Shiran Fernando gears up for Budget 2018 and the reforms that may go along with it

There are many moving pieces currently in the economy as the private sector gears up for Budget 2018. For starters, key reforms are due to be implemented such as the new Inland Revenue Act and Foreign Exchange Management Bill. Thereafter, a new Audit Bill and Customs Ordinance are expected to be presented in parliament.

The government has also signed a concessionary lease agreement for the Hambantota Port, which is expected to revitalise maritime activities in the south. While these reforms are in place, the macro economy is gradually moving towards stability, relative to the policy uncertainty of the last two years and with sharp adjustments in currency and interest rates.

A MIXED PERFORMANCE The second review by the International Monetary Fund (IMF) as part of its US$ 1.5 billion three-year facility reflected a mixed performance in terms of the country achieving certain targets set out when the programme commenced. Sri Lanka has performed well in achieving fiscal targets like tax revenue.

The advice of the IMF to the Central Bank of Sri Lanka (CBSL) has been to build up reserves by purchasing dollars in the market. Although this was delayed at the start of the year due to outflows from the bond market, it has been consistently achieved since March with net purchases being above one billion dollars in the March-July period. This move to adapt to market changes has been acknowledged by the IMF in its review.

STRUCTURAL BENCHMARKS There were a few notable misses in terms of meeting the deadlines set under the programme such as cabinet approval for an automatic pricing mechanism for both electricity and fuel by the end of last year.

In its most recent review, the IMF has acknowledged the political realities of such a move without a process that involves public consultation and education before being approved by the cabinet. As a result, the deadline has been extended to March and September of 2018 for fuel and electricity respectively. Moreover, the review saw the introduction of a few new structural benchmarks. By the end of October, CBSL is obliged to unveil a road map on how it hopes to implement flexible inflation and exchange rate regimes.

The Ministry of Finance has also been assigned the task of implementing an IT based commitment system for line ministries by January. With the system establishing commitment ceilings, the ministry will be transitioning away from a cash based management system to a more commitment based option.

TIGHTER POLICY RATES The review also saw the continued advice of further tightening policy rates as ‘desirable’ in particular to curb inflation and credit expansion pressures. The Central Bank hasn’t raised policy rates since March; and it has indicated a ‘wait and see’ approach to this at subsequent meetings.

Inflation pressures have been largely driven by supply issues from natural disasters such as droughts and floods, as well as the impact of changes relating to taxation. These could be viewed as temporary as opposed to being due to demand pressures, which would warrant policy action.

Growth in credit to the private sector has witnessed a declining trend on a year on year basis although certain months (e.g. June) have seen an unexpected monthly spike. But the expectation is for credit to ease in the second half of this year while CBSL may be inclined to wait on the data to confirm this trend prior to taking further policy action.

The Central Bank will also be mindful that GDP growth has been under pressure and that a further hike in interest rates may not be desirable to see a pickup in economic activity.

BALANCE OF PAYMENTS The steady growth recorded in exports has been a positive for Sri Lanka’s external account this year. In the first half of 2017, export earnings were up by 5.7 percent, led by tea and seafood.

While import expenditure has also risen in the first six months of this year, it is expected to ease in the second half with an improvement in weather conditions. So the trade deficit could be under less pressure in the second half of 2017.

Despite the expansion in the trade deficit, the balance of payments is forecast to be in surplus to the tune of US$ 1.5 billion in the first half of 2017 compared to a deficit of 1.1 billion dollars in the corresponding period of last year.

This surplus is being driven by the continued appetite for debt related issues with a total of three billion dollars in inflows through a syndicated loan, a sovereign dollar bond and long-term loans. But the concern will be over the slowdown in tourism earnings and a contraction in overseas remittances against the backdrop of uncertainty in the Middle East.