Sri Lanka - Political and Economic Update

National Budget - March 2019

2019 Budget – Summary

The Minister of Finance presented the 2019 National Budget to the Sri Lankan parliament on 5th March.

The government is projecting a budget deficit for 2019 equivalent to 4.4% of GDP, with a further decline to 3.5% of GDP in 2020.  These deficits, if achieved, would be the lowest since the late 1970s, and compare to an expected deficit for 2018 of 5.3% GDP.

The government’s projections assume an increase in real GDP of 3.5% in 2019 and of 4% in 2020.

In order to achieve its objectives, the government is proposing to raise tax revenue to 13.3% of GDP in 2019 (11.9% in 2018) and to 14.2% of GDP in 2020.   The chief revenue raising measures are an increase in excise duty and luxury tax on motor vehicles, an increase in excise duties on cigarettes and liquor, and an increase in customs duty on the same.  These and other measures are expected to raise tax revenue by 21.3% YoY in 2019 and by 16.5% in 2020.

Government expenditure is expected to rise from 19.4% of GDP in 2018 to 20.2% of GDP in 2019 and 20.3% of GDP in 2020.  Within this, investment spending is expected to rise by 21% YoY to 4.8% of GDP in 2019 and by 7.3% in 2020.  Recurrent expenditure is expected to increase by 10.7% YoY in 2019 to 15.5% of GDP, and by 10.2% in 2020 to 15.7% of GDP.  The items contributing most to the rise in revenue expenditure are increases in public sector salaries and public sector pensions.

Debt to GDP is estimated to have been 84% of GDP at the end of 2018.   On the government’s projections, it is forecast to decline to 83% of GDP in 2019 and to 70% of GDP in 2022.

Implications for foreign investment

There are a number of changes in the budget which are designed to encourage further foreign investment into Sri Lanka:

  • Tax deductions/exemptions for foreign direct investors in three scale bands –
    • Mid-size investments >$50mn: 100% annual income tax deduction for first 10 years of commercial operations; exemption from certain up-front taxes (Nation Building Tax, Port and Airport Development Levy, Cess, Duty etc.) until the commencement of commercial operations.
    • Investments >$100mn, <$1bn: 150% annual income tax deduction for first 10 years of commercial operations; exemption from the same up-front taxes until the start of commercial operations.
    • Investments > $1bn: dividend tax to be charged at a zero rate to non-residents during the period in which dividends are paid out of profits sheltered by enhanced capital allowances.
  • Reduction in the Economic Service Charge for export sectors from 0.5% to 0.25% of liable turnover
  • Royalty payments and rent payments of up to Rs. 50,000/month (approx. $3,400/year at the current exchange rate) each are to be exempt from WHT.

The government has indicated it will be further developing the National Export Strategy and the Export Market Access Programme, and that it will be supporting the construction of the Bingiriya and Wagawatte Industrial Zones outside Colombo.

In addition to the above, certain income tax exemptions are being introduced to encourage non-resident investments in sovereign bonds, and also loans made by non-residents to individuals in Sri Lanka.

IMF provisionally agrees to extend the Extended Fund Facility for another year

At the end of February, the IMF announced that its staff have completed their latest review of the economic reform program under the Extended Fund Facility (EFF).

Subject to Board approval, they have agreed to extend the EFF arrangement for an additional year.

Assuming a 2019 Budget consistent with the EFF-supported programme, the IMF Board is expected to consider Sri Lanka’s request for the completion of the EFF review in May 2019.

IMF’s latest comments on the Sri Lankan economy

Commenting on the status of the economy, the IMF reported that the economy is gradually stabilising after the recent political uncertainty.

Real GDP growth is expected to improve to about 3.5% YoY in 2019, from 3% in 2018.  Inflation is projected to reach 4.5% YoY in 2019.

The current account, which widened to 3.2% of GDP in 2018 on the back of higher fuel prices, lower agricultural exports and a surge in imports of vehicles, is expected to narrow in 2019 as it benefits from the correction in the exchange rate.

The primary fiscal surplus fell short of targets in December, largely due to weak revenues, and the foreign exchange reserve target was missed by a sizeable margin.  This is ascribed to tight global financial conditions, exacerbated by the political crisis at the end of last year.

In its press release, the IMF team welcomed the authorities’ commitments to raise the primary surplus to 1.5% of GDP in 2019 budget and to put the high public debt on a downward path, bringing the fiscal deficit to 3.5% of GDP in 2020 and to 2% of GDP over the medium term.

In terms of specifics, the IMF team has made the following recommendations:

  • Renewed efforts to improve the transparency, accountability and cost-efficiency of large state-owned enterprises – in particular, bringing Sri Lankan Airlines on to a sound footing, and completing energy price reforms
  • Support for the central bank’s commitment to rebuild reserve buffers and to allow exchange rate flexibility to protect the economy against shocks
  • A need for the central bank to maintain a prudent and data-dependent monetary policy, standing ready to raise interest rates should inflationary pressures re-emerge.
  • A need to strengthen the central bank’s mandate, autonomy, accountability and transparency through amendments to the Monetary Law Act
  • Ongoing steps to strengthen financial sector stability through efforts to harmonise the regulatory and supervisory regimes and to strengthen the crisis-preparedness toolkit for financial institutions.
  • Continuing structural reforms to support strong and inclusive growth by promoting trade openness and investment, strengthening the governance and anti-corruption framework, encouraging female labour force participation, and enhancing social protection and preparedness against natural disasters.

The full text of the IMF’s press release may be seen using the following link:

https://www.imf.org/en/News/Articles/2019/02/28/sri-lanka-pr1963-imf-reaches-staff-level-agreement-on-the-5th-review-of-sri-lankas-eff