Moody’s says tax cuts credit negative

By Indika Sakalasooriya 
International rating agency, Moody’s Investors Service, yesterday said the sweeping tax cuts announced by Sri Lanka’s new government headed by President Gotabaya Rajapaksa is credit negative amid increased risks stemming from potentially weak government revenue and low debt affordability.

The tax cuts, which included a reduction in Value Added Tax (VAT) rate, increase of tax-free threshold of Pay As You Earn (PAYE) tax and the removal of Nation Building Tax (NBT), were announced after the maiden Cabinet meeting of Rajapaksa administration on Wednesday.  “The tax cuts announced were not surprising and in-line with promises from the Rajapaksa campaign. But they are likely to have a negative impact on the government revenue, which will put pressure on the country’s persistent budget deficit. Hence, the tax cuts will have a credit negative impact,” Gene Fang, Associate Managing Director, Sovereign Risk Group, Moody’s Investors Service told Mirror Business in a telephone interview.

Moody’s, which maintains a B2/Stable rating on Sri Lanka, estimates the hit from the tax cuts to revenue to be around 1 to 1.5 percent of the gross domestic product (GDP).
The VAT rate cut and PAYE tax revision are aimed at reigniting consumption while the increase of tax-free monthly threshold for turnover for VAT from Rs.1 million to Rs.25 million is expected to give boost small and medium-sized businesses.

Despite the sweeping tax cuts announced on Wednesday, Rajapaksa government is yet to announce any significant revenue-raising measures amid worries regarding higher fiscal deficit and substantial increase in the government’s debt burden. 

Sri Lanka is likely to overshoot the fiscal deficit target of 4.8 percent set for this year under the International Monetary Fund (IMF) programme by at least 100 basis points largely as a result of Easter attacks in April and shortfall in revenue due to slowdown in economic activities.

Sri Lanka’s fiscal deficit fell to 5.3 percent of the GDP last year from a six-year high of 7.6 percent in 2015. 

IMF Mission Chief for Sri Lanka, Manuela Goretti, in an email said the IMF is yet review the tax revisions and discuss them with the Sri Lankan authorities. 

“In general, any measures to stimulate investment and growth should be part of a comprehensive policy strategy that also advances fiscal consolidation and safeguards public debt sustainability, given Sri Lanka’s still high public debt and refinancing needs over the medium term,” Goretti added.

Completing the sixth review of Sri Lanka’s loan programme early this month, Deputy Managing Director and Acting Chair of the Board Mitsuhiro Furusawa urged Sri Lanka to make sustained efforts to mobilize revenues in 2020 to “place public debt on a downward path, while preserving space for critical social and investment spending.”

Talking to financial news website Economynext, newly appointed Treasury Secretary S.R. Attygalle said that the government will control non-essential expenditures in 2020 to keep the deficit down. 

“Initially there would be a revenue dip,” Attygalle was quoted as saying. “We will prioritize expenditure and maintain the deficit around 5 percent of GDP in 2020.”

Sri Lanka’s economic growth slumped to 1.6 percent in the second quarter of 2019—slowest pace in more than five years—as the Easter attacks delivered a thumping blow to the country’s fast-growing tourism industry. 

IMF has projected the economic growth to strengthen to 3.5 percent in 2020, from 2.7 percent in 2019, as tourist arrivals and related activities are slated to gradually recover.

However, President Rajapaksa’s election manifesto targets average growth of at least 6.2 percent in the coming year, which will be an extremely challenging task given the country’s external debt obligations, which is estimated at US $ 3 billion per year over the next five years.