- No Danger Of Inflation
The property market, the key driver of credit growth has not taken off, an IMF official told reporters on Friday. IMF’s team leader for Sri Lanka Dr. Brian Aitken said that he expected inflationary pressure to be subdued despite excess liquidity in the market coupled with high credit growth because of its low credit base, thus a slow increase in the asset base, minimizing inflationary pressure on the economy.
CBSL has been sterilizing excess liquidity in the market, over Rs. 100 billion on a daily basis due to inflows, through its repo window.
The property market, the key driver of credit growth has not taken off, he said.
Aitken therefore was happy with the country’s current interest rate regime. A principle way to control inflation is by raising rates.
Aitken expected food inflation, caused primarily by the recent floods, to be temporary.
The occasion was the IMF team visit to review its US$ 2.5 billion standby arrangement (SBA) with Sri Lanka, with particular reference to the island’s fiscal and monetary targets for last year as set by the Fund. IMF has already disbursed US$ 1.5 billion from its SBA and another tranche of US$ 200 million for disbursement is pending, with the balance four tranches of US$ 200 million each in line for disbursement and spread over a period encompassing upto the first quarter of next year.
The decision for the disbursement of the next tranche of US$ 200 million is expected to be taken up by Washington next month after receiving Aitken’s report. Aitken is due again in the island in May to review the situation for the disbursement of the next tranche.
He said that the dip in foreign direct investments (FDI) last year may have been due to investors adopting a “wait and see” attitude as to what the proposals of the Tax Commission were and not due to IMF pressure. Aitken gave this reply when this reporter asked him whether the contraction of FDI inflows into the country last year was due to IMF pressure on the Government to have a re-look at the BoI tax concessionary regime, coupled with the pending Tax Commission report to the Government at that time.
“No one has said that the retardation of FDI inflows into Sri Lanka was due to IMF’s influence,” Aitken said.
FDI inflows last year, the island’s first full year of peace after 26 years of war was US$ 500 million according to the Central Bank of Sri Lanka (CBSL)-IMF Resident Representative Dr. Koshy Mathai said that it was US$ 375 million-whereas in the preceding year, when the country was at war with the LTTE till May 19, FDI inflows at US$ 601 million (according to CBSL) was higher than FDI inflows the following year. The Tax Commission’s recommendations were tabled in Parliament in President Mahinda Rajapaksa’s 2011 Budget proposals. IMF was a strong proponent of rationalizing the BoI’s tax concessionary regime.
Aitken told reporters that FDI doesn’t flow into a country because of a low tax regime, but it does flow in when there is stability, predictability and when there is ease of doing business, he said.
The Government is correctly moving to a simplified and broadbased tax regime which would help uplift tax revenue, said Aitken.He said last years tax collections comprised 15¾% of GDP with a commitment by the Government to increase it by 0.6% of GDP this year and by a further 1% of GDP in the next. BoI targets an FDI inflow in excess of US$ one billion this year. Aitken said that some hotels projects were about to takeoff. The corporate sector needs a broader tax base, said Aitken. Previously one or two entities were paying a 35% corporate tax while the rest were paying 28%, he said. The Government in Budget 2011 brought down corporate taxes to 28%.
Earlier the petroleum, liquor, tobacco and banking sectors paid higher taxes which were passed down to the consumer, he said.
Another commitment made by the Government to the IMF was that the state owned Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC) would break even this year.
However Aitken said that if the CPC made profits, the CEB making a loss would not matter in the IMF’s scheme of things.
This was after this reporter pointed out that the CEB is projected to make a Rs. 16 billion loss this year (see also page 33).
He said that the losses made by these institutions have come down from 1% of GDP to ½ % of GDP by last year.
But an escalation in oil prices would require an upward adjustment in retail petroleum prices, he said.
On the distortion caused by exempting the CEB and CPC from paying taxes, he said that there was no distortion, likening the tax charges to such institutions to “robbing Peter to pay Paul” syndrome as both were state entities. Aitken also said that the Government has seemingly met its last year’s targets, except that there had been a US$ 400 million deficit in the net international reserves (NIR) target due to it having to meet some import bills.
Last year’s NIR target was some US$ 1.3 billion, while for this year the IMF has uplifted it by a further US$ 135 million. In the calculation of NIR income generated by exports and remittances are taken into account, but not loans, concessionary or otherwise.
Aitken said that CBSL’s recent position of defending the local currency was not going to make a serious dent in its reserves position. He however said that the IMF preferred a flexible exchange rate.
Aitken expected remittances to grow this year despite the upheavals in the Middle-East (Sri Lanka’s major source of remittances, primarily by exporting housemaids to this region), coupled with increased diaspora funding. He however expected reserves to be lower this year than the last. CBSL said that gross international reserves last year were US$ 6.6 billion. Aitken also expected the trade deficit to widen this year due to increased imports and the balance of payments to take a hit as a result. He said that the authorities had informed him that there won’t be any expenditure over-runs due to the recent floods and contingencies could be met by the re-allocation of expenditure.
The donor community was expected to look at Sri Lanka’s “flood situation” later this month, Aitken said. Other sectors of the economy are growing despite the floods, so the impact is marginal, he said.
IMF was flexible to consider expenditure over-runs due to natural disasters, said Aitken. The Government has committed to the IMF to bring the fiscal deficit down to 6¾% of GDP this year (from 8% of GDP last year) and to further bring it down to 5¼% of GDP next year.