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Monday April 15th, 2024

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.

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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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Iran President to visit Sr Lanka on April 24 anid rising tension, inaugurate Omaoya power project

ECONOMYNEXT – Iranian President Ebrahim Raisi will arrive in Sri Lanka on April 24 on a one-day official visit to inaugurate Tehran-assisted $529 million worth Uma Oya multipurpose development project with 120MW hydro power generation capacity, official sources said.

The announcement on President Raisi’s visit comes two days after Iran launched explosive drones and fired missiles at Israel in its first direct attack on Israeli territory, a retaliatory strike that raised the threat of a wider regional conflict.

“The President is visiting to inaugurate the Omaoya project. He will be on a one-day visit,” an official at Iran embassy in Colombo told EconomyNext.

A Sri Lankan Foreign Ministry official confirmed the move.

This is the first time an Iranian President coming to Sri Lanka Iranian after then President Mahmoud Ahmadinejad’s visit in April 2008.

The Omaoya project was originally scheduled to be completed in 2015, but had been delayed several times due to unexpected issued faced during the project cycle and funding issue after the United States imposed economic sanctions on Iran and economic crisis in Sri Lanka.

The project was started in 2010 and the funding was to be received as loan grant from the Iranian government. However, Iran was able to provide $50 million before the sanctions. Sri Lanka has to bear the cost after the sanctions.

The project includes storing water in two reservoirs with dams before being brought through a 23 km tunnel to two turbines located underground and generating hydro power with a capacity of 120 megawatts and added to the national grid.

After power generation, the water is expected to be brought to three reservoirs while supplying water to 20,000 acres of old and new paddy fields in both the Yala and Maha cultivating seasons.

The Memorandum of Understanding (MOU) for the construction was signed between the two countries in 2007 while Sri Lanka’s Cabinet approved the execution of the contract agreement between the Executing Agency, Sri Lanka’s Ministry of Irrigation and Water Management (MOIWM) of the GOSL and Iran’s FARAB Energy and Water Projects (FC).

When commencing the project on March 15, 2010, the scheduled date of completion of the project was on March 15, 2015. But the schedule completion date was extended to December 31, 2020 due to the unexpected water ingress into the head race tunnel and followed by social impacts.

The trade between the both countries suffered after the US sanctions. However, Sri Lanka inked a deal in December 2021 with Iran to set off export of tea to Iran against a legacy oil credit owed by state-run Ceylon Petroleum Corporation to the National Iranian Oil Company.

Sri Lanka owes $251 million for crude imported before the US imposed sanctions on Iran. (Colombo/April 15/2024)

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Sri Lanka to discuss two contentious points with bondholders: report

ECONOMYNEXT – Sri Lanka and sovereign bondholders are to discuss two matters in the near future which the two sides failed to reach agreement at March talks in London, a media report quoting a top aide to President Wickremesinghe as saying.

Sri Lanka and bondholders had discussed four matters on restructuring international sovereign bonds in late March and agreement had been reached on two, President’s Chief of Staff Sagala Ratnayake was quoted as saying on state-run ITN television.

A restructuring proposal by bondholders was not in line with IMF requirements, and Sri Lanka had sent a counter proposal, he said.

The matters will be discussed at round of talks in the near future.

Sri Lanka was optimistic of reaching an agreement with the bondholders before June, officials have said.

According to matters already in the public domain, sovereign bond holders are keen to get a bond tied to dollar gross domestic product, as they feel IMF growth projections are too low.

In past re-structuring so-called value recovery instruments, a type of warrant, gave their owners extra payments if a country did better than expected and were tied to items like oil prices.

Bondholders had initially proposed bond which would have a lower hair cut initially, and it will have additional hair cuts if growth is low (about 3.1 percent) as projected in an IMF debt sustainability analysis. (Colombo/Apr15/2024)

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BIMSTEC Secretary General visits Sri Lanka, discusses regional cooperation

ECONOMYNEXT – The Secretary General of the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC), discussed measures to enhance regional cooperation, during his visit to the island last week.

Ambassador Indra Mani Pandey, Secretary General of BIMSTEC visited Sri Lanka from 07 – 12 April 2024, following his assumption of office as Secretary General of BIMSTEC in January this year.

The Secretary General “met with senior officials of relevant Ministries/Agencies to discuss measures to enhance regional cooperation under various BIMSTEC initiatives,” the Foreign Ministry said in a statement.

Several BIMSTEC countries have bilateral trade agreements, such as Sri Lanka and India, Thailand and Myanmar, Sri Lanka and Thailand, but no collective regional agreement to enable intra-regional leverage.

During the visit, Secretary General Pandey held discussions with Ministry of Foreign Affairs officials and paid courtesy calls on the President and the Minister of Foreign Affairs.

Secretary General Pandey participated at an event on “Regional Cooperation through BIMSTEC” organized by the Lakshman Kadirgamar Institute (LKI) on 9 April. (Colombo/April15/2024)

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