Moody’s says govt. revenue targets ambitious, warns of fiscal slippage

Moody’s Investors Service cast its doubts over the achievement of the budgeted revenues by the Sri Lankan government in 2017,  as the revenue projections have been made based on ambitious assumptions on economic growth, near full tax compliance, and higher tax buoyancy which may be unrealistic. Achieving revenue targets could be further challenged by the country’s fractious politics which could derail the State-Owned Enterprise (SoE) reforms, which are crucial for envisaged higher revenues and economic growth. 
Fellow ratings agency Fitch and several local economists have also pointed out the overly ambitious nature of Sri Lanka’s fiscal policy targets.The government projects a 27 percent increase in tax revenues in 2017 but the rating agency said that achieving this target, though ambitious, will be key to ensuring a sustained reduction in fiscal deficit and the country’s credit outlook.
Sri Lanka has a B1 rating with a negative outlook from Moody’s.   
However, the ratings agency warned that any slippage in fiscal targets could raise debt levels further, undermine investor confidence and bring instability into the system.  
“If slower reform progress were to affect availability of external financing, pressure on a still fragile external position would mount,” Moody’s stated in its latest report on Sri Lanka. 
However the first 9 months’ fiscal data showed that the government revenues had outperformed the 2016 budget as the State revenues had risen by 23 percent year-on-year to Rs. 1,180 billion mainly stemmed from the higher tax income.  
The government expects to slash the fiscal deficit to 5.4 percent of Gross Domestic Product (GDP) by the end of 2016 and further to 4.6 percent in 2017 before bringing it further down to 3.5 percent in 2020, partly in a commitment given to the International Monetary Fund in return for its 3-year, US$ 1.5 billion bailout package in June this year. The budget 2017 projects the economic growth to accelerate to between 6 percent and 7 percent in 2017 based on expectations of stable mid-single digit inflation, steady exchange rate supported by larger foreign exchange reserves, strong domestic economic activities complemented by low interest rates and the recovery in the global economy.

However now all signs point to much slower growth for the country as the interest rates are now under upward pressure, the rupee is under downward pressure and the country’s external sector has now turned more fragile with the foreign reserves depleting. 
Further the significant fiscal tightening currently envisaged combined with likely relatively tight monetary policy could dampen the Gross Domestic Product (GDP) growth to a greater extent than currently projected by the government, Moody’s opined. 
As a result, “we project GDP growth to be lower, rising to 5.2 percent in 2018 from 5.0 percent in 2017, similar to the IMF projections--4.8 percent and 4.9 percent in 2017 and 2018, respectively,” it added. 
Meanwhile the government’s assumption of near full tax compliance will also be highly dependent on the swift automation of the Inland Revenue Department functions and linkages with a single window system at Sri Lanka Customs. 
“However, seamless implementation of the new IT systems and full tax compliance appear somewhat challenging”, Moody’s said. 
Further, Moody’s noted that the government’s expectations of efficiency and responsiveness of revenue mobilisation to economic growth, known as tax buoyancy, is ambitious, considering the recent slowdown seen in the nominal GDP growth. The implied tax buoyancy by the government is 2.7 based on a nominal GDP growth rate of 10 percent and projected tax revenue growth of 27 percent but Moody’s considers this is high relative to the past,” as nominal GDP growth has slowed substantially from an average rate of 16.6 percent over the decade to 2015, and revenue growth has been in a steady decline relative to GDP for years”. 
“If unusually high tax buoyancy relates to a material increase in effective tax rates, it will dampen disposable incomes and spending,” Moody’s added.