Foreign funds looking at investing in Sri Lanka face an interesting dilemma.
With GDP growing at an average annual rate of 7.4% over the past five years, the south Asian nation has one of the fastest growing economies in the world. And yet it also continues to struggle with several sources of instability including high levels of public debt and a depreciating currency triggered by capital outflows.
To tackle such issues, the new government of Sri Lanka is taking “bold political steps” to re-establish fiscal consolidation and reduce public debt so as to stop the capital outflows and attract foreign investment, finance minister Ravi Karunanayake said at FinanceAsia’s inaugural Sri Lanka Investment Summit in Singapore on Tuesday.
Speaking before a packed room of investors at the Four Seasons Hotel, Karunanayake reiterated that enforcing financial discipline is key if the economy is to be steered back on to its rightful track.
As part of this plan, the government intends to roll out a series of reforms in the next few months including the privatisation of certain state-owned companies considered non-strategic and the introduction of public-private partnership projects, particularly in the infrastructure space.
The measures are intended to raise capital from the private sector to help pay off the country’s massive government debt, which it inherited from a civil war that lasted more than 25 years. Sri Lanka’s external debt burden was around 57% of GDP last year and was the highest among emerging markets in Asia, Moody’s said in a report last month.
Tax reform
Marie Diron, senior vice president of the sovereign risk group at Moody’s, told FinanceAsia that the country will have to reform its taxation system if it is to increase government revenue.
“Sri Lanka’s tax revenue has been very low because its tax base has been very narrow. Many people have been granted exemptions to income tax after the civil war,” Diron said. “Low tax income has been the major cause of [the] budget deficit over the past few years but it is not easy to execute tax reforms given the political obstacles that the government faces.”
As a long-term target, the government is looking to raise tax revenue as a percentage of GDP to the high teens from around 10% currently, Arjuna Mahendran, Sri Lanka’s central bank governor, said.
The country's parliament has taken the first step to increase value added tax to 15% from 11%, although this is widely seen as one of the conditions for the International Monetary Fund to grant a bailout loan to the debt-laden nation.
Negotiations with the IMF to fill the nation’s $2.5 billion financing gap this year are described by Karunanayake as “a step in the right direction.” Sri Lanka last month also entered into an agreement with the Asian Development Bank to provide more than $2 billion in loans and equity to pay for infrastructure and invest in education.
“An agreement with the IMF and financing from the ADB will provide some liquidity and thereby ease immediate financing pressures. At the same time, the financing will likely be at more favourable terms than market borrowing, alleviating debt servicing cost pressures to some extent,” Moody’s said in a February report.
Privatisation
As part of the debt-reduction program, the Sri Lankan government is preparing to offload some of its holdings in state-owned companies operating in non-strategic sectors.
Karunanayake said public stakes in certain companies will be listed on the Colombo Stock Exchange in two to three months, without mentioning the potential candidates for sale.
Such a move is much needed for the local stock market because it can greatly improve liquidity, which has been the main concern for foreign investors looking at the domestic equity market, said Vajira Kulatilaka, chairman of the Colombo Stock Exchange.
Hasitha Premaratne, chief financial officer of Brandix Lanka, said the privatisation scheme and the public-private partnership programme will give rise to large-scale projects for foreign investors. “In Sri Lanka we don’t have big projects in private sector so these programmes will help attract foreign investors looking to invest in scale.”
Through the multilateral public sector reform, Sri Lanka is looking to achieve an annual GDP growth rate of 6% to 9% and the creation of one million jobs over the next few years, Karunanayake said.
Click here for more of FinanceAsia’s reporting on Sri Lanka.
