Economic recovery bid: Disinflation cheer, domestic debt fear

As its economy and finance stature grows in slow momentum, Sri Lanka maintains a multi-alignment approach instead of non-alliance stance to geopolitics harnessing foreign fiscal support in 2023 amidst the stable political situation under the leadership of President Ranil Wickremesinghe.
The sensitive fiscal, external, and financial sector imbalances pose some uncertainty for the economic outlook.

Growth prospects depend on debt restructuring and growth enhancing structural reforms. At the same time, fiscal consolidation will likely diminish these prospects, with the fiscal deficit expected to gradually fall over the medium-term.

Monetary and fiscal authorities assured that any restructuring of domestic debt, made known to people as debt optimisation, will be purely on a voluntary basis.
But this announcement by the government sent fear-waves across the economy activating the panic sentiment of the people.

There was a fear that, due to this voluntary debt optimisation, the public will lose a significant part of the financial assets they are holding, not necessarily in government securities.
Inflation is forecasted to come down from a high base as monetization of fiscal deficits is reined in.
The current account deficit is expected to decline owing to import compression, despite slowing exports due to weak global demand. Additional resources will be needed in 2023 and beyond to close the external financing gap.

The island nation’s inflation is now coming down faster than expected. The interest rates from the peak easing down, especially after the Central Bank announced the complete debt restructuring process.
The market interest rates will come down faster so in the second half, interest rates would be normalized in line with the inflation expectations prediction which is a single digit towards the end of the fourth quarter this year, the Central Bank said.

Around slightly over five years into 2023, and India is well underway with preparations for a pivotal year.
With all eyes on Sri Lanka, The government may be increasingly sensitive to global insights of how it handles possible shocks – external or internal – ranging from escalation on its borders to incidents of provoked youth violence.

Deflationary pressure in Sri Lanka is easing as consumer prices rise at the slowest pace in two years, suggesting improvement in domestic demand and a road ahead to full economic recovery,
The consumer price index rose by just 0.1 per cent in April from a year ago, the lowest rate since February 2021, according to the National Bureau of Statistics on Thursday (11). In March and February, it increased by 0.7 per cent and 1 percent respectively.

The producer price index, which measures factory-gate prices, declined by 3.6 per cent, marking the biggest contraction in three years. It’s the seventh straight month the figure has fallen.
The Finance Ministry is now strictly managing the treasury cash flow to meet the recurrent expenditure amidst signs of some stability, not by improving the economy, but with several tax increases and subsidy cuts that have further curtailed demand.

On account of these new revenue generation measures and 6 per cent expenditure cuts of ministry budgets, the government is to introduce a Financial Management Act (FMA) aimed at managing public finance and expenditure, finance ministry documents disclosed.
With the expected tax adjustments, the government is expecting a total income of Rs. 173 billion, but for the essential recurrent expenditure alone it requires Rs. 196 billion, resulting in a deficit of Rs. 23 billion for the month of March.

State salaries cost Rs. 87.4 billion, pensions and income supplements (Samurdhi programme) were Rs.29.5 billion while other expenses were Rs. 10.8 billion.
The amount needed to service debts in March is Rs. 508 billion. Debt service was Rs 377.6 billion for January 2023 which has to be covered with borrowings from treasury bills, bonds and a Central Bank provisional advance of Rs.100 billion, a finance ministry report revealed.
The relevant bill on finance is being finalised with the aim of improving the responsible fiscal management process when dealing with public finances and to take substantial decisions based on efficient resource utilisation.

The new Act will provide provisions to introduce reforms and modernise the accounting and reporting standards and make public sector accountability as a mandatory requirement.
The Inland Revenue Department (IRD) announced that it had collected tax revenues of Rs. 317 billion in 1Q-2023. This figure was Rs.147 billion in 1Q-2022 and the IRD believes that this trend will continue as the economy begins to recover in the latter half of 2023 year end.
The indicative target for the central government tax revenue for 2023E is Rs. 2,940 billion. However, achieving the indicative targets as detailed in the recent IMF report on the Sri Lanka EFF may be challenging.

The stability of the public deposits and banking system’s stability should be properly maintained, and one of the key objectives of the Central Bank is to maintain banking system stability.
The Central Bank is hoping the interest rates would be normalized in the second half of the year, in line with the inflation expectations prediction which is a single digit towards the end of the fourth quarter.
In this era of uncertainty when Sri Lanka is facing its worst ever economic crisis since independence in 1948, President Wickremesinghe’s administration is making proactive efforts to pull the country and its people out of the economic abyss.

The agreement with the International Monetary Fund (IMF) for the US$ 3 billion extended fund facility was a major step towards recovery.
Several countries including India, China and the United States are also helping in a generous manner to help the government reach sustainable development goals and give substantial relief to millions of people caught up in a poverty trap.

In these moves, the government needs to make full use of marvelous developments in digital technology.
The necessary macroeconomic adjustments may initially adversely affect growth and poverty but will correct overall imbalances, help regain access to international financial markets and build the foundation for sustainable growth.

Mitigating the impacts on the poor and vulnerable remains critical during the adjustment. Reducing poverty requires better-targeted social assistance, an expansion of employment in industry and services, and a recovery in the real value of incomes.
On the upside, the government’s reform program, supported by financing from international partners, could boost confidence and attract fresh capital inflows key to restart the labor market and restore livelihoods.

President Wickremesinghe this week gave instructions to initiate the “Aswesuma” welfare benefit payment scheme, which is scheduled to commence from July 01.
These payments will be distributed among four social categories, namely transitional, vulnerable, poor, and extremely poor. Additionally, the usual allowances for the differently abled, elderly, and kidney patients will also be provided.
Accordingly, 400,000 transitional beneficiaries will receive Rs. 2,500 per month until December 31, 2023, 400,000 vulnerable beneficiaries will receive Rs. 5,000 per month until March 31, 2024, 800,000 poor beneficiaries will receive Rs. 8,500 per month, and 400,000 extremely poor beneficiaries will receive Rs. 15,000 per month for three years beginning July 1, 2023.
Meanwhile, the Inland Revenue Department has to achieve the annual revenue target of about Rs. 2 trillion, in the remaining three quarters, the department should work hard to increase its revenue realisation to Rs. 561 billion.

If the second quarter also yields a low revenue realisation of, say 70% of the budgetary target of Rs. 500 billion, during the second half of 2023, the department should strive for a revenue realisation of Rs. 661 billion in each of the remaining two quarters.
This is a challenging task for the Inland Revenue Department to realise the full target for the year. If the revenue falls below the budgeted target of Rs. 3.2 trillion and unless the government cuts its current and capital expenditure drastically, the need for restructuring the domestic debt, even when one considers only the central government debt, will be a ground certainty and not just a possibility.
The government is planning to resolve its fragile budgetary issue, including the issues relating to meeting the domestic debt obligations, through the increase in the tax revenue known as fiscal consolidation by increased revenues of the government.

As it is, this strategy has a limitation because there is an upper limit of increasing the tax revenue of the government given the gloomy economic recovery and the drastic curtailment of the aggregate demand of both private individuals and the government under the macroeconomic stabilisation program currently being pursued.

This curtailment of the aggregate demand is necessary to return to price stability which has gone haywire due to the irresponsible money supply increases in the past. But it has stunted the growth prospects and, according to the projections by the IMF, growth will return steadily but slowly to 3 percent by 2028.

– Carcharodon