Fitch loads reforms in budget to boost dwindling revenue base

While acknowledging budget 2017 contains a number of positive measures to boost the country’s extremely low revenue base, Fitch Ratings yesterdays said the impact of the new revenue reforms will hinge on their effective implementation. 
The rating agency also noted that some of the budget assumptions look optimistic, posing risks to the projections.

The 2017 budget targets a fiscal deficit equivalent to 4.6 percent of gross domestic product (GDP), down from an expected 5.4 percent in 2016 and 7.4 percent in 2015, when the deficit widened mainly as a result of sharp public-sector wage rises. 

“Fiscal consolidation will be helped by tax reforms that should go some way to bolstering the weak revenue base, which is a key reason for the sovereign’s weak fiscal finances,” Fitch said. 
The reforms include a hike in the value-added tax (VAT) rate from 11 percent to 15 percent, along with other tax measures announced in the budget such as a 10 percent tax on capital gains that is scheduled to be introduced next year and an increase in the top personal income tax rate. 
The government also expects to generate more revenue from the simplification of the tax system and removal of some tax exemptions and concessions. However, a leading economist in the country this week stressed that the 2017 budget has moved away from the process of gradually simplifying the country’s tax system with a less number of taxes. 
The government projects that revenue will increase by close to 27 percent in 2017, pushing the revenue to GDP ratio up to nearly 15 percent of GDP from an estimated 12.9 percent in 2016.
“Fitch views the new measures as a positive step but there is a risk of a shortfall. The impact of the tax reforms will hinge on effective implementation,” the rating 
agency noted.
Meanwhile, Fitch forecasted a growth of 5 percent for 2017, much lower from the government’s GDP growth forecast of 6 to 
7 percent. 
The rating agency also noted that the government’s efforts to restrain expenditure growth next year appear limited. 
“Salaries and wages are to be increased at a less rapid pace than in 2016 but nominal expenditure is still forecast to grow by 17 percent to finance an ongoing infrastructure drive and meet the rising cost of debt-servicing and subsidies.”
However, Fitch expects spending may be cut back in the event that revenue disappoints.
The government has a medium-term target of reducing the budget deficit to 3.5 percent of GDP by 2020, which is aligned with a three-year programme it has the International Monetary Fund (IMF). 
It expects to achieve this deficit reduction mainly through a combination of further tax reform and efficiency gains in public expenditure. Some of the revenue measures announced in the 2017 budget are part of this medium-term fiscal strategy.
“High government debt is, in any case, likely to remain a weakness in Sri Lanka’s sovereign profile. Fitch estimates the level of debt at 76.5 percent of GDP as of end-2016, which is significantly above the ‘B’ median of 52 percent,” the rating agency noted. 
Fitch downgraded Sri Lanka’s sovereign rating by one notch to ‘B+’ in February and placed it on negative outlook. The three-year IMF programme that began in June has helped to ease balance-of-payments problems but Fitch noted that the long-standing weaknesses in public finances will persist without sustained commitment from the authorities.