Sri Lanka tax revenues grow 29-pct up to May amid inflation
ECONOMYNEXT – Sri Lanka’s tax revenues grew 29 percent to 811.9 billion rupees in the five months to May 2022 while spending went up 16 percent to 1,275 billion rupees, keeping the overall deficit largely unchanged amid a small increase in capital spending, official data shows.
Capital spending was 174.2 billion rupees, up from 162.4 billion rupees.
The overall deficit for the first five months was 636.7 billion rupees up to May 2022 from 634.8 billion rupees a year earlier.
Domestic borrowings went p to 742.7 billion rupees, up from 585.7 billion rupees with net repayment of 106 billion rupees of foreign debt.
CB credit bigger than deficit
Central Bank financing was 810.7 billion rupees, greater than both the budget deficit and total domestic financing.
In Sri Lanka and most other countries, central bank credit is blamed on budgets, but intermediate regime central banks (soft-peg) buy maturing Treasury securities from commercial banks to keep rates down or to sterilize reserves sold for imports.
Later the liquidity injections are blamed on budgets. In the days of the classical economists open market operations were conducted with private securities (bankers’ acceptances), leading to a correct diagnosis of the problems and permanent remedies.
Economists also cut taxes to boost growth in 2019 after claiming that there was a ‘persisted output gap’ in the wake of the 2016 and 2018 currency crises.
After a balance of payments deficit is created and the credibility of the soft-peg is lost, the soft-pegged central bank is also forced to use reserves to repay debt, further expanding central bank credit and rapid loss of reserves.
Sri Lanka defaulted in April 2022, after two years of money printing and tax cuts to target an output gap.
Restoring monetary stability requires a steep rise in rates and a smashing of domestic economic activity to reduce outflows.
Though Sri Lanka’s real GDP is expected to contract 2022, the economy is inflating in rupee terms after severe bout of money printing by the central bank to keep rates down and boost growth (output gap targeting).
The central bank has said real GDP may fall 8 percent in 2022.
Inflation
The central bank in its annual report released in April projected nominal GDP of 20.7 trillion rupees in 2022, up from 16.8 trillion last year.
Based on that calculation revenue to GDP went up to 3.9 percent of GDP up May from 3.7 percent a year ago and current spending was down to 6.2 percent from 6.6 percent.
The current account deficit fell to 2.2 percent of GDP from 2.8 percent.
The central bank however allowed interest rates to go up from around April 2022 to slow credit, imports and restore monetary stability.
The slowing economy tends to reduce imports and consumption, while high inflation tends to increase nominal revenues.
Peg Correction
However the corrective rates to re-establish credibility of the broken soft-peg and reduce inflation also tends to steeply increase interest costs pushing up the overall deficit.
Due to the need for monetary tightening, International Monetary Fund programs usually target a primary deficit, which is the deficit before interest rates.
Interest rates of countries with soft-pegs tend to be nominally high, compared to hard pegs and free floats, which have 2 percent inflation targets.
In 2022, unlike in past soft-peg crises, Sri Lanka is also re-structuring debt, having defaulted on foreign debt from April.
There are concerns of domestic rupee debt re-structuring which is keeping interest rates elevated.
Interest rates tend to stabilize after only after a float of the currency ends money and exchange rate conflicts (sterilized forex sales0. Under an IMF program, the currency is then re-pegged to rebuild reserves under a net international reserve target.
Steep downgrades have also triggered net repayments of foreign borrowings from the banking system. (Colombo/Aug29/2022)
