Sri Lanka revenue reform, step towards stronger finances – Fitch
View(s):Sri Lanka’s budget for 2017 is broadly in line with the targets set out under its IMF programme, and contains a number of positive measures to boost the very weak revenue base, Fitch Ratings said in a media release this week.
However the agency said it believes the impact of the revenue reforms will depend on implementation with some of the budget assumptions which look optimistic, posing risks to the projections.
The 2017 budget targets a fiscal deficit equivalent to 4.6 per cent of GDP, down from an expected 5.4 per cent in 2016 and 7.4 per cent in 2015, when the deficit widened mainly as a result of sharp public sector wage rises. Fiscal consolidation will be helped by tax reforms that should go some way to bolstering the weak revenue base, which is a key reason for the sovereign’s weak fiscal finances.
Fitch said the reforms include a hike in the VAT rate from 11 per cent to 15 per cent, along with tax measures announced in the budget such as a 10 per cent capital gains tax that is scheduled to be introduced next year and an increase in the top personal income tax rate. The government also expects to generate more revenue from the simplification of the tax system and removal of some tax exemptions and concessions. The government projects that revenue will increase by close to 27 per cent in 2017, pushing the revenue/GDP ratio up to nearly 15 per cent of GDP from an estimated 12.9 per cent in 2016.
“Fitch views the new measures as a positive step, but there is a risk of a shortfall. The impact of the tax reforms will hinge on effective implementation. Moreover, the government’s GDP growth forecast for 2017 of between 6 per cent 7 per cent is higher than what Fitch believes is likely, given the expected drag from fiscal consolidation. Our growth forecast for 2017 is around 5 per cent,” it said.
Efforts to restrain expenditure growth next year appear limited. Salaries and wages are to be increased at a less rapid pace than in 2016, but nominal expenditure is still forecast to grow by 17 per cent to finance an ongoing infrastructure drive and meet the rising cost of debt servicing and subsidies. Fitch said it expects spending may be cut back in the event that revenue disappoints.
The government has a medium term target of reducing the budget deficit to 3.5 per cent of GDP by 2020, which is aligned with the IMF programme. It expects to achieve this deficit reduction mainly through a combination of further tax reform and efficiency gains in public expenditure. Some of the revenue measures announced in the 2017 budget are part of this medium term fiscal strategy, the release noted.