Sri Lanka’s economic health slips amid hefty tax cuts

• First Capital’s Economic Health Score in Jan. slips to 59, from 60 in Dec.
• But score compilers give two points to ‘investor confidence’ criterion

Sri Lanka’s economic health score slipped in January due to the expected fiscal slippage from the hefty tax concessions rolled out by the new administration since December 2019, but score compilers had given two points to the ‘investor confidence’ criterion. 

First Capital Research, part of First Capital Holdings, updates its score for the overall economic health on a regular basis. 
The latest health score for January 2020 came in at 59, slipping from 60 in December 2019, but significantly up from 43 a year ago, when the economy was recovering from a 52-day constitutional crisis. 

“Reduction in tax revenue and uncertainty in all other indicators (foreign reserves, inflation and exchange rate) may significantly deteriorate macroeconomic conditions and increase volatility of interest rates. Accordingly, we lower our First Capital Economic Health Score for the bond market for the next couple of quarters,” First Capital Research said. 
The compilers of the January score, however expect the situation to deteriorate further towards the second quarter in 2020, between 55-60, after rising to 60-65 during the 
first quarter.

The research house however ticked-down its risk level on the overall economy to ‘medium-low’ in the ongoing quarter, from ‘medium’ in the previous period. But the risk level is projected to return to ‘medium’ in the second quarter again, as the score is also expected to sink. 

First Capital’s Economic Health Score echoes with the latest economic assessment by S&P Global Ratings in relation to certain aspects. 

S&P Global Ratings on Tuesday joined Fitch Ratings in revising down Sri Lanka’s sovereign outlook to ‘Negative’, from ‘Stable’, on the premise that new tax cuts undermine the country’s fiscal and debt sustainability.  

However, in the same vein, S&P added that the forthcoming general election could boost investor confidence and 
economic growth.     

              
Soon after the tax cuts were announced, Moody’s, which maintains a B2/Stable rating on Sri Lanka, estimated the hit from the tax cuts to revenue to be around 1 to 1.5 percent of Gross Domestic Product (GDP).

The criteria, which moved the score, were inflation, foreign activity in the rupee treasuries and cut in rating outlook by Fitch in December. 

Inflation spiked in December as food prices remain stubbornly high despite the sweeping tax cuts. But foreigners showed signs of returning to government securities during the first week of January 2020.

Meanwhile, the government also appears to be very keen in clearing the regulatory hurdles stifling business activities, and has taken on the tough task of reforming the perennially unproductive State sector.