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IMF advocates property tax and ending corporate freebies amid ‘green shoots’
Sri Lanka must stay the course, collect more tax, end corporate tax handouts, endure macroeconomic reforms, and importantly, secure agreements with private bond holders and biggest bilateral creditor China, the IMF recommended Thursday, pointing to ‘green shoots’ of economic life, while also noting severe socio-economic costs of reforms.
IMF Senior Mission Chief for Sri Lanka, Peter Breuer’s key messages after an economic health check this week, reflected policy conditions the IMF has consistently advocated for lending, knowing the risks to implementing the program considering previous slippages. On 16 previous IMF engagements, Sri Lanka’s wheels have fallen off.
IMF Senior Mission Chief for Sri Lanka, Peter Breuer. Pic by Indika Handuwala
Speaking nearly a year since the IMF Board approved a four-year financing arrangement, Mr Breuer said reforms are “yielding the first signs of recovery’’ after six straight quarters of contraction, noting 1.6% growth in real economic output in the third quarter 2023, “which is the first expansion in six consecutive quarters’’.
Growth was 4.5% in the fourth quarter. Citing Department of Census and Statistics estimates, the Central Bank of Sri Lanka, noted the uptick in January’s monetary policy review.
While the IMF observed ‘green shoots’, just last month, the CBSL characterised it as “a steadfast recovery’’ in 2023, (in fact, real GDP in 2023 was a negative 2.3%), and also predicted “growth is expected to remain subdued in the short term’’ in 2024.
Referring to tax freebies, Mr Breuer insisted Sri Lanka must not continue the practice.
He also referred to a “commitment in the (IMF) program to not grant any more tax concessions. Tax concessions are a missing component of tax revenues’’.
Recent Treasury data reveal that Rs 23.94 billion in corporate income tax concessions have been given in 2022-2023 to Board of Investment companies in apparel, agriculture, manufacturing, services and utilities, tourism, infrastructure, power, and knowledge services sectors, on an aggregate tax base of Rs 168.20 billion. Apparel makers got Rs 5.26bn corporate tax handouts on an aggregate tax base of Rs 50.18bn and Rs 356m value-added tax concessions on an aggregate tax base of Rs 3.17bn. Tourism companies got Rs 551m corporate income tax subsidies and Rs 83m VAT concessions on an aggregate tax base of Rs 820m.
Among those benefiting from tax holidays are multinationals such as Unilever, prominent local companies such as Rocell Bathware, Swisstek Aluminium, Hemas Manufacturing, David Pieris Motor Co., Laugfs Eco Sri, Tea Trails (Pvt), apparel heavies Brandix, MAS Holdings, Lanka IOC, Dialog, Mobitel, Daya Aviation (Pvt), Senok Aviation, Araliya Green Hills Hotels Pvt, Galle Face Hotel, Colombo Courtyards, Hemas Hospitals, Dole Lanka, Siddhalepa Exports, Hayleys Agro Biotech, Cargills Confectioneries (Pvt), and Hayleys Neluwa Hydropower. There are hundreds of companies.
The standard tax rate is 24%.
VAT benefits to the eight sectors was Rs 55.71bn on an aggregate tax base of Rs 493.77bn.
The BOI is notorious for giving extensive tax freebies (tax holidays and up to 20% concessions) to businesses under the ill-defined ‘strategic development project’ law, where unfettered discretion is exercised by the investment agency and politicians.
China’s CHEH Port City Colombo (Pvt) got a 25-year corporate income tax exemption under ‘strategic development project’. It was also given 10-year PAYE tax exemptions to 30 expat staff, among other benefits. Shangri-La Hotels Lanka (Pvt) Ltd enjoys 10 years’ corporate income tax holiday, followed by 6% rate for 15 years.
The IMF also suggested that living conditions of Sri Lankans are yet to improve. The indicative target (a numerical tracker) on social spending has not been met. The switch to Aswesuma should have ended by end-December 2023.
IMF Resident Representative in Sri Lanka, Sarwat Jahan said the “positive growth has not filtered through (to) all segments’’ and “there are many people who still do feel hardship’’. But, she said, if Sri Lanka continues reforms, a “full recovery’’ that will be “felt by all of Sri Lankans’’ can be expected.
Gross domestic product is not a measure of the standard of living or well-being.
“Real” GDP is calculated by adjusting nominal value to factor in price changes to understand if output has risen because prices have increased, or if output has increased.
Sri Lanka’s gross official reserves increased to US$4.5bn at end-February 2024 with foreign exchange purchases by the CBSL. Data show that inflows from the IMF, the World Bank and the Asian Development Bank, also padded up the forex pile. In 2023, CBSL bought net US$1.9bn.
In January, the CBSL said it bought US$245 million, on net basis. Gross official reserves includes a restricted US$1.4bn swap facility from People’s Bank of China.
Inflation dropped from a peak and it was partly due to demand declining. Monetary policy easing since June helped.
Despite official headline inflation indicator data (Colombo Consumer Price Index), prices of essential food have remained in the stratosphere. Imported red onion retailed at Rs 460 a kilo Thursday. A coconut sells for Rs 125, nadu is Rs 220 a kilo and tuna (kelawalla) is Rs 1,680 a kilo.
Export earnings, including that of industrial exports have dropped. In 2023, export income fell by 9.1% from the year before to US$11.9bn. Industrial exports fell by 11.3% to US$9.27bn. The drop continued in January. The trade balance was a negative US$4.9bn.
Multi-billion-dollar remittances from Sri Lankans overseas (US$5.97bn in 2022, more than enough to cover the 2023 trade balance) still cushion the economy. Remittances also support the external current account.
Industrial activity, including construction and manufacturing, contracted by 9.2% in 2023. The service sector shrank for a second consecutive year.
After this second review Sri Lanka would have access to about US$330m, on approval by the IMF executive board. That would mean the IMF would have given Sri Lanka US$1 billion, which must be repaid.
IMF had also required the Inland Revenue Department to create a new High Net Worth Individuals unit, to ensure that ‘whales’ and ‘fat cats’ pay their taxes. The IMF also asked for a stronger risk management unit by December 2023.
Especially due to the sting of higher taxation (value-added tax and income tax, in particular), public support for IMF reforms has rapidly waned.
But, the IMF proposed more taxes without disclosing specifics.
Mr Breuer reiterated that “the introduction of the property tax’’ is “critical’’, along with “revenue measures to meet the revenue mobilisation goals in 2025 and beyond. Revenue administration and anti-corruption efforts to boost tax collections are also key’’.
He called for “swift progress’’ on “a progressive property tax’’ to ensure “fair burden sharing, while sustaining the revenue-based consolidation’’.
Mr Breuer argued for stronger tax administration, removal of tax exemptions, and “actively eliminating tax evasion to make reforms more sustainable and to further build confidence among Sri Lanka’s creditors to regain debt sustainability to gain their support’’.
At local level, a form of property tax exists in Sri Lanka, where annually buildings, land and immovable property are rated on value (rentable value) by local authorities, though not on capital value, based on market value. These are levied through statutes such as Municipal Council Ordinance, Urban Council Ordinance, and Pradeshiya Sabha Act, where annual value is defined.
Referring to debt sustainability, Mr Breuer underlined the importance of securing final agreements with official creditors and reaching “agreements in principle with the commercial creditors where the bondholders are, of course, a significant proportion’’.
He said it is the IMF’s “strong expectation that there would be an agreement in principle by the time of the second review’’.
Total Government debt was at US$91.11bn at end September 2023 and US$96.16bn at end December 2023. International Sovereign Bonds amount to US$12.55bn. Of this, US$2.25bn unpaid principal remained at end December 2023.
Project loans have increased to US$22.59bn from US$21.65bn.
Total Central Government external debt as at the end of December, 2023 amounted to US$37.3 billion.
Among multilateral loans, Sri Lanka owes the IMF US$681.6m. This includes unpaid principal. Asian Development Bank is owed US$6.23bn. China-led Asian Infrastructure Investment Bank (AIIB) is owed US$91.7m, and the World Bank is owed US$4.37bn
Reuters reported citing sources Thursday that “a steering committee of bondholders is set to begin talks with the government next week’’.
IMF’s Mr Breuer held out the promise that “Sri Lanka has a chance of emerging from the crisis’’. But, he said: “The path is a knife edged path.’’
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