Sri Lanka hikes VAT, taxes capital gains before IMF loan talks

Ranil Wickremasinghe

Sri Lanka will raise its value added tax and reintroduce capital gains tax to break out of a debt trap, Prime Minister Ranil Wickremesinghe said on Tuesday, ahead of talks on a $1.5-billion loan it is seeking from the International Monetary Fund.

Sri Lanka’s finances are under scrutiny after ratings agency Fitch last week downgraded its sovereign rating by a notch, to “B+”, spurred by a ballooning fiscal deficit, rising foreign debt and sluggish growth prospects.

It also faces a balance-of-payments crisis after a third of its foreign exchange reserves was depleted within the 15 months to January by the central bank’s defence of the rupee currency, pressured by heavy debt piled up under the previous government.

“This crisis can be overcome only by reducing the budget deficit and a medium-term joint financial programme aiming at suitable reforms to reduce the debt burden,” Wickremesinghe told lawmakers.

Taking action to boost revenues, he announced that VAT would be hiked to 15 percent from 11 percent, while capital gains will be taxed for the first time since 1987.

Wickremesinghe said the government owed 9.5 trillion rupees ($65.6 billion), as he revised some of the main budget numbers presented in November.

He said the former government headed by Mahinda Rajapaksa has not included 1.04 trillion rupees in borrowing by state enterprises in the national debt, which was estimated at 8.48 trillion rupees at the end of last year.

The prime minister, also the minister of policy planning and economic development, said the country has to pay 1.21 trillion rupees on its debts this year, including 562 billion rupees in interest.

The IMF has long called on Sri Lanka to reduce its budget deficit, raise revenues, and bolster its foreign exchange reserves. These are likely to be the main conditions for the grant of a loan, economists say.

Sri Lankan shares fell more than 2 percent on Tuesday, hitting a near two-year low on concerns over the government’s possible tax hikes to qualify for what the finance ministry expects will be a $1.5-billion IMF loan. [nL3N1633XT]

The uncertainty over taxes also hit the rupee LKR=LK currency.

“The government is responding to an urgent revenue need,” Anushka Wijesinghe, the chief economist of Sri Lanka’s main business chamber, told Reuters.

“But ad hoc tax policy changes like these will hurt investor sentiment. The credibility of the budget is lost.”

($1=144.8500 Sri Lankan rupees)