SL budget highlights ongoing fiscal challenges, unlikely to significantly boost growth –Moody’s

Despite the growth focus of Sri Lanka’s 20201 budget, it is unlikely to provide a meaningful boost to output, while increased spending will add to fiscal pressures, which is credit negative, Moody’s, a global rating agency, said in a statement on Monday. 
The budget targets a 2021 fiscal deficit of 8.8 per cent of GDP, compared with a revised 2020 estimate of 7.9 per cent of GDP. 
“We forecast a similar gap for 2021, but for the deficit to remain above 8 per cent of GDP through 2023 in light of persistently adverse fiscal dynamics and a slow economic recovery. As such, we expect Sri Lanka's debt burden to increase to around 100 per cent of GDP over 2020-21, above the Caa-rated median of 88 per cent of GDP, and only begin to gradually decline in subsequent years. We expect the government to face challenges in rationalizing government spending and delivering fiscal consolidation post-coronavirus, as a large interest bill, rigid public sector wages, and subsidies and transfers keep recurring government spending elevated. The dilemma between delivering on ambitious fiscal consolidation targets and supporting economic recovery will continue to weigh on Sri Lanka's credit profile ahead of significant and recurring external debt-servicing requirements through 2025,” it said. 

Economic boost from budget will be limited.

The budget includes large allocations for domestically financed infrastructure development, incentives for domestic production, support for small and medium-sized enterprises and upgrading Sri Lanka's rural road networks, to which the largest portion of public investment spending has been allocated. It also includes scaled-up support to the tourism industry, which has taken a severe hit given the country's border closures. 
But despite the focus of the development-oriented budget on reviving economic growth and reducing poverty, the benefits will be limited by the magnitude of the pandemic-driven hit to demand for Sri Lankan exports and the collapse in tourism activity. Domestic demand is also likely to remain sluggish given still-subdued business and consumer confidence, and ongoing import restrictions affecting industries such as construction and manufacturing. 
Moody’s said it expects Sri Lanka's economy to contract by more than 3 per cent in 2020, with prospects for a gradual rebound in 2021 increasingly at risk given renewed virus flare-ups and lockdown measures globally. The plan to support domestically financed infrastructure projects may also face funding constraints as a weak economic recovery curbs revenue and as rigid recurrent expenditure is difficult to rationalize. 
The budgetary allocation for public investment has increased to Rs.1.1 billion, up more than 55 per cent from government estimates for 2020 spending. Even as the government begins to digitalize government systems and processes, including procurement, and implement reform of state-owned enterprises, these reforms will not meaningfully consolidate public expenditure. On the revenue side, the budgeted 28 per cent increase in government revenue compared to 2020, largely stemming from robust growth in taxes on goods and services, and external trade, is unlikely to be achieved. 
A recovery in demand for Sri Lankan exports in 2021 is increasingly at risk given the uneven economic trajectory in major markets like the US and Europe. While the budget introduces some modest revenue-enhancing measures, including simplification of capital gains taxes and implementation of an e-filing system, “we do not expect stronger economic growth alone to rebuild Sri Lanka's revenue base, from an already narrow position”, the statement said.
Revenue-to-GDP has steadily declined from 14.1 per cent of GDP in 2016 to an estimated 9.5 per cent of GDP in 2020, an outcome of a multi-year period of sluggish economic growth, weak tax administration implementation, and rate changes, including the December 2019 value added tax cuts, which the government has committed to maintaining over the next five years.

Fiscal consolidation challenges could hinder finance raising needs. 

The risks clouding the near-term economic recovery and obstacles around fiscal consolidation are likely to pose hurdles to achieving ambitious targets, especially putting the government's debt-to-GDP ratio on a more sustainable, downward path. A bleaker outlook for fiscal consolidation is likely to continue to challenge the government's ability to raise financing for upcoming debt obligations and narrow annual borrowing needs, which in 2021, externally, amount to approximately $4 billion. 
“Borrowing needs will stay elevated through 2025, including a large portion of maturing international sovereign bonds. Elevated repayment risks will continue to raise pressure on the government's external and liquidity position as the recovery in major sources of foreign exchange earnings is likely to be slow, keeping the country's international reserves position thin,” Moody’s said.