ECONOMYNEXT – Sri Lankan Finance Minister Basil Rajapaksa will present one of the most challenging budgets in the post-independence era on Friday (12) aiming to minimize the risk of sovereign default amid a public uproar about the government’s policies creating shortages of essentials.
The island nation’s economy is facing foreign exchange shortages from liquidity injections, an external debt crisis, weakened foreign inflows and a government revenue shortfall all at the same time.
The 81 billion US dollar economy’s credit ratings have been downgraded to CCC, just above default, by global rating agencies.
No Welfare
Finance Minister Rajapaksa has been tight-lipped on the budget, but signaled that it cannot be a welfare budget.
“We may have to take from the people,” he said when journalists asked what he was intending to give as relief to the people.
Finance Ministry officials have said the budget will have some policies to appease rural Sri Lankans, the backbone of the ruling Sri Lanka Podujana Peramuna (SLPP)’s vote base, who have been increasingly critical of the government for its failure to provide fertilizer on time.
The budget is unlikely to be an election-oriented one as the government is in the process of postponing both local government and provincial elections by one year, finance ministry officials said.
“It will focus on the environment, renewable energy, green initiatives, as well as small and medium enterprises,” one official told Economy Next.
Sources close to the finance minister said he had asked officials before the budget preparation if the country could go for a “zero deficit” budget in 2022.
Basil Rajapaksa’s swearing in as Finance Minister in July was seen as the arrival of a magician with an Aladdin lamp who can solve the looming crisis overnight.
Two month into office, the finance minister told the grim reality of the Sri Lankan economy to the parliament.
He conceded that the island nation was facing a severe external crisis as well as a domestic crisis with revenues falling and expenses continuing to rise.
Basil, the younger brother of both President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, will deliver his maiden budget and analysts expect that to be the first blueprint of the SLPP government which was forced to go with an interim budget in 2020 and pandemic-hit budget last year.
Growing Concerns
The central bank has printed excess money to keep interest rates near historic low despite a budget deficit in excess of 10 percent of gross domestic product that triggered forex shortages as soon as private credit recovered.
Import controls have failed to curb depletion of foreign reserves. Series of rating downgrades by all global rating agencies have deprived Sri Lanka of going for foreign borrowing.
Critics of the government doubt whether the budget can make a good enough change to get country out of the mess Sri Lanka is in.
However analysts say there are measures that can be taken.
The government needs to first focus on bringing down the budget deficit by raising taxes.
“The budget has to come up with some sort of a fiscal consolidation to reduce the budget deficit,” Dimantha Mathew, head of research, First Capital Equities (Pvt) Ltd told Economy Next.
“They will try to come up with some new taxes, maybe a Covid tax. The government is likely to reduce the threshold of taxable income.”
Mathew said the government will have to take measures if it wants to attract more foreign investments.
“All you need to do is improve the doing business index. We have a lot of issues over contractual execution.”
“We also need to float the currency, raise interest rates if we are to become competitive. How far can we go with a dollar interest rate higher than that of rupee?”
Other analysts said Basil Rajapaksa may target both banks and telecommunication industries, which are considered as cash cows for their higher profitability even during the pandemic.
Economic policy has improved recently with price controls being taken off items from milk to sugar to cement. The ending of price controls had ended shortages and queues for several goods.
However inflation is rising with the price of exported and imported goods going up with a weakened currency.
Amid forex shortages are cooking gas supplies have been sporadic. The government is provide adequate organic fertilizer for farmers to cultivate in the ongoing Maha season.
Prices of foods have skyrocketed since July including staple food and vegetables, making affordable foods luxury to even upper middle income families.
There have been warnings of food crisis in the first quarter of 2022 due to President Gotabaya Rajapaksa’s overnight decision to shift to organic fertilizer, while many small and medium enterprises have been already closed down hit by the pandemic, weak demand and import controls.
Rural farmers have started grumbling over the ruling Sri Lanka Podujana Partys stubborn decision on organic fertilizer, while importers and exporters have complained about the central bank’s foreign exchange management.
The rupee is sold nearly 15 percent higher in the kerb market than the official 200 to the US dollar rate.
Sri Lanka is also facing a risk of sovereign debt problems as it is unable tap bond markets due to high risk premium after a series of rating downgrades.
The government has vowed to face the risk of heavy external debts without seeking International Monetary Fund (IMF) assistance, though the global fund manager expects Sri Lanka to go for the ultimate lender given its precarious financial situation.
Foreign Inflows
Sri Lanka has about 4-5 billion US dollars of central government borrowings to repay each year. Stronger foreign inflows will make it easier to repay maturing foreign debt and avoid a rise in rates.
Government officials have said the government annually needs at least 2.5 billion US dollar additional inflow to manage its foreign borrowings through 2026.
The island nation has to repay a 500 million US dollar sovereign bond in January next year and another 1 billion US dollar in July.
Central Bank Governor Ajith Nivard Cabraal has planned over 25 billion US dollar inflow including from exports of goods and services, remittances, and tourism in the six months through March next year.
Covid-Lockdown has hit tourism and remittances through official channels have also diminished with parallel markets offering higher rates. Tourism is starting to limp back.
Analysts expect the government to have some policies on certain sectors in the budget that would help boost foreign investments into the country.
“It should be an investment friendly, pro-private sector job creation budget and it should target to attract foreign investments,” Danushka Samarasinghe, director at Nations Lanka Equities said.
“So the way out for Sri Lankan from the current difficult position is to divest ownership (minority stake to controlling stake) of state owned enterprises. Power, port, and property sector reforms could be key magnets to attract foreign investment.”
Sri Lanka’s budget this year is likely to look into the strategic interests of foreign countries as well as the country needing dollar inflows to boost its reserves, another analyst said.
President Gotabaya Rajapaksa’s government, which has been seen as a Chinese-friendly government, has said it was ready to work with any foreign countries for the benefits of Sri Lanka. (Colombo/Nov11/2021)