The new stock broking firm TKS Securities last week came out with its own 2011 Budget preview. It briefly analysed the political and economic developments as well listing a few possible developments in the Budget 2011 which will be made public today in Parliament by President Mahinda Rajapaksa. Here are excerpts from TKS Securities report:
* The fiscal budget proposals for 2011 which would be presented in parliament on 22 November 2010 is eagerly awaited by the investment community and the public since it would be the first budget to be presented in the house after the end of a 27 year long war.Despite the war ending in May 2009, the Government did not go ahead with the normal procedure to present the 2010 Budget in Parliament and instead presented an interim budget proposals for the current year. Reasons could have been the focus on two main elections, consolidation from a period of hardship following an intense war, global financial crisis and also inherent political risk stemming from a weak parliament.
* We believe 2011 Budget proposals would be a starting point for a focused economic development program for the next 10 years. Hence the forthcoming budget proposals would be more investor friendly and free market oriented while somewhat compromising the subsidy culture favoured by the masses.The strong political mandate received by the incumbent Government creates the ideal opportunity to address the much needed strategic and structural changes to the economy which would enable the US$ 48 b economy to grow by a near 9.4% in 2011.
* Political stability could drive the much needed economic development
* Budget proposals of 2011 would take economic development as its priority
* Fiscal deficit targeted at 6.6%
* Tax cuts would revive economic activity
* State-sponsored infrastructure development drive to continue
* Investment promotion system would be restructured
* North and east development a main stay in the plan for the coming decade
* Few kick backs to local industries
* Cut back in subsidies
* Restructuring loss-making Government enterprises
* Listing of State institutions and more Government-private sector
Recent political developments
Following the presidential elections in January 2010 (in which the incumbent President Mahinda Rajapaksa won with a 58% majority), Sri Lanka’s parliamentary elections were held in April 2010. The President’s United People’s Freedom Alliance won 144 seats, just six short of a two-thirds majority. The main opposition party, the United National Party, won only 60 seats compared with 82 in 2004.
On 8 September 2010, Parliament passed the 18th Amendment to the Constitution with more than a two-thirds majority. The amendment removes the two-term restriction under the current executive presidency system thereby enabling any individual to serve as many terms (given a win in presidential polls) as the executive president.
On 19 November 2010, President Rajapaksa took oaths to commence his second term in office as the Executive President of Sri Lanka for the next six years. Hence having a two-thirds majority in Parliament (with Parliamentary elections due only after five years), the President is in a very strong political footing during his second term and we believe economic growth and development would be the primary focus in the coming years.
Economic developments
Weathering the global financial crisis and the economic doldrums resulting from the end game with a separatist terrorist group (which lasted nearly three decades), Sri Lanka’s economy had grown by 3.5% in 2009. However, 2010 has turned a new phase in development with the circa US$ 48 b economy, among the fastest growing in Asia.
Sri Lanka’s economy witnessed a marked improvement in economic performance in the first half of 2010 with GDP growth rates of 7.1% for the first quarter and 8.5% for the second quarter compared with the same quarters in 2009. The 2010 second quarter growth rate is noteworthy as it is the highest recorded quarterly GDP growth since 2002. The three major sectors of the economy all grew in the second quarter of 2010 over the same quarter in 2009; agriculture by 5.1%, industry by 9.2%, and services by 8.8%.
In 2H2010 we believe the industrial and services sectors of the economy would maintain the same growth momentum an average 9% YoY growth. Agriculture sector would near 6.4% growth mainly in 1Q2011 which would be strengthened with strong tea prices and the Maha Season (October-January) projected to provide a bumper paddy harvest with fresh fields adding to the north and east supply.
Sri Lanka’s sovereign credit rating was upgraded in September 2010 by international rating agencies; Standard & Poor’s (S&P) and Fitch Ratings. Standard & Poor’s (S&P) upgraded Sri Lanka’s long-term foreign currency sovereign credit rating to B+ and the long-term local currency rating to BB- with a stable outlook.
Fitch Ratings affirmed Sri Lanka’s long-term foreign and local currency issuer default rating (IDR) at B+ while upgrading the outlook to “Positive”. Moody’s Investors Service assigned a B1 foreign currency issuer rating with a stable outlook.
The fourth review of the Sri Lanka Stand-by Arrangement was successfully completed by the International Monetary Fund (IMF) and the fifth tranche of SDR 137.8 m (approximately US$ 212.5 m) was approved by IMF’s Board and disbursed on 24 September 2010. With this, IMF has disbursed a total of US$ 1.275 b under the US$ 2.6 b standby facility, approved in July 2009.
On 27 September 2010, Sri Lanka’s third international sovereign bond, a US$ 1 b 10-year issue with a coupon rate of 6.25%, attracted an order book that exceeded US$ 6.3 b. The coupon rate of the sovereign bond is significantly lower than those of previous two international offerings in 2007 (8.25%) and 2009 (7.40%). The oversubscription of the bond issue reflects higher global investor confidence in the economy.
The Government will use the proceeds from the bond issue to finance its current infrastructure investment plans and to restructure a part of the existing debt stock to improve overall public debt management.
Fall in global prices coupled with prudent monetary management led to a rapid decline in point-to-point inflation from a peak of 28.2% in June 2008 to single digit levels by February 2009. The low inflationary environment has continued with October 2010 point to point inflation at 6.6% and the moving 12 month annual average inflation at 5.4%.
Exports grew 10.8% YoY to US$ 5.0 b in Jan-Aug 2010, and imports by 36.9% YoY to US$ 8.7 b, largely because of a revival of domestic consumption. The growth in imports were driven by a 45.1% YoY increase in consumer imports to US$ 1.8 b, 39.9% YoY growth in intermediate goods imports to US$ 4.8 b (of which US$ 2.1 b was for petroleum product imports, rising by 56.3% YoY) and investment good imports which rose by 21.1% YoY to US$ 1.9 b. As a consequence, the trade deficit increased by 103.7% YoY to US$ 3.6 b. Workers’ remittances rose by 12.9% to US$ 2.5 b during the first eight months of 2010.
With greater inflows of foreign exchange (chiefly hot capital flows and the exporters bringing back cash which was parked overseas), the country’s foreign reserves were reported at US$ 6.8 b (sufficient to finance 6.4 months average imports and also is more than twice the monetary base of circa US$ 3.3 b) by end October 2010.
The fiscal deficit in 2009 was 9.8% of GDP, exceeding the planned deficit of 7.0%. This was mainly due to weak revenue collection in conjunction with higher expenditure and the overall slowdown of the economy due to the final stages of the war and the global financial crisis. The fiscal deficit was financed mainly from borrowings, which expanded to 9.8% of GDP (Rs. 469.6 b) in 2009 from a target of 7.0% of GDP (Rs. 342.8 b). Based on data for the first eight months of 2010, Sri Lanka is on track to meet the 2010 fiscal deficit target of 8.0% with the Jan-Aug 2010 fiscal deficit recorded at 7.18% of GDP.
Current spending increased by 3.3% to Rs. 635.3 b, while total revenues increased by 21.0% to Rs. 495.3 b. The current account deficit was down 31.9% from 2009 at Rs. 140.0 b. Though the revenue as a percentage of GDP was below target at 9.0% (vs. the 2010 plan of 14.9%) during the first eight months, we believe the variance would narrow by end 2010 with the boost in import tax revenue.
In an attempt to boost Government revenues, the Finance Ministry halved import duty on passenger vehicles in June 2010. This move have brought the desired effect with the vehicle imports soaring to 11,815 as at September 2010 vs. 1,282 passenger vehicles been imported in the corresponding period in 2009.
The surge in vehicle imports was after the slash in import duty while over 10,000 vehicles were brought down from June to September 2010. Hence thus far the state coffers have collected circa Rs. 25 b from various types of taxes connected with vehicle importation in 1-3Q2010.
Possible developments in the 2011 Budget
The fiscal deficit would be projected at 6.6% of GDP in 2011. This target is in line with the IMF requirements (as per the criteria laid down when providing the US$ 2.6 b standby low cost loan facility) is a tough ask though achievable if all proposed revenue enhancement plans fall through.
Tax revenue is expected to be beefed up to 15.3% of 2011 GDP. Growth in tax revenue would be driven by a growth in economic activity rather than an increase in respective tax rates. While the tax structure could be simplified and rates slashed. We believe the VAT (presently having a range of 0%-20%) would be simplified with products and services either identified as VAT exempt or not. Thus VAT rate could be fixed possibly at 12.5% or 15%. If such a rate revision takes effect, VAT on most products and services would fall (e.g. Financial services, vehicles, luxury items, etc.). Normal corporate tax rate would also be reduced selectively from the current 35%.
Further the high office may lower the tax rate for export companies to 10% in order to maintain sectoral growth and enable the exporters to weather the appreciation of the local currency. We believe the government may provide incentive for public listed companies by reducing the corporate tax rate (possibly to 30%) and provide formulae to payout tax rebates for all corporate based on fresh investments made during a fiscal year. Personal income tax rates are also expected to be lowered in anticipation of higher indirect tax revenue (we expect the higher threshold rate of 35% to be slashed to 25%). Furthermore we believe that the 2011 Budget proposals would include a flat tax for every State employee (State sector employment is over one m) who are presently not required to pay income tax and also allow tax evaders to open tax files free of any penalties.
State institutions would be listed in the stock market though the Government would maintain control. The LP Gas operations which were bought by the Government, Sri Lanka Insurance Corp., Sri Lankan Airlines, the State banks are a few possibilities. Further the 2011 Budget might seek to issue special purpose bonds/investment certificates to finance the infrastructure developments such as the proposed highways, airport, telecommunication towers, etc.
The Board of Investments would be restructured under a new investment promotion framework and enable more transparent and uniform incentives for FDIs. We believe the 2011 Budget proposals would target at least US$ 1.5 b, which is agreeably a difficult figure to achieve given it requires the current inflow to be doubled.
The prevailing forex controls may be relaxed enabling individuals and institutions to invest overseas. Banks would be encouraged to build up their own forex reserves.
Development of the north and east regions would be given prominence, with better incentives for investors to start fresh projects alongside the state infrastructure development drive.
Regional industries chiefly, agriculture, dairy production, tourism and fisheries sectors would be given more incentives such as low cost credit and leasing of State property.
We believe the 2011 fiscal budget would keep the cost of fertiliser subsidy in check or even cut back the current cost of circa US$ 30 m. The current poverty elevation subsidy scheme (Samurdhi) which costs the Government coffers a near US$ 35 m per annum is expected be reduced to US$10 mn while having the plan to create sustainable employment.
The Ceylon Electricity Board would be restructured and the state would target to cut back the current losses of near US$ 30 m to around US$ 11 m in 2011.
Tertiary education system reforms would be introduced enabling foreign universities establish themselves in Sri Lanka.
Debt to GDP levels are expected to be kept around 81.5% levels.
We believe a moderate increase in state sector compensation and pension cost is to be expected.
In conclusion we expect the forthcoming budget proposals to be more investor friendly enticing the private sector and FDIs to play an active role in the economic development of the country. Hence with the indication that interest rates would remain low the 2011 Budget proposals would be equity market friendly. Given our expectations from the 2011 Budget proposals remain valid, it would be positive for the broad market while sectors such as banking and finance, hotels and tourism, trading, local industries and agriculture could be the key beneficiaries.
Budget 2011 expectations
Reuters: Sri Lanka on Monday presents its first full-year budget since its long civil war ended in 2009, and it is expected to set out reforms to improve fiscal management and ease longstanding foreign investment hurdles.
The Government wants to trim its perennially wide budget deficit to 6.8 per cent, a main goal under $2.6 billion International Monetary Fund (IMF) loan programme.
Following are key figures and highlights of what to expect:
* Government spending expected to be 1.28 trillion ($11.5 billion)
* Public investment set to increase by 10.8 per cent to Rs. 400 billion in 2011 from 361 billion this year
* Expenditure on public sector wages projected to increase by 18.6 per cent year-on-year to 318 billion rupees in 2011
* Revenue estimated to rise 10 per cent year-on-year to 900 billion
* Defence budget expected to grow by 6.3 per cent to Rs. 215.2 billion, despite end of the war.
Budget gap
The global lender has categorically said this budget will be an important sign of the authorities’ willingness to execute the reforms it has long promised to help address structural weaknesses that beset its $42 billion economy.
The IMF wanted Sri Lanka to trim its budget gap to five per cent by the end of 2011. The Government is targeting 6.8 per cent, saying it cannot move so swiftly to cut public investment so fast. It missed its 2009 IMF target and will likely miss in 2010.
Tax reforms
* Tax reforms are expected to focus on widening the tax base and simplifying what is now a byzantine system that is often flouted. Around 1.3 million State employees may find themselves taxed.
* Rationalisation of the foreign investment regime. The Government is expected to nullify blanket tax exemptions on foreign direct investment and consider it on case-by-case, while removing bureaucratic barriers.
* However, the Government is expected to announce some concessions for outside investment in the agriculture, tourism, ports, fisheries, information technology, and business process outsourcing sectors.
* Banking sector taxes are expected to be reduced, but Treasury officials have said it is too early for such a move.
Relaxing exchange controls
* This is expected to allow local businesses to invest in other countries and foreigners to invest with flexibility. Presently, foreign exchange is tightly controlled, and the Government wants to make it easier for investors to get in and out of Sri Lanka more quickly.
Public sector pay hike
* The public sector is expected to be given a net monthly salary increase of around $13, far below the $80 trade unions have been demanding. This could create political tension, as the unions have a long history of agitation and job actions and have even toppled governments in the past.
Key figures expected in the 2011 budget, according to the latest fiscal report by the Finance Ministry: (all figures given as a percentage of GDP)
AsiaSec’s take on status of the economy
Harping on the fact that Sri Lanka emerged from a three-decade bloodshed is a cliché at this juncture. This point has been overly discussed and articulated in the current context.
No nation which emerged from the ashes kept re-printing its chronicles, and that is what we need to emulate in Sri Lanka to build a stronger nation.
The key factor of importance is the healthy growth in the real economy. Sri Lanka has always shown resilience even during the periods of extreme hardship. The 1H2010 GDP data shows 8% (YoY) increase. The growth of agriculture, industry and the services sectors amounted to 5.1 %, 9.2% and 8.8% respectively during the corresponding period. The services sector is expanding as a response to the higher demand for food and beverages and transportation.
Furthermore, the foreign inflows have recorded a staggering increase where the forecasted figure for FIIs in 2010 hails at US$ 1,110 million, stamping a boost of circa 254.6% YoY. It indicates the positive outlook of the investors on Sri Lanka’s fruitful future prospects.
However, the expanding trade deficit is an area of concern. It could be a possible deterrent coupled with the looming foreign debt position of the country. Albeit, these turn of events increase the reserve balance and the foreign debt is matured by the short term foreign indirect investments flowing in to the financial assets of the country.
However, the strategy of building reserves via short term investments (Foreign Indirect Investments) and borrowing is not free of flaws. This could have serious negative implications on the BOP, by rising susceptibility to any external financial shocks.
Sri Lanka is in severe need of FDI flowing to the real economy, to create capital accumulation and fuel export oriented businesses. In order to attract the FDIs the Government will have to create an investor-conducive environment. Hence, the upcoming fiscal budget is the most spoken focal point of the economy.
Asia Research expects a “pro-investor, pro-poor budget”. We expect the current tax base to be broadened and tax evaders to be brought to the system, invariably improving the revenue base of the country. Furthermore, Government would also have to take into account the curtailment of looming Government expenditure via intelligent fiscal reforms and consolidation.
With the pro-investor monetary milieu (low inflation and interest rates) expecting to fuel the credit growth and invariably augmenting the GDP, the above mentioned short term ripples should be withered easily, and set Sri Lanka on smooth sailing mission.
source - www.ft.lk
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