Budget 2021: Economic Revival Despite Fiscal Headwinds and Tough Balancing Act

By Hiruni Perera | Published: 2:00 AM Nov 21 2020

Prime Minister and Finance Minister Mahinda Rajapaksa presented the 75th Budget of Independent Sri Lanka to Parliament on 17 November. This is the first comprehensive full year Budget statement of the current Government and its contents have attracted the attention of many local and foreign investors.

Accordingly, the Government had taken steps to present next year’s budget in accordance with President Gotabaya Rajapaksa’s ‘Vistas of Prosperity and Splendour’, a three-year economic plan for 2021-2023, in line with the presidential election manifesto.

During his budget speech, Prime Minister and Finance Minister Mahinda Rajapaksa stated that this is a development budget presented to elevate an economy that has been shattered. 

The Budget–2021 covers all sectors under a macroeconomic vision and it will open up numerous special investment opportunities to the business community for production of local goods and services under the competitive setting of the global economy. The public sector should provide the necessary support in this regard.

This time we invited ‘First Capital Research’ to comment on the budget. Following is the budget note made by one of their analysts on the Sri Lankan capital market and other related economic sectors of the economy.

By Hiruni Perera

The Budget for 2021 is focused on supporting the economy amidst massive disruptions to business activity due to lockdowns resulting from the spread of the COVID-19 pandemic, while taking measures to promote domestic investments to revive the economy. Heavy focus has been laid on continuing its infrastructure drive with concentration also placed on consolidating the NBFI segment and providing tax holidays for targeted selective sectors. As the Government takes forward its fiscal and monetary stimulus package, budget deficit expands to 8.9% of GDP for 2021 while the Debt to GDP ratio is expected to rise to 96%.

Government’s tax simplification policy is taken forward as it plans to combine multiple taxes to GST while also investing further on the RAMIS system. Protecting local industries in this time of survival is priority for the Government, as it plans to expand CESS to protect local industries. Selective sectors such as agriculture, fisheries, renewable energy and ship building have been provided tax holidays to promote the sectors. In order to support the tourism sector, the debt moratorium granted has been further extended.

The budget has a special focus on investing in infrastructure with funds being allocated to expand the expressway network, road network and continuing housing projects supported by low cost housing loans. Strengthening the NBFI sector has been identified as a critical point with proposals placed for consolidation within the sector while also recommending a National Development Banking Corporation, merging multiple small State banks.

As Capital Market Development measures, tax holidays were proposed for newly listed firms with multiple benefits granted to promote REITs within the capital market sphere.



Budget 2021 cheers capital markets

As we believe, Budget 2021 has proposed many initiatives to improve the overall sentiment in the Sri Lankan capital markets which includes debt (comprising Government Treasury Bills and bonds) and equities (Colombo Stock Exchange).

With a move to improve the fund flows into the debt market, it was proposed to credit the Samurdhi benefit to a newly opened Samurdhi Life Savings Account in the Samurdhi Bank and making it mandatory to invest these savings in Government Securities similar to the laws governing the NSB & EPF.

Moreover, investments in Government Securities up to LKR 100,000 per month will be considered as deductible expenditures in the calculation of personal income tax.

Issuing a statement, the Colombo Stock Exchange (CSE) welcomed the progressive capital market related proposals presented to Parliament by Prime Minister Mahinda Rajapaksa in the 2021 Budget proposals speech made on Tuesday.

With a move to improve long-term sustainable investments into CSE, following measures have been suggested.

In order to improve attractiveness of REITs investments, the Government has proposed to exempt Sri Lanka Real Estate Investment Trust (SLREIT) investments regulated by the SEC from capital gains tax and dividends from income tax. The proposal further seeks to reduce the Stamp Duty applicable to real estate transaction associated with REITs to 0.75% (from the currently applicable 4% for property transactions).

As a measure to promote new listings in the Colombo Stock Exchange, 50% tax concession for the years 2021/22, has been proposed for companies that will be listed before 31 December 2021 and to maintain a corporate tax rate of 14% for the subsequent three years.

With the intention of boosting foreign investments, tax exemptions were provided on dividends of foreign companies for three years if such dividends are reinvested on expansion of their businesses or in the money or stock market or in Sri Lanka International Sovereign Bonds.

As an additional measure to encourage stock market investment, the Government has proposed to include investments made in shares of listed companies incurred up to LKR 100,000 per month as deductible expenditures in the calculation of personal income tax.

We believe above-mentioned tax concessions to attract new investments to both debt and stock market while driving the country to own a robust capital market in the near future.

CSE sector wise impact from the Budget Banking sector

If Commercial banks in Sri Lanka has purchased Sri Lankan International Sovereign Bonds subject to a minimum of USD 100Mn, the risk weighted provisioning under Central Bank Regulations are suspended for 3 years and profits on capital and interest income of this investments have made exempted from taxes.

This is expected to improve the profitability of the banking counters especially who have high exposure to foreign currency denominated Government securities thus reversing the provisions made in relation to impairment on above-mentioned government securities.

However, it was also proposed to extend the concessions and recovery of loans granted under the re-financing facilities of CBSL for tourism sector until 30 September, 2021 while banks will be provided with a Treasury guarantee covering 50% of such loans.  Extended debt moratoriums may cause a bane for banks as the increase in number of restructuring/ rescheduling facilities due to credit relief schemes increases credit risk.  

Accordingly, overall budget 2021 proposals are expected to have a neutral impact on the banking sector.



NBFI sector

During the recent years, the NBFI sector encountered multiple issues with regard to its performance, as well as key reforms. Accordingly, NBFI sector consolidation came in spotlight during the last few years and has been one of the proposals strongly held by the current Government in order to strengthen the stability of the sector.

In light of this, it was proposed to merge the subsidiary finance companies with the parent company while finance companies functioning under commercial banks were proposed to merge with the parent bank in order to strengthen the NBFI sector. Merger-related expenses were made tax deductible.

Although the above-mentioned proposal is expected to result in a short-term disruption to the NBFI sector, in the long-term it is expected to strengthen the overall stability while improving the public confidence of the Non-Banking financial system.

Tobacco & Alcohol Sector

Single Special Goods and Service Tax was introduced on alcohol and tobacco replacing the existing taxes although the rate is not confirmed yet. Therefore, depending on the rate, impact could be different. However, in the past, taxes on alcohol and tobacco have been major contributors to the State coffers.

The tax collection has been improved through the launch of an online system known as RAMIS System. Through this method collection of taxes will be efficient compared to the previous methods, resulting in better revenue collection.




Agriculture, Plantation and Poultry 

Agriculture, Plantation and Poultry can be considered as a major winner from Budget 2021 as the Government has suggested enormous proposals to improve the prospects of the industry which includes:

Exempting farming, including Agriculture, Fisheries and Livestock Farming from income taxes for the next 5 years.

Proposal to allocate LKR 200 million for the development of Fisheries Farm Zones with infrastructure facilities in line with the environmental standards in the Districts of Batticaloa, Jaffna, Puttlam and Mannar which are suitable for fish production such as prawns, lobster, carp, tilapia and modha. It was also proposed to further increase the provisions for developing facilities of fishery harbours and modern fishing vessels and for increasing deep sea fishery production during 2021 Medium Term Budgetary Framework.

Formulating bilateral trade agreements that will expand the market for exports of country’s specific agricultural products such as tea, cinnamon, pepper, traditional ornaments and consumer goods, as well as toxic-free vegetables, grains and fruits.

Imposing the special commodity levy to balance the supply and demand of domestic production for selected agricultural products.

5-year tax exemption for the dairy sector if the investment exceeds  USD 25Mn.

We believe that above policies to favour the Agriculture, Plantation and Poultry sector although increasing the daily wage of estate workers to LKR 1,000 from January 2021 to result in increased cost of sales thus reducing the profitability.

Telecommunication

Govt. has proposed an initiative to invest LKR 15 billion during the period 2021-2022 to expand 4G connections islandwide, whilst domestic industrialists (local labour) will be incentivised to engage in the construction and installation of the towers via a 

five-year tax break. This will aid the telecommunication providers in relation to the investments in the country although imposition of a Special Goods and Service Tax on the Telecommunication Industry (if the new rate is higher than the current) can adversely affect the profitability.



Power and Energy

With the Government’s intention of improving the contribution from the renewable energy sector, substantial proposals were suggested to improve the industry prospects which includes:

A tax holiday of seven years for all renewable energy projects and stated its intention to increase the contribution of Renewable Energy, with a goal to source 70% of the total energy requirement via Renewable Energy by 2030. 

Proposal to add 1,000 MW to the national grid during the period of 2021-2023, backed by a 500 MW rooftop solar project to be implemented via 100,000 low income households. The project would be backed by loan schemes offered through the ADB and the Indian Line of Credit, at a rate of 4% to the households.

Proposal to grant LKR 150,000 to 10,000 SME entrepreneurs in the agriculture space to help reduce electricity costs, via the installation of Solar Power operated water pumps.

Additionally, the GoSL has also proposed to implement a special loan scheme for public servants to obtain solar powered electricity.

Automobile

Automobile sector is a net beneficiary from the proposals suggested from Budget 2021 as it was proposed to reduce the import taxes levied on vehicle spare parts required for new production sectors to incentivise entrepreneurs in automobile industries engaged in vehicle repairing and vehicle assembly. However, vehicles will be subjected to a Single Special Goods and Service Tax (GST).

Manufacturing and Exports

In line with the Government’s focus on reviving the domestic production and import substitution following proposals were suggested to improve the local manufacturing sector:

Proposed to allow the import of high technology and equipment of developed countries as well as unique raw materials and intermediate products that cannot be manufactured in the country which could result in development of high value addition exports.

Impose CESS to provide the required protection on the imports and exports of domestic production.

Remove import taxes on the raw materials not available in the country, machineries and equipment with modern technology, to boost exports, and also to encourage domestic industries to produce value added goods.

In order to encourage the exports of multi-national companies which are import based for requirements of the domestic market, it is proposed to reduce the tax imposed on their dividends by 25% in 2021 and 50% in 2023 under the condition that they increase their exports by 30% and 50% in the respective years.

Provide investment incentives for rubber and coconut related industries, building materials and office equipment and furniture as major industries. Proposed to provide incentives for investments on household needs as well as coconut related industries including brooms, ekel brooms, rugs and rubber related products including agricultural and consumer needs, building materials, office furniture, to support them as main industries.

Shipbuilding

It was proposed to provide separate docks, dockyard access facilities and long-term credit facilities to promote boat and shipbuilding activities which has high development prospects. It is also proposed to grant a tax break of 7 years for local boat and shipbuilding.

Construction and Building Materials

Below mentioned proposals bodes well for construction and building material sector companies and we can expect an optimistic outlook on the Construction sector in Sri Lanka:

Under the expansion of expressway network, it was proposed to construct Kerawalapitiya-Meerigama as well as Kurunegala-Dambulla and Pothuhera-Galagedara sections of the Central Expressway and to construct of Ingiriya- Kahathuduwa section as first phase of Ruwanpura Expressway which will be completed by 2024.

Public Investments will also be allocated to develop bridges and byroads to ease the traffic congestion in Colombo and its suburbs and implementation of the 3-year Road Development Programme which covers all 25 districts.

Under the ‘Water for All’ national plan, it is planned to invest LKR 1.0 Trillion (LKR 1,000 billion) in 2021-2024 in 1,000 community water projects, 171 major projects aimed at enhancing the production capacity, new water supply schemes and expedite ongoing projects with the objective of ensuring access to drinking water to the entire population.

Real Estate Sector

Allowing Non-residents to purchase luxury condominiums utilising, foreign currency earnings made in Sri Lanka, earnings in foreign countries or a loan obtained from a Bank outside Sri Lanka can be considered as a positive move taken to revive the real estate sector in Sri Lanka.

By Hiruni Perera | Published: 2:00 AM Nov 21 2020

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