SPOTLIGHT ON REFORMS AND REVENUE

Shiran Fernando surveys the path ahead and the urgency for reforms and revenue

The presidential and parliamentary elections are behind us; and by end November, the external debt restructuring was approaching completion. A staff level agreement between the IMF and Sri Lankan government was also reached, following the third review.

Growth indicators are turning positive with more room to grow while the Sri Lankan Rupee has appreciated against the US Dollar. It seems things are turning around for the economy, following a few tough years.

And there is greater optimism that comes with a new regime.

So how can this turnaround be sustained as we take several steps forward towards inclusive and sustainable development?

THE TAX REGIME This is not necessarily the best news for taxpayers who are filing and paying their taxes. However, Sri Lanka has to continue to increase its tax collection record in order to reach the targets that will help the country be sustainable in its debt repayments.

The IMF estimates that an additional 1.5 percent of GDP needs to be collected so that tax revenue reaches close to 14 percent of GDP in 2025 and Sri Lanka can reach the primary surplus (budget deficit less interest expenses) of 2.3 percent of GDP.

So will existing taxpayers be burdened further or will it be broad-based?

This is the subject of discussion between the new administration and the IMF before the next tranche of the International Monetary Fund’s facility of approximately US$ 330 million is disbursed.

The government would like to provide some respite to the public by reducing VAT, reinstating certain value added tax exemptions that were removed last year and providing income tax relief. Some of this was mentioned in the National People’s Power (NPP) manifesto in the lead up to the presidential election.

With this potential loss of revenue, a further tax revenue of 1.5 percent needs to be collected. In its second review, the IMF estimated that lifting the vehicle import ban could bring the government an income of 0.8 percent of GDP.

This may take place during the early part of 2025 though the detailed tax policy wasn’t revealed even in late November.

The other big item is a wealth tax through an imputed rental income tax, which was expected to yield 0.4 percent of GDP. However, since the government has decided not to proceed with this option, new avenues will need to be explored to derive a higher level of tax.

One way is to step up the improvement of tax administration in relation to income tax, and customs and excise, so that the net is widened. A key focus has to be towards customs reforms. Digitisation efforts and modernisation of the customs law will greatly support this process.

The government’s focus on digitisation by bringing in a reputed businessman from the private sector to drive it is commendable. However, for this to be a success, it will need the buy in of the bureaucracy by showing that the changes will enable better and efficient services for the public.

FACTOR MARKET During the first year of a new administration, there is immense political capital to use in delivering on difficult reforms.

In the past, governments prioritised constitutional reforms over implementing economic reforms in the first couple of years of their terms of office. In trying to deliver these reforms, there’s a possible loss of political will to deliver on factor market reforms in the realms of land, labour and capital.

Sri Lanka has on average received less than one percent of GDP annually from foreign direct investments (FDI). Investors maintain that there are issues with accessing land, receiving the various levels of licenses and permission to set up, costs and labour regulations.

So the country focussed on providing tax holidays to compensate for this and endured substantial fiscal losses as a result. Furthermore, FDI hasn’t been visible in export oriented industries.

Though Sri Lanka isn’t going to be a low-cost niche manufacturing centre or service destination, the reform of regulations on labour, land and capital will convert investor interest into reality.

For example, the new Sri Lanka Electricity Act will help improve competition in the market and increase renewable energy contributions to the national grid. This will help ease the cost of power generation compared to coal or thermal options.

Digitisation of the land bank will help increase transparency of land ownership – in particular state land. Streamlining regulations and approval processes will help foreign and local investors, and SMEs, to plug and play – and worry less about domestic factors.

GROWTH FOCUS Sri Lanka can no longer rely on fiscal and monetary policy to be levers for economic growth. Acceleration must come from unlocking factor market constraints so that the private sector – be it large conglomerates or SMEs – is able to invest and grow.