Budget in line with IMF plan but fiscals still weak: Fitch

• Says high debt and servicing costs weigh on credit profile
• Sees downside risks to government’s revenue projections
• Forecasts an increase in debt to GDP ratio in 2017 

Fitch Ratings yesterday gave thumbs up for the Budget 2018, which is widely hailed as a futuristic policy document, but did not fail to add that the country’s fiscal front still remains extremely vulnerable due to high government debt and large cost of debt servicing. 

The rating agency said the budget for 2018 has broadly stuck to the targets for fiscal deficit reduction under Sri Lanka’s three-year programme with the International Monetary Fund (IMF).

“However, high government debt and the large cost of debt servicing weigh heavily on Sri Lanka’s credit profile and will require sustained fiscal consolidation over the long term,” Fitch said.   

Sri Lanka faces a challenging external debt service schedule in the near term, with very large external debt maturities coming up over 2019-22. The country’s external position was one of the key factors that led the government into an IMF programme.

The recently announced budget targets a fiscal deficit of 4.8 percent of GDP in 2018, which is only slightly above the 4.7 percent target agreed with the IMF and continues the consolidation that began in 2016. 

Floods and drought weighed on the economy and public finances during 2017, and contributed to the government missing its initial 2017 fiscal deficit target of 4.6 percent of GDP. Nevertheless, the government still expects the 2017 deficit outturn to fall to 5.2 percent of GDP, from 5.4 percent in 2016. Consolidation in 2017 has been driven by measures to boost tax revenue, including a hike in the Value-Added Tax (VAT) to 15 percent in November 2016 from 11 percent. The government expects revenue to rise strongly again in 2018 to 15.7 percent of GDP, from 14.7 percent in 2017. Revenue should be supported by the new Inland Revenue Act passed in September 2016, provided implementation is effective. 

The Act, which will come into effect from 1 April 2018, aims to simplify the tax laws and improve the efficiency of the system. 

“Despite these positive reforms, we see downside risks to the government’s revenue projections, given that they are based on a GDP growth assumption of 5-6 percent for next year, compared with our own of 4.5 percent,” Fitch said.   

On the expenditure side, the government expects public investment spending to rise by 20 percent in 2018, while recurring spending is forecasted to decline. Interest payments are expected to account for more than one-third of total revenue, which is a key weakness in the fiscal profile.  

“Addressing long-standing weaknesses in Sri Lanka’s public finances will require an extended commitment to consolidation from the authorities. In particular, we highlighted the importance of a stabilisation of government debt ratios when we affirmed Sri Lanka’s rating at ‘B+’ with a Stable Outlook in February 2017,” Fitch noted.  

Meanwhile, the rating agency expects Sri Lanka’s debt to GDP ratio to increase again in 2017. The country’s debt to GDP ratio stood at 79.3 percent in 2016, well above the 60.9 percent median for sovereigns rated ‘B’ or lower.

“Our baseline projection is that the government debt ratios will stabilize within the next couple of years, but these forecasts are vulnerable to fiscal slippage or an 
economic downturn. 

Exchange rate depreciation could also push up the local-currency value of government debt, given around 40 percent of the total was denominated in foreign currency at end-2016, according to Fitch estimates,” Fitch said. 

Sri Lanka’s foreign-exchange reserves rose to USD7.5 billion at end-October, from US$ 6.1 billion at end-2016, and Fitch estimates reserves could be sufficient to cover 3.3 months of current account payment by end-2017. 

However, the external liquidity ratio at 65.6 percent, it is still well below the ‘B’ median of 134.2 percent, Fitch estimates.