Sri Lanka’s VAT fiasco adds pressure, makes budget crucial

MARWAAN MACAN-MARKAR, Asia regional correspondent Nikkei Asian Review


Jaewoo Lee, leader of an International Monetray Fund team to Sri Lanka, speaks at a press conference on Sep 23 at the Central Bank in Colombo. (Photo by Marwaan Macan-Markar)

COLOMBO —Sri Lanka’s finance ministers strike at midnight, while the country sleeps. The public wakes up to the shocking news in the Gazette, the government journal that prints official decrees, of price increases in selected goods following overnight tax increases.

President Maithripala Sirisena’s administration last resorted to the "midnight gazette," as the local media describe this sly maneuver, on Aug. 19. The issue that justified its action? The imposition of a tax on imported large onions from India to protect local farmers producing smaller onions.

Sirisena’s coalition administration — which came to power following a surprise win in the January 2015 presidential election — is not shy of using this sleight of hand, despite widespread criticism. On May 2, it used the midnight gazette to increase value added tax from 11% to 15%. A backlash led by opposition parliamentarians followed, focusing on protests that the government was reducing the role of the legislature to rubber-stamping taxes that had already been imposed.

The uproar led to a landmark ruling in early August by the Supreme Court, in a case filed by an opposition lawmaker and two Buddhist monks that accused the government of not following due process. The suit claimed the VAT hike was illegal because parliament was not consulted before the new rates were enforced. The judges agreed, freezing the process until the government follows the required process:a debate in parliament, followed by a vote.

The government accepted the ruling, but has created uncertainty about its intentions by failing to say when it will present a VAT bill to parliament. Business leaders are waiting for signs from the finance ministry, which is currently preparing a budget to be presented in mid-November. Some details of the VAT strategy have emerged, including a rise in the revenue threshold for retailers from 33,000 Sri Lankan rupees ($225) a day to 138,000 rupees, which will exempt many small traders. There is also a growing list of goods and services that will likely be exempt.

The delay in finalizing the new VAT rates spells trouble, however, as the ruling National Unity Government seeks to implement a deal agreed with the International Monetary Fund for a $1.5 billion loan intended to help the administration to cope with a growing fiscal deficit, soaring foreign debt and a big trade imbalance.

In June, the IMF approved the payment of a first tranche of $168 million, with the remainder available in six instalments over a three-year span, subject to quarterly reviews. However, the deal is contingent on radical changes in Sri Lanka’s finances that are causing strains in the government, a coalition formed by former rivals Sirisena and Prime Minister Ranil Wickremesinghe. The two men hail from parties that are traditional rivals.

The strings attached to the IMF package include a hike in VAT to raise government revenues, and reform of more than 200 loss-making state-owned enterprises — including Sri Lankan Airlines, the national carrier — which are together reported to have accumulated $15 billion in debt. Colombo-based banking sources say the figure could be higher, since the previous government allowed some loans by local banks to be kept off the SOEs’ books.

The IMF says that Sri Lanka’s gross domestic product could grow by a relatively healthy 5% in 2016, compared with 4.8% in the previous year, helping to create room for fiscal and economic reforms. But it has also warned that the government must fulfil its commitments if the three-year Extended Fund Facility is to continue in place.

"It is important that the government expedites the legislative process of implementing the value added tax amendments that are needed to support revenue targets for 2016 and 2017," Jaewoo Lee, head of an IMF delegation, said in late September, at the end of a two-week visit to the South Asian island. "If the VAT [change] is not implemented in a timely manner, we will have to postpone the review," Lee said.

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