Flash Report / Sri Lanka

Sri Lankan budget aims for ambitious consolidation

  • Austerity not on the agenda in 2021, but medium-term consolidation path is more ambitious than expected
  • Deficit and debt targets will probably prove overly optimistic, but acknowledge need to reduce debt burden
  • Market reaction is mildly positive
Sri Lankan budget aims for ambitious consolidation

Today, Prime Minister Mahinda Rajapaksa, who is also the finance minister, presented Sri Lanka’s 2021 budget. We had been looking forward to the budget since the Rajapaksas won the elections with a landslide in August as the first concrete sign of the new administration’s fiscal policy plans.

On 2 November, we upgraded Sri Lankan eurobonds from Hold to Buy after a sharp two-month selloff, with bonds rallying by c12.5-14.5% across the curve amid a broader EM risk rally. However, we did not have high hopes heading into the budget given initial signs that austerity was not on the table.

The budget has surprised modestly to the upside, with the 2020 deficit slated to come in at 7.9% of GDP versus an IMF estimate of 9.6%. The 2021 deficit is expected to come in slightly wider at 8.8% of GDP versus an IMF estimate of 8.1%, but the government has adopted a much more ambitious medium-term consolidation path than initially expected. It aims to consolidate the budget deficit to 4% of GDP by 2025, versus the IMF’s projection of 7.4%, and to achieve a primary surplus from 2025 onwards.

Medium-term budget projections

This will reduce the debt burden from a peak of 96.3% of GDP in 2021 to 75.5% in 2025, versus the IMF’s projection of 96.6%. However, the declining debt burden is driven in large part by optimistic macro and interest rate assumptions, with the government forecasting growth of 5.5% in 2021 and 6% over the medium term (versus 5.3% and 4.8%, respectively, by the IMF), and the interest bill falling from 6% of GDP in 2019 to 4.7% by 2025 (versus an increase to 6.9% per IMF projections).

Plugging in the IMF’s macro and interest rate assumptions, the debt stock still declines to 91% of GDP by 2025. This is notably better than the October IMF projection, but well above the 75.5% forecast by the government.

Public debt forecasts

Projections notwithstanding, Sri Lanka’s 2021 budget does provide a tangible signal that the government acknowledges the need to consolidate the deficit and stabilise the debt burden. We continue to think that Sri Lanka will be able to muddle through over the next year, but fiscal consolidation post-2021 is essential to put debt on a sustainable path.

The initial market reaction to the budget has been positive, with bonds rallying c0.6% across the curve at the time of writing against a backdrop of broader EM weakness. While we expect some slippage relative to today’s ambitious/optimistic targets, we affirm our Buy recommendation on Sri Lanka 21s and 24s.

Sri Lankan eurobonds

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This report is independent investment research as contemplated by COBS 12.2 of the FCA Handbook and is a research recommendation under COBS 12.4 of the FCA Handbook. Where it is not technically a res...

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