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Hard times ahead

05 Jun 2022

By Shenal Fernando  Sri Lanka is currently facing its greatest economic crisis since independence. On one hand, there is a devastating foreign exchange crisis, while on the other, there is a troubling fiscal imbalance resulting from the decrease in Government revenue together with the increase in expenditure over the past two years. When considering the fiscal imbalance, Sri Lanka’s budget deficit as a percentage of GDP reached double digits over the past two years at 11.1% in 2020 and 12.2% in 2021. Apparently, the situation has aggravated to such an extent that the Treasury has been forced to increasingly obtain Central Bank of Sri Lanka (CBSL) financing to undertake Government expenditures, including a substantial part of interest, salaries and wages, pensions, and Samurdhi payments.  The tax cuts granted in 2019 have been blamed by many economists and policy institutions as the primary reason for the significant loss in Government revenue over the past two years. The 2019 tax cuts included reduction of tax rates of Value Added Tax (VAT), Personal Income Tax (PIT), and Corporate Income Tax (CIT), and narrowed tax bases of VAT and PIT, while introducing a plethora of tax incentives, such as tax exemptions for agriculture and Information Technology (IT) and enabled services, as well as tax deductions and tax holidays. Consequently, the estimated annual loss in Government revenue due to these tax cuts is around Rs. 600-800 million. In 2021, Sri Lanka saw its budget exceed Rs. 2 trillion for the first time and according to estimates, it is expected to reach Rs. 2.4 trillion in 2022. The delicate state of the economy was admitted by the new Prime Minister Ranil Wickremesinghe, who addressed the nation for the first time on 16 May 2022 and stated: “At present, the Sri Lankan economy is extremely precarious. Although the former Government’s budget projected a revenue of Rs. 2.3 trillion, Rs. 1.6 trillion is the realistic projection of this year’s revenue. The estimated Government expenditure for this year is Rs. 3.3 trillion. However, due to the increase in interest rates and additional expenditures of the former Government, the total Government expenditure is Rs. 4 trillion. The budget deficit for the year is Rs. 2.4 trillion. This amount equals 13% of the GDP.” Therefore, the recently announced tax reforms by the Government of Sri Lanka (GoSL) to achieve austerity represents a pivotal step in the right direction. On 30 May 2022, the Cabinet of Ministers approved a proposal submitted by the Prime Minister in his capacity as the Minister of Finance, Economic Stabilisation, and National Policies to amend the Inland Revenue Act No. 24 of 2017, Value Added Tax Act No. 14 of 2002, Telecommunication Levy Act No. 21 of 2011, Betting and Gaming Levy Act No. 40 of 1988, and the Fiscal Management (Responsibility) Act No. 3 of 2003 in order to raise Government revenue by Rs. 125 billion in 2022 and Rs. 292 billion annually going forward. Following this decision by the Cabinet of Ministers, steps were taken to immediately increase the VAT rate from 8% to 12% by Gazette Extraordinary No. 2282/26 dated 31 May 2022 subject to parliamentary approval. Similarly, the telecommunication levy was also increased from 11.25% to 15% with immediate effect by a letter issued by the Telecommunications Regulatory Commission of Sri Lanka, subject to the amendment of the Telecommunication Levy Act. These measures implemented with immediate effect are expected to raise around Rs. 94 billion in 2022 and Rs. 161 billion annually going forward. Certainly, the need of the hour is a fiscal consolidation plan involving robust revenue enhancement measures, together with expenditure rationalisation measures to ensure macroeconomic stability to support the medium- to long-term economic growth objectives of the country.  


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