VAT increase my dampen consumption in the near-term: CT CLSA

Colombo-based equity brokerage and investment bank CT CLSA says the Value-Added Tax (VAT) increase slated to come into effect from January 1, 2024, is likely to dampen consumer spending in the near term.

The Cabinet of Ministers this week approved a proposal to increase VAT by 3 percent to 18 percent with effect from next year, as the government scrambles to meet the revenue targets set by the International Monetary Fund (IMF).
The multilateral lender has delayed the second tranche of the US$ 3 billion Extended Fund Facility (EFF) as Sri Lanka has failed to achieve the revenue targets set for this year.

According to IMF estimates, Sri Lanka is likely to fall behind achieving the revenue targets agreed with the multilateral lender by 15 percent by end of this year. As per the agreed targets, Sri Lanka needs to raise government revenue equivalent to 12 percent of GDP by 2024. 

“We believe that the increase in VAT would likely dampen consumer spending in the near term given that energy prices were also increased recently which would result in lower disposable income levels,” CT CLSA said in a brief research report.

The government also said the new VAT rate will also be applicable on certain goods and services that were previously exempt. However, these items have not been announced yet.

For the first half of 2023, the government raised Rs.231 billion from VAT. 
“Assuming consumption remains relatively unaffected, the government is likely to raise a further Rs.92 billion in 2024E with the increase in VAT rate to 18 percent. However, we believe that consumption is likely to be impacted at least in the first few months of 2024E until salary revisions kick in (generally from April),” CT CLSA said.
The President recently indicated that a salary increment for government employees will be announced in the National Budget for 2024 on 13 November 2023.

“This move could potentially drive consumption from 2Q2024E onwards given that state sector employees have not received any meaningful compensation for the elevated inflation levels in 2022 given the economic crisis,” CT CLSA said.

Uptick in consumption remains paramount for Sri Lanka’s economy to make a turnaround. Sri Lanka’s economy contracted by 7.8 percent in 2022 and 7.9 percent in the first half of 2023.