CB chief shrugs off growth concerns from higher taxes

• Says economic growth mostly determined by interest rates
• Points out higher tax income leads to lower deficits which in turn put less pressure on rates  
• CB last week slashed policy rates by a further 100bps to support growth 
• It expects an economic rebound in 2024 after two years of contraction 

After cutting rates for the fourth time last week to spur economic growth, Central Bank Governor Dr. Nandalal Weerasinghe said he doesn’t think the higher taxes are going to be a major

drag on the economy as tax is only a transfer of resources from one section to another and thus its impact on the overall economy is going to be minimum.  
Since June of last year, the government has increased both direct and indirect tax rates, and introduced new taxes, thereby entirely reversing the significant tax cuts implemented in 2019 by President Gotabaya Rajapaksa. 

This move by the government comes in the wake of a landmark judgement a couple of weeks ago, in which the Supreme Court faulted President Rajapaksa and several others for the economic crisis experienced last year.
The government announced plans in early November to raise the Value-Added Tax rate by another 3 percentage points to 18 percent, effective from next year in order to meet the revenue targets set under the International Monetary Fund programme. 

Along with that the government announced plans to remove all VAT exemptions except for healthcare, education and a few essential food items, which raised concerns about another bout of inflation. 
Some opine that raising taxes at this juncture when the economy is starting to show some signs of recovery after two years of deep recession could either delay or further weigh on the economy as higher taxes take away the money which otherwise would be left with the people to purchase goods and services. 
However, the country’s Central Bank chief thinks otherwise. 

“When the VAT is raised from 15 to 18 percent, what it does is increasing the government’s revenue. And when the government takes money through taxes, such money is also spent on the other side. For instance, the government has allocated Rs.200 billion to be spent as part of social security net. And likewise there are other areas where the government aims to spend such money,” Dr. Weerasinghe said in response to a question if the repeatedly raised taxes would hurt the prospects of economic growth, at a press conference held last Friday.
Dr. Weerasinghe highlighted that, in the short term, the primary driver of economic growth is largely influenced by the monetary policy. This policy plays a pivotal role in shaping the direction of interest rates. If these rates are maintained at a level conducive for easy borrowing, enabling both investment and consumption, it acts as a catalyst for stimulating economic growth, he pointed out.

 “What a tax policy does is to take money from a section of the society and to distribute it among another section. Therefore it doesn’t have a big impact on the overall economic growth as such money in return is spent on various other sections of the economy,” he further explained though reluctantly as typically the Central Bank doesn’t comment on the fiscal policy. 
However, some commentators opine that Sri Lanka’s taxes are an inefficient transfer of resources as the bulk of the State revenue is spent on paying State sector salaries, pensions and interest costs.

Speaking further, Dr. Weerasinghe said higher tax revenue on the other hand narrows the budget deficit of the government lessening the need to borrow. This in turn put less pressure on government securities yields and domestic market interest rates, creating a favourable environment for growth allowing the private sector to borrow money for investment and consumption at lower rates.

While the Central Bank did not provide projections, Dr. Weerasinghe anticipates a mild rebound in the economy during the second half of the year. However, he acknowledged that the overall growth for the full year is projected to remain marginally negative, primarily attributed to the contraction experienced in the first half of the year.
However, the Central Bank expects a growth in the economy next year. 
Despite the fiscal policy remaining extremely tight, the monetary policy is likely to remain accommodative in the short-term with the absence of any unforeseen shocks, supporting the ongoing recovery of the economy. 
Fitch Ratings, in a recent analysis of the budget, forecasted 3.3 percent growth for the Sri Lankan economy in 2024.