Sri Lanka Government’s relief package worth of Rs. 229 billion is set to boomerang on the country’s fiscal stability, several economic experts and international rating agencies claimed.

Moody’s Investors Service has warned that the relief package announced by Finance Minister Basil Rajapaksa recently, could compound Sri Lanka’s fiscal challenge.

On 3 January,the Finance Minister announced a fiscal relief package worth Rs 229 billion ($1 billion, 1.6% of our 2022 GDP forecast) to support the economy and alleviate the impact of higher consumer prices on low-income households.

Moody’s Investors Service said that while the size of the package is moderate and will be fully funded via reallocations from the budget (6% of budget expenditure in 2022), it reduces the scope for fiscal and debt consolidation at a time when fiscal flexibility is already severely limited by the large share of interest payments in government revenue (60-70%).

“Funding the package with reallocations from the budget in part reflects this limited fiscal space, which constrains the government’s ability to use fiscal policy to mitigate the impact of economic shocks,” Moody’s said.

Furthermore, Moody’s noted that the risk of fiscal slippage has increased with the emergence of the omicron variant of the coronavirus.

Some countries have tightened activity and travel restrictions, and any reintroduction of measures domestically or a delay in the recovery of Sri Lanka’s tourism sector would intensify fiscal and external pressures, Moody’s added.

Key features of the relief package include cash handouts of Rs 1,000 to citizens receiving income support, agricultural subsidies, the removal of certain taxes on food and medicine and an increase in public-sector salaries (Rs 5,000 a month from January).

Such measures would support domestic demand and the economic recovery as surging prices – particularly for food – stemming from global supply chain-related disruptions and some import restrictions over 2020-21 reduce the purchasing power of households.

Consumer price inflation rose to 8.3% year-over-year in October 2021 and accelerated to more than 11% in November , 12.1% in December 2021   and 14.2% in janury 2022 , with food prices surging day by day , Census and Statistics Department data showed.   

“The rating agency  expects inflation-adjusted real GDP growth to pick up to around 5% in 2022 from around 4-5% in 2021, in part because of a lower base and because domestic economic activity has largely normalised, with international borders open to vaccinated tourists since October 2021.

 However, risks remain as the new omicron variant of the coronavirus could delay such a recovery, and several countries have reversed their easing of travel restrictions. 

Should such risks materialise, the recovery in Government revenue would likely be delayed beyond our assumptions, with fiscal and debt metrics remaining very weak for longer,” Moody’s said.

Moody’s is forecasting that the fiscal deficit will narrow only slightly to around 9-10% of GDP in 2022 from around 11% in 2021, mainly reflecting their expectation for lower revenue growth than the budget envisages.

“Wide deficits will keep the government’s debt burden at higher levels for some time; we estimate that the debt burden will rise to around 108% of GDP by the end of 2022 from around 101% at the end of 2020 and 87% at the end of 2019, before stabilising at the elevated 2022 level thereafter, mainly reflecting the recovery in nominal GDP growth. 

Such levels are significantly above the Caa median and much higher than the government’s medium-term target of around 75% in 2025,” Moody’s said.

In addition, a delay in the recovery of tourism receipts would weigh on Sri Lanka’s precarious external liquidity position.

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