Colombo readies tax, investment reforms

Sri Lanka will initiate tax and investment reforms in its next budget following a parliamentary election in April, a government official said yesterday, amid pressure from the IMF to rein in a budget deficit.

Last week the International Monetary Fund delayed the third tranche of a $2.6bn loan after Sri Lanka failed to achieve its 2009 IMF budget deficit target.

The budget deficit last year hit an eight-year high of 9.7%, well over the IMF target of 7%. On Tuesday, Sri Lanka said it would miss the 2010 IMF deficit target as well.

“The aim of the reforms is to change the current investment climate to attract massive inflows into the country,” a senior government official, who is privy to the government’s planned reforms, said on condition of anonymity.

“There will be clarity in our tax regime for a sustainable government revenue and productivity improvement will be the key in the public sector.”

Another government official confirmed the reforms, saying they were at an “initial stage”.

Economists say the persistently high fiscal deficit has been due to low tax collection and high government expenditure mainly due the 25-year long civil war and a bloated public sector.

“The reforms will widen the tax net so that the effective tax rates will be reduced as more people pay taxes, while efficiency, effectiveness and no wastages will be ensured in the public sector,” the official said.

The reforms will pay special attention to restructuring the state’s loss-making petroleum corporation and electricity firm, which the government had agreed with the IMF, he said.

“But all the changes will be gradually implemented in a manner that won’t have any drastic impact on the labour force or the stability of macroeconomic fundamentals.”

Analysts say the failure to implement the reforms could lead to a ratings downgrade, volatility in macroeconomic fundamentals, and the withdrawal of foreign funds from government securities. It could also increase borrowing costs for the planned 10-year, $500mn sovereign bond later in 2010.

Foreign investment in government securities surged after the IMF approved a loan last July to avert a balance of payments crisis, caused by the global financial crisis after the end of the civil war in May. The loan helped stabilise the rupee and interest rates.

However, concerns over the budget deficit have hurt investor confidence with offshore investors leaving the country’s share market, data shows.

Until Wednesday, foreigners have been net sellers in 31 out of the 39 trading sessions so far this year and have sold a net of over $44mn worth shares. They have also sold a net $23mn worth shares since the presidential election.

However, analysts say the numbers are distorted due to the gradual exit of a US-based hedge fund after its Sri Lankan-born founder was charged in an insider dealing case.