Sri Lanka: The government announced a 5.9% fiscal deficit target for 2016

In the wake of general elections before this year, Sri Lanka has emerged with a renewed emphasis on economic reforms and fiscal consolidation, which has allayed concerns for a lot of local and foreign investors.

Until August, election delays had entirely created a wait-and-see approach in the private sector, with investors pressing pause on several high-profile projects. Most notably, the country’s major-ever foreign investment – the $1.4-bn Colombo Port City real estate project funded by the China Communications Construction Company – remains on hold as the year comes to a close.

Road to fiscal consolidation

Released in November, the 2016 budget signalled the new coalition government’s initial major policy declaration and included a reduction in investment ownership restrictions and a variety of tax incentives. The government will be looking for these reforms to help boost foreign direct investment (FDI), which has averaged just 1.5% of GDP over the last five years, compared to an average of 3.1% part other “BB”-rated nations.

Nonetheless, concerns remain over the government’s ability to improve revenues while as well reining in expenditures. The government announced a 5.9% fiscal deficit target for 2016, only a slight decline over the 6% estimate for 2015, and according to ratings agency Fitch, the budget “provides no clear plan for fiscal consolidation over the medium term”.

Government revenues have been in decline since 2010, falling to just 12.3% of GDP in 2014 due to weak tax government and collection structures. A further 6.4% drop in gain tax collection is expected in 2016, placing better pressure on other revenue streams to support the government’s projected 38% rise in in general revenue.

Adding to the pressure is a continued rise in expenditures, which are expected to reach 22.3% of GDP in 2016, up from 19.1% in 2015, fuelled by major government investments in infrastructure, health care and education.

The fiscal imbalance has been exacerbated by public sector fee hikes and increased social welfare spending in 2015 – some of the initial moves made by the new coalition government – alongside price controls on green-leaf tea and subsidies on natural rubber and fertilisers.

Market measures

To help fund the deficit, Sri Lanka’s government visited international capital markets twice in 2015. In late May the country sold a $650m, 10-year sovereign bond at a rate of 6.125%, while the second 10-year oversubscribed bond offer, issued in late October, sold at a coupon rate of 6.85%, raising some $1.5bn.

The higher pricing of the second offer was attributed in part to a decline in Sri Lanka’s foreign reserves – which fell from $8.8bn to $5.6bn in the 12 months to October 2015, according to figures from the Central Bank of Sri Lanka (CBSL) – inclunding broader world economic uncertainty.

The rupee’s decline, which mirrors a general weakening of Asian currencies this year, reached a record low of LKR143:$1 in late November, down some 10.5% year-to-date.

Trade figures

Declining crude oil prices – which fell by additional than 50% in 2014 – offered some relief for the country’s balance of payments, and were from presently on passed on to consumers and businesses through national-led reductions in gasoline prices.

The country, which hopes to achieve 100% energy self-sufficiency by 2030, currently imports fossil fuels to satisfy around 44% of domestic consumption. Energy imports have traditionally cost the country $5bn per annum in foreign exchange, equivalent to roughly 25% of total import spending and nearly half of export gain. According to the CBSL, declining prices and imports led to a 60.5% reduction in the country’s fuel import bill as of August.

However, these energy savings have been largely offset by Sri Lanka’s rising import bill in general. An easing of duties saw consumer spending on imported motor vehicles nearly double y-o-y in the initial eight months of 2015 to $905m, according to the CBSL, though loan-to-price caps and higher taxes on vehicles, along with the depreciation of the rupee, are expected to curb consumer appetite into 2016.

Overall, exports continued to decline as a % of GDP in 2015, next falling by double digits in 2013 and 2014. On a cumulative basis, export earnings fell by 3.4% y-o-y in the initial eight months of 2015, according to central bank data, largely due to weak world request.

Industry stakeholders continue to underscore the importance of diversifying and adding price to Sri Lanka’s export basket and trade relationships, replicating the country’s before success in the garment market. A variety of sectors, inclunding branded tea, rubber products, gems, IT and business process outsourcing, are all seen as potential avenues for expansion.

Tourism ranks as top performer

Tourism, meanwhile, posted record increase in 2015. Thanks in large part to Chinese tourists, whose numbers have risen additional than 10-fold since the civil war ended in 2009, Sri Lanka saw arrivals surge over the year, surpassing the 1.5m mark in November for an 18.1% y-o-y increase.

Along with inward remittances, tourism represents an significant component of Sri Lanka’s foreign exchange earnings, though both are vulnerable to volatility in international economic conditions.

As major international hotels, inclunding luxury players Shangri-La and Grand Hyatt, continue to emerge in Sri Lanka, the country will be looking to reinforce its tourism profile overseas in 2016 and beyond.