Macro challenges to make SL’s upper middle income dream a distant reality?

Sri Lanka’s journey towards becoming an upper middle income country is likely to be delayed, given the slower pace of economic development amid difficult macroeconomic conditions and tough external challenges posing a threat. The government statistics office, Census and Statistics Department’s (CSD) latest data last week showed that the country’s per capita income in 2015 had increased by only 1.9 percent or US $ 73 to US $ 3,837.

The upper middle income threshold begins from a per capita income of US $ 4, 126. CSD estimates Sri Lanka would reach the upper middle income status in 2016 provided the country recorded 5.3 percent growth level in its gross domestic product (GDP) in 2016. But the estimate depends on number of assumptions.

The country’s inflation in 2016 must be 3 percent; mid-year population growth should remain same at 0.94 percent as in 2015 and an exchange rate of Rs.135.9 per dollar. While the Central Bank targets a medium term inflation range of 3 to 4 percent supported by supply side improvements, the inflation is likely to rise due to the proposed increase in Value Added Tax by 2.5 percent, higher borrowing cost and higher importation prices due to weakening currency against the dollar. Sri Lanka’s economy slowed to 4.8 percent last year to Rs.8.6 trillion from 4.9 percent growth in 2014. However, a combination of above factors could further dent the economy, dashing the government’s hope to expand the economy at a higher rate, the economists opine. The country’s defiant Finance Minister Ravi Karunanayake nevertheless believes that the economy would grow by 6.5 percent in 2016 while the rupee/dollar exchange rate would improve to Rs.110. Post-war Sri Lankan economy was growing at a healthy rate with rising per capita income and falling poverty head count.

Falling Value Added Tax (VAT) collection has been identified as the main cause of the decline in tax revenue in recent years. The VAT component of total tax collection has also fallen to 26 percent in 2014 from 41 percent in 2005. Further the VAT collection as a share of GDP has also declined to 2.7 percent in 2014 from 5.8 percent in 2004. Budget 2016 targets a 12.7 percent tax revenue and 16.3 percent total revenue to GDP and the recent upward revisions in direct and indirect taxes and the proposal to re-introduce the controversial capital gains tax is a sure boost to the tax revenues. This would also favourably influence IMF as the government is negotiating a US $ 1-1.5 billion stand-byarrangement facility with the lender. Falling government revenues and export earnings as a percentage of GDP during the last 15 years have been identified as the two economic paradoxes in the Lankan economy.