Sri Lanka looks to turn the page

An interim budget unveiled by Sri Lanka’s new government aims to bring down debt levels while maintaining growth, with newly elected President Maithripala Sirisena pledging in his inaugural speech in January to defeat corruption as well as lead a social transformation of the island nation.

Sri Lanka’s economy grew by 7.4% in 2014, edging above the 7.2% growth recorded in 2013, according to data released by the government statistics office in March. Growth stalled slightly in the fourth quarter to 6.4% – a near two-year low and down from 7.7% in the previous quarter − but the IMF is forecasting “relatively robust” growth of 6-7% this year. “The mission agreed with the authorities that prospects remain favourable and that sustaining robust growth over the medium-term will require continued commitment to policies in support of macroeconomic stability, and structural reforms to enhance productivity and competitiveness,” said the IMF in a March report.

Budget ambitions

Under its budget, approved by the parliament in February, the government is targeting a series of cuts to capital investment including a 1.6% reduction in infrastructure spend to LKR177bn ($1.3bn) as well as the introduction of a one-time 25% “super-gain tax” on companies or individuals that earned profits of more than LKR2bn ($15.3m) in 2013/14. The measures are intended to help narrow the budget deficit to 4.4% of GDP this year, an ambitious target that would represent a 38-year low and a further reduction from the goal of 4.6% set out by the former government in the budget handed down in November.

Total budgetary expenditure was set at LKR2.1trn ($16.2bn), down from the LKR2.21trn ($16.9bn) in the previous budget, leading to a projected deficit of LKR499bn ($3.8bn), mostly to be covered by additional borrowing.

When announcing the new budget, the finance minister, Ravi Karunanayake, said that the economy was in a “sad state”, but that extensive reforms and cost-cutting measures would help reduce public sector debt and boost growth. The IMF, which ended a $2.6bn loan programme to Sri Lanka in 2012, warned last year that the country was vulnerable to sudden external shocks due to high levels of foreign commercial borrowings.

However, the budget reflects most of the promises made by the newly elected president ahead of the January 8 poll and is largely viewed as a voter-friendly document, with an eye firmly on the parliamentary elections scheduled for June.

While the final revenue and spending figures for the new budget were not dramatically different from the draft document it replaced, it marked a departure from the heavy emphasis on infrastructure investment of the previous administration and represents more of a bottom-up approach to the economy, seeking to boost growth through domestic demand rather than relying on state outlays.

Foreign policy

The transition in government has also heralded a change in foreign policy. A succession of visits from representatives of foreign governments has taken place in recent months as Sri Lanka looks to renew ties with many neighbouring countries. In March, Indian Prime Minister Narendra Modi spent two days in Sri Lanka, indicating a revival of bilateral relations which had stagnated under the previous administration. India is expected to offer a credit line to Sri Lanka to ensure funds for infrastructure and development projects, as well as expand support for military training and collaborate on energy projects.

At the end of March, Vietnamese officials travelled to Colombo for a sub-committee meeting that is expected to signal the start of increased trade between the two countries, and a target of reaching $1bn in bilateral trade has been set.

While China has pledged over $1bn in new grant money to Sri Lanka, relations between the nations have cooled somewhat since President Sirisena came to power. China has been a major source of investment in Sri Lanka’s infrastructure in recent years, but in late February the new government put a Chinese-backed $1.4bn port city project on hold pending investigation of irregularities. The project had been approved under the previous government.

The government is targeting increased foreign direct investment (FDI) to drive growth, especially through improved governance, as inconsistent fiscal policies, amongst other issues, have contributed to low levels of investment in the past. In 2013 FDI declined by 2.7% year-on-year to $916m, although it increased by 9.2% the following year, to $1bn, according to the central bank. Despite the need for greater FDI, as the World Bank noted in its “South Asia Economic Focus Spring 2015” report, “Sri Lanka attracts less FDI than expected despite its geographic, education and infrastructure advantages.”

Political uncertainty surrounding the parliamentary elections in June may weigh on investor appetite in the short term, as all eyes turn to the government’s next steps, including policy changes and greater clarity with regard to the future.