Sri Lanka’s 2024 Budget Challenges

Targets and Deficit:

• Sri Lanka’s 2024 budget faces challenges in meeting its targets.
• The projected fiscal deficit for 2024 is wider than anticipated, at 9.1% of GDP.
• Excluding bank recapitalization costs, the deficit is at 7.6% of GDP.

IMF Projections vs. Budget:

• The IMF’s projections for 2024 align with Sri Lanka’s primary surplus goal but differ in expenditure targets.

Financing and Revenue Risks:

• The release of IMF financing depends on Sri Lanka’s progress in securing assurances from creditors.
• Meeting revenue goals for 2024 is uncertain due to past fiscal slippages and a hefty 45% increase in revenue targets.
• Factors like a VAT increase and inflation might contribute, but economic growth is projected to be modest.

Government Spending and Potential Adjustments:

• Increased spending plans for salaries, wages, and capital expenditure might strain the budget.
• However, there’s room for adjustments, especially in capital expenditure if revenue falls short.
  

Reform Efforts and Rating:

• Government initiatives for governance reform may aid revenue collection, but their effectiveness will take time to assess.
• Fitch’s current rating for Sri Lanka remains at ‘RD’ (Restricted Default) pending completion of a commercial debt restructuring.

Future Outlook:

• Sri Lanka’s post-default rating hinges on its credit profile and normalization with the international financial community.
• The country’s Long-Term Local-Currency IDR was upgraded in September, reflecting progress in domestic debt optimization.

Key Points in Detail:

1. Challenges in Meeting Fiscal Targets:

   • Sri Lanka’s budget for 2024 faces significant challenges, particularly in achieving the outlined fiscal targets.
   • Fitch Ratings suggests that even with expected economic recovery, the fiscal deficit is projected to be wider than initially forecasted, standing at 9.1% of GDP.

2. IMF Projections versus Government Targets:

   • While the International Monetary Fund (IMF) projections for 2024 align with Sri Lanka’s primary surplus goal (0.8% of GDP), there are disparities in expenditure targets.
   • The government’s expenditure target for 2024, at 22.2% of GDP, exceeds the IMF’s envisioned 19.7%, and it surpasses the revised budget estimate of 18.7% for 2023.

3. Uncertain Revenue Generation and Risks:

   • The achievement of revenue goals in 2024 is uncertain, given Sri Lanka’s history of fiscal slippage.
   • Despite a planned 3-percentage-point increase in the value-added tax (VAT) to 18%, there are concerns about revenue collection, especially as it fell 29% short of targets over 9M23.
   • The ambitious target of raising revenue by almost 45% in 2024 poses a considerable risk, and factors like inflation, while contributing, may not provide a robust boost.

4. Increased Spending and Potential Adjustments:

   • The government’s spending plans for 2024 include a 14% increase in spending on salaries and wages, as well as a substantial rise in capital expenditure, slated to increase by 55%.
   • While increased spending might strain the budget, there is potential for adjustments, especially in capital expenditure, if revenue falls short.

5. Governance Reforms and Revenue Collection:

   • Sri Lanka’s government aims to implement governance reforms, including the establishment of a new revenue authority under the Ministry of Finance to enhance tax collection.
   • Additionally, a new investment law is proposed to establish a National Economic Commission to promote investment.
   • However, the effectiveness of these reforms will take time to assess, and their impact on revenue collection remains uncertain.

6. Fitch Rating and Future Outlook:

   • Fitch Ratings currently maintains Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘RD’ (Restricted Default).
   • The rating is contingent on the completion of a commercial debt restructuring that normalizes Sri Lanka’s relationship with the international financial community.
   • The post-default rating will depend on Fitch’s assessment of Sri Lanka’s credit profile.