Moody’s says Sri Lanka’s 2021 budget unlikely to significantly boost growth

Moody’s Investors Service says Sri Lanka’s 2021 budget is unlikely to significantly boost growth in the country.

On 17 November, Sri Lanka’s (Caa1 stable) Prime Minister and Minister of Finance Mahinda Rajapaksa presented the proposed 2021 budget.

The budget calls for LKR3.6 trillion ($19.5 billion, 23.7% of 2020 forecast GDP) in expenditure, a 26% increase from its estimate for 2020.

“Despite the growth focus of the budget, we do not expect it to provide a meaningful boost to output, while increased spending will add to fiscal pressures, a credit negative,” Moody’s said.

Moody’s said the the budget targets a 2021 fiscal deficit of 8.8% of GDP, compared with a revised 2020 estimate of 7.9% of GDP.

“We forecast a similar gap for 2021, but for the deficit to remain above 8% 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% of GDP over 2020-21, above the Caa-rated median of 88% of GDP, and only begin to gradually decline in subsequent years,” Moody’s said.

Moody’s expect the Government to face challenges in rationalizing Government spending and delivering fiscal consolidation postcoronavirus, 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,” Moody’s said.

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.

Moody’s expects Sri Lanka’s economy to contract by more than 3% 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 LKR1.1 billion, up more than 55% 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,” Moody’s said.

On the revenue side, the budgeted 28% 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 (Aaa stable) 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. (Colombo Gazette)

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