Sri Lanka tax cuts can boost demand, but create instability later: ICRA Lanka

ECONOMYNEXT – A series of tax cuts may boost demand in the short term but could generate instability later, unless revenues were boosted to avoid monetary financing leads to currency weakness, ICRA Lanka, a rating agency has said.

“Whilst acknowledging the potential boost to the aggregate demand and corporate profitability from the fiscal stimulus in the short-run, ICRA Lanka believes Sri Lanka should broaden the tax base and continue fiscal consolidation to avoid macroeconomic instability to benefit from the tax buoyancy effect,” ICRA Lanka said in a statement.

“Reduction in tax revenue is highly unlikely to be compensated by raising non-tax revenue in the short-run, therefore we expect government may consider raising some taxes to counterbalance the loss in revenue.

“Furthermore, increasing profitability of SOEs can also improve non-tax revenue.”

Raising revenue to reduce the deficit is vital, so that monetary financing of which leads to currency
weakness is avoided, the rating agency said.

“The impact of the fiscal stimulus on the economy cannot be looked at in isolation,” ICRA Lanka said.

“Given Sri Lanka’s external debt obligations scheduled for 2020 (US$ 3.7 Bn) and beyond, strengthening of rupee is required for reserve accumulation.

“More government revenue means lesser requirement for monetary financing consequently preserving the value of the currency.

ICRA said expenses such as salaries and subsidies were inflexible, and could not be cut. Interest costs were also large and there was a gap in the current account of the budget.

The ending of the fuel price formula would also increase risks, the rating agency said.

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“Reducing the transfers to households will be difficult, but by improving the efficiency of public institutions and corporations, the government can reduce the cost of transfers to State Owned Enterprises (SOEs),” ICRA said.

“In this context, ICRA Lanka feels that government’s commitment to fiscal consolidation can be seriously undermined by a move such as removing fuel price formula.” (Colombo/Dec10/2019)

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