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Sri Lanka eyes 8.5-pct of GDP deficit in 2020, Rs440bn revenue loss after stimulus

ECONOMYNEXT – Sri Lanka is planning a budget deficit of 8.5 percent of gross domestic product in 2020 up from 6.8 percent a year earlier and a revenue loss 440 billion rupees following tax cuts, while capital expenses will be slashed, finance ministry data shows.

Sri Lanka is expecting tax revenues to fall 429 billion rupees to 1305 billion rupees and non-tax revenues by 11 billion rupees to 145 billion rupees, taking total revenues down 440 billion rupees to 1,450 billion rupees according a draft budget published by the finance ministry.

As a share of GDP total revenues will fall to 9.2 percent from 12.5 percent.

Sri Lanka’s parliament has not passed a budget for 2020 and spending allocations are made periodically under presidential authority.

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Sri Lanka slashed taxes in 2020 in a fiscal ‘stimulus’ and the central bank followed with rates cuts and liquidity injections triggering forex shortages and leading to a rating downgrade as fears rose over the ability to repay foreign debt.

The fiscal and monetary ‘stimulus’ which came on top of a currency collapse in 2018 which slowed the economy will drive the current account and overall deficits to record levels.

Pro-Cyclical Instability

The 2018 currency collapse and subsequent slowdown came from a pro-cyclical monetary ‘stimulus’ in April and July 2018 in the form of rate cuts and liquidity injections just as the economy was recovery from a previous currency crisis.

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Unlike floating rate reserve currency central banks which trigger asset price bubbles, pegged exchange rates trigger currency crises when they print money. Output shocks are followed in both cases.

The finance ministry is hoping to keep current spending at 2,362 billion rupees, up from 2,301 billion rupees, or 15.3 percent of GDP from 15.3 percent.

The revenue deficit however will rise to a new record of 912 billion rupees or 5.8 percent of GDP.

The Treasury is also expecting slash capital spending 177 billion rupees 437 billion rupees or to 2.8 percent of GDP from 4.1 percent.

The government will review a 9 billion US dollar debt pipeline “and re-profile it by advancing urgent projects, canceling those that will not generates an adequate return financially or economically while differing certain projects that needs to be undertaken later,” the finance ministry said.

“The government will also take into account the exposure to foreign currency and the terms of the loan including the cost of financing and the tenure.

“At the same time some of these projects will be implemented through equity investments rather than through debt finance.

“This will support the government to rationalize its debt stock while also ensuring assets creations without elevated level of indebtedness.”

Sri Lanka will not build new state buildings and current spending has also been tightened by stopping the purchase of vehicles.

The finance ministry said 2020 cash flows would be further hit from arrears carried over from 2019.

The overall deficit will rise to at least 8.5 percent of GDP from 6.8 percent a year earlier or a record 1,341 billion rupees from 1,016 billion a year earlier.

Rising Debt, Monetary Instabilty

Sri Lanka is expecting to raise 491 billion rupees from foreign financing, up from 363 billion rupees a year earlier.

Domestic financing is expected to rise to 850 billion rupees from 654 billion rupees a earlier.

The central government debt which rose to 86 percent of GDP in 2019 from 83 percent a year earlier, is expected to further rise to 92.4 percent in 2020, according to finance ministry projections.

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The debt has been rising partly due to currency collapses, which inflated foreign debt and killed domestic purchasing power, slowing the economy.

The monetary stimulus coming from liquidity injections triggered the currency collapse despite overall deficit being brought down to 685 billion rupees from 760 billion a year earlier or to 4.6 percent of GDP from 5.3 percent.

“Central banks that operate in developing countries have poor records,” economist Steve Hanke writes in the Spring/Summer 2020 Cato Journal.

“They are frequently the source of “high” inflations or hyperinflations. Currency and banking crises are also commonplace in developing countries with central banks.

“Fiscal deficits and debt levels are relatively high in these countries, too. These elevated debt levels often lead to sovereign debt defaults because borrowing is typically in debt that is denominated in a foreign currency.

“Not surprisingly, capital and exchange controls are prevalent. And if all this is not bad enough, developing countries with central banks typically experience unstable growth because their central banks engage in procyclical monetary policies.”

In 2018 as the budget deficit was brought down the central bank printed 246 billion rupees data show, first to generate excess liquidity and then to sterilize outflows a runs were triggered on the rupee.

In 2019 – mostly in the first hLF of the year, the reverse happened amid weak private credit, bringing some kind of monetary stability though the fiscal deficit expanded.

There have been calls to reform the central bank and restrain its domestic operation department in bid to avoid sovereign defaults and further currency collapses. In 2020 Sri Lanka is also planning to re-finance banks loans with 150 billion rupees of central bank credit.

Sri Lanka has contained the spread of Coronavirus and saved spending on healthcare though there were lockdowns up to May which had further slowed economic activity and revenues. (Colombo/June09/2020 – Updated graphic)