Govt to increase revenue generation in 2022 Budget revision

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The International Monetary Fund (IMF) is likely to urge Sri Lanka to undertake further reforms in their revenue structure to exclude domestic debt from the restructuring process, a senior government spokesman told Finance Today.

That the domestic debt of Sri Lanka may also be “unsustainable” is an unexpected double whammy that needs special and urgent treatment.

“To exclude domestic debt from the restructuring process,” the official continued, “It is imperative that austerity measures be taken to increase government revenue.”

Accordingly, the budget reallocation and revision for 2022, which is proposed to be presented to Parliament within the next few weeks, will take further steps in this direction, he said.

“The Government has already decided to reintroduce 2019 budget policies with necessary amendments to the relevant acts, shortly and the Government is currently monitoring the progress of recently introduced tax rate revisions,” he said.

According to him, it will take another 2 to 3 months to measure the success of recently introduce VAT rate revision and another 4 to 5 months to evaluate the progress of other tax policy revisions.

However, he said the Finance Ministry has already decided to prepare an income and expenditure forecast for the rest of the year with IMF assistance.

Referring to the depth of the issue confronting Sri Lanka, the official said the proposed revised budget would inevitably lead to a major overhaul of the tax system, a key economic feature much trumpeted by the former regime of economic pundits. He said the revised 2022 Budget will carry plans to ensure public expenditure is systematically targeted for detailed review for reduction, if not elimination.

Sri Lanka’s debt is evenly split across domestic and external debt. So far, the Government has taken steps to restructure only the total foreign debt of circa US$ 51 billion.

Due to the impact on the country’s entire banking and financial system including the Central Bank, retirement funds such as the Employees’ Provident Fund (EPF), Employees’ Trust Fund (ETF), and insurance life funds, which together carry significant holdings of government debt in the form of Treasury Bonds, domestic debt has been excluded from the external debt restructuring process currently underway.

Such exclusion now looks doubtful and will depend on the extent of fiscal consolidation focusing on both revenue generation and expense control.

According to a recent report by Standard Charted Bank, over 80% of annual interest expense charged to the aggregate government income generated by Sri Lanka is incurred by its domestic debt given its high absolute yields.

“We therefore believe a domestic debt restructuring will be needed, though the Government has said it is not keen to do so, given the likely negative impact on the domestic financial sector,” the Bank said in their report.

According to the Bank, the Government expects a revenue-focused fiscal consolidation plan to be put in place by the IMF, given Sri Lanka’s very low revenue levels presently being generated.

In the circumstances, the IMF has indicated that its Extended Fund Facility will support a large upfront fiscal adjustment as well as efforts to shift spending from subsidies and inefficient public investment towards health, education, and the delivery of social benefits. Thus, replacement to Sri Lanka’s existing food, energy, and other subsidies with possible cash transfer mechanism will be an important element of any significant fiscal reform framework.

Such changes could, however, be politically controversial, as they inevitably lead to higher food and fuel prices, now highly sensitive issues in the public domain. Critics said the weaknesses in public financial management are likely to remain, despite signs of willingness to undertake fiscal reform. Given that political/social stability is directly linked to sustained economic performance, fiscal adjustment remains a key risk and hence ‘restructuring’ domestic debt is not yet completely out of consideration.

Sri Lanka’s state revenue was as low as 8% of GDP in 2021, it is expected to increase to 12-15% of GDP by 2025, in the background of the expected growth potential boosting the tax capacity.

According to latest data, the revenues rose by 30.7% to Rs 311.5 billion in the January-February period over the same period in 2021. Budget deficit in the first two months of this year expanded to Rs 240.2 billion, compared to Rs 227.7 billion in the same period in 2021. The Central Bank of Sri Lanka in April forecasted the budget deficit at 10.2% of GDP for 2022. In 2021, the deficit hit 12.2% of GDP.

By Ishara Gamage