a cascading 2.5 percent turnover tax, whimsically calling it a ‘social security contribution’, in trying to reverse a policy error involving a steep valued added cut in 2019 to create what policy makers call a ‘production economy’ which is said to exist elsewhere.

The VAT cut devastated state finances and led to severe monetary instability, and an external crisis involving possible sovereign default as the central bank tried to keep rates down in the face of the deficit by printing money.

The tax cuts as well as the attempt to keep rates down despite the deficit has led to cascading policy errors involving import controls, exchange controls and forex surrender requirements as well as the seeking of credit lines for consumption imports which tend to push up external debt.

In 2021 revenues is estimated to have recovered 13.3 percent to 1,556 billion rupees from 1,373 billion rupees. However revenues are were still down from 1,890 billion in 2019 when the VAT framework was intact.

The overall deficit for 2021 had been revised up to 1,826 billion rupees or 11.1 percent of GDP in the budget.

Going by past experience the final deficit tends to go up from what is presented in the budget.

Current spending at 2,817 billion rupees in 2021 is estimated to have come down to 17.1 percent of GDP from 17.8 percent in 2020.

Current Expenditure

Sri Lanka’s current spending had ratcheted up to over 17 percent of GDP from 12.2 percent in 2014 when the disastrous ‘revenue based fiscal consolidation’ debacle started in 2015 throwing spending based consolidation out of the window hiking subsidies and salaries.

Politicians were led to believe by the International Monetary Fund among others, that there were large volumes of untaxed money just waiting to be plucked via ‘revenue based fiscal consolidation’.

Classical economist B R Shenoy has said ‘revenue based fiscal consolidation’ is a ‘statistical’ method of balancing budgets which is not founded on the political realities of democracies, and will devastate the private savings available for investment and future growth.

The budget for 2021 at least has made token gestures towards cutting spending, including a freeze on salaries except teachers who have agitated and won a 30 billion rupees pay rise.

Finance Minister Basil Rajapaksa also promised to enact legislation to stop supplementary estimates, or midway increases in spending which may legally block further salary hikes.

Rajapaksa, who of late has displayed a tendency to speak plainly of late said the public sector was an unbearable (uhu-lun-ner barry) burden on other sectors.


Sri Lanka public sector ‘unbearable burden’: Finance Minister

The public sector has been bloated by unemployed graduates in a policy driven by the Janatha Vimukthi Peramuna in 2004, and was latched on to the Sri Lanka Freedom Party led coalition and has been continued ever since.

Tax Policy Reversal

After severely undermining the Value Added Tax regime with the 2019 cuts, the current budget is trying to shore up revenues by resorting to a new cascading Social Security Contribution.

Sri Lanka tried to end cascading turnover taxes with the introduction of GST/Value added taxes in the mid 1990s, but bureaucrats keep bringing them back.

Cascading taxes tend to give high tax yields while adding to end prices and undermining export competitiveness.

The budget has also continued a policy started in 2015 of charging retrospective windfall taxes from large companies, calling it a ’25 percent surcharge’.

The 2015 budget as part of efforts to bridge the 100 day program heedless spending, brought it a windfall tax labeling it a ‘super gains tax’ starting a new deadly trend in regime uncertainty.

Several rent-seeking import substitution business had made actual windfalls in 2021, exploiting consumers under cover of import controls, analysts say.

Windfall taxes are now being shown to be a habit.

Other than the windfall tax, which is expected to destroy 100 billion rupees of investible capital in 2021, no other investment destroying income taxes have been increased.

However both taxes will go some way to bridge the deficit, which is required to help bring some stability to state finances and the external sector by reducing the corrective interest rates that is required in 2022 to prevent a monetary meltdown and default.

Domestically Financed

The 2022 budget is planning a 8.8 percent budget deficit or 1,658 billion rupees, down from an 1,826 billion rupee or 11.1 percent deficit in 2021 which is still not final.

The 2021 deficit was financed with 962 billion rupees in printed money of which 331 billion rupees was absorbed in a reserve money expansion and inflation and the rest went out in a balance of payments deficit.

According to revised estimated a deficit of 1,874 billion rupees or 11.4 percent of GDP was financed domestically with 48 billion rupees being repaid on a net basis on foreign borrowings.

In 2022, the finance ministry is expecting to repay 179 billion rupees in foreign borrowings pushing up the domestic borrowings 1,807 billion rupees, which is one percent of GDP higher than the 8.8 percent deficit.

The 9.8 percent number is under 10 percent, but Sri Lanka has a history of exceeding projected deficits.

The interest bill for 2022 is projected at 1,115 billion rupees up from 1,055 billion in 2021. Analysts expects 2022 to require higher interest rates to fix the external crisis and end money printing.

However there may be room to cut capital spending. It is also not clear whether the planned land sales are including in non-tax revenues and how it may help the budget.

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Sri Lanka seeks to settle India ACU debt, credit lines over 5-years

ECONOMYNEXT – Sri Lanka has requested India to settle payments due to the country under the Asian Clearing Union mechanism and credit lines given in 2022 over 5 years, Indrajit Coomaraswamy, an advisor the island’s government said.

Sri Lanka is negotiating with India to settle the money over a 5-year period, Coomaraswamy, a former central bank governor told an online forum hosted by the Central Bank.

“Our request from the Indians is to settle it over five years,” he said. “That I think is still in the early stages of negotiation. The same with the one billion line of credit.”

Sri Lanka’s central bank owed the ACU 2.0 billion US dollars to the Asian Clearing Union according to a year end debt statement, issued by the Finance Ministry.

Sri Lanka owned India, 1,621 million dollars according to ACU data by year end, excluding interest.

India has given a 1 billion US dollar credit line to Sri Lanka as well a credit line for petroleum.

Sri Lanka in March 2024 has paid 121 million US dollar out of a 331 million US dollar IMF tranche to settle an Indian credit line.

Indian credits were given after the country defaulted in April 2022 as budget support/import when most other bilateral lenders halted giving money. (Colombo/Mar26/2023)

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Sri Lanka coconut auction prices up 1.16-pct

ECONOMYNEXT- Sri Lanka’s coconut auction prices went up by 1.16 percent from a week ago at an auction on Thursday, data showed.

The average price for 1,000 nuts grew to 83,219.45 from 82,260.58 a week earlier at the weekly auction conducted by Sri Lanka’s Coconut Development Authority on March 23.

The highest price was 92,500 rupees for 1,000 nuts up from the previous week’s 90,600 rupees, while the lowest was 76,500 also up from 70,000 rupees.

The auction offered 900,010 coconuts and 583,291 nuts were sold. (Colombo/Mar 26/2023)

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Sri Lanka in talks for billion dollar equivalent Indian rupee swap

ECONOMYNEXT – Sri Lanka is in talks with India for a billion US dollar equivalent Indian rupee central bank swap, to facilitate trade, Indrajit Coomaraswamy, ad advisor to the government said.

“The amount is still uncertain it could be up to the equivalent of a billion US dollars,” Coomaraswamy told an online forum hosted by Sri Lanka’s central bank.

The money will be used to facilate India Sri Lanka trade, he said.

India has been trying to popularize the use of Indian rupees for external trade and also encouraged Sri Lanka banks to set up Indian rupee VOSTRO accounts.

However the first step in popularizing a currency for external trade is to get domestic agents, especially exporters, to accept their own currency for trade, like in the case of the US or EU, analysts say.

India’s billion US dollar credit to Sri Lanka given during the 2022 crisis is settled in Indian rupees (transaction need).

However the Indian government itself has chosen to denominate it in US currency for debt purposes (future value).

In most South Asian nations, receivers of remittances are willing to accept domestic currencies, leading to active VOSTRO account transactions.

Sri Lanka is expected to repay a 400 million US dollar swap with the Reserve Bank of India next year under an International Monetary Fund backed program for external stability and debt re-structuring.

Central bank swap proceeds sold to banks, which are then sterilized with inflationary open market operations, can trigger forex shortages and currency crises, analysts warn.

Sri Lanka went to the International Monetary Fund after two years of inflationary monetary operations by the central bank’s issue department (money printed to suppress interest rates) triggered the biggest currency crisis in its history and external sovereign default.

Sri Lanka had gone to the IMF 16 times with similar external troubles except for the April 2003 extended fund facility under Central Bank Governor A S Jayewardene which was a purely reform-oriented program with the World Bank (PRGF/PRSP) program at a time when he was collecting reserves with deflationary monetary policy and perhaps the lowest inflation since the Bretton Woods collapsed. (Colombo/Mar26/2023)

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