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21.11.2013

No change in course
The budget proposals were broadly a continuation of the course set over the last 3 years. While there was speculation prior to the budget that taxes would be increased significantly, the government has commendably maintained its stance of lower tax rates and broader base giving policy certainty. However an indication of further reforms could have been anticipated in the revenue side in the form of private sector investments in the state owned enterprises. Increased involvement of the private sector in investment activities could also have reduced the requirement of public investment to a more sustainable level of 5.5% of GDP, compared to the current level of close to 6%. In the absence of such reforms it is unlikely that the budget deficit could be brought below 4% by 2016. More international bonds – A USD 750 Mn long term international bond for the construction of urban and estate housing complexes through the Urban Development Authority which will be backed by a Government Guarantee, along with a further USD 750 Mn for the Government to finance counterpart funds required for various development projects will be issued in 2014. With the global interest rates likely to rise with the tapering of QE program of USA in 2014, the risk profile of foreign commercial borrowing is considerably higher than the past. On the other hand it is mentioned that Debt/GDP ratio is to be reduced to 65% by 2016 compared to around 80% prevailing currently. Finance companies to merge – Any finance company which is a subsidiary company owned by a main company, to be absorbed by the main company to consolidate their operations. Banks, which have finance companies to consolidate their operations by acquiring the finance companies within the group to further strengthen the banks. In support of this initiative, qualifying payment status given for acquisition expenditure of banks or companies, if they have acquired any finance company. State owned enterprises turning around – Commendably the losses incurred by state owned enterprises in 2012 of LKR 154 Bn (around 2% of GDP) are expected to be turned around to a profit of LKR 38 Bn in 2013. Up to September the profit is recorded at LKR 34 Bn. The key reasons are the turnaround of Ceylon Electricity Board and significant reduction in losses of Ceylon Petroleum Corporation. Airlines continue bleeding – Accordingly Sri Lankan Airlines has become the largest loss making entity with an expected loss of LKR 27 Bn for 2013. A further USD 150 Mn will be provided to Sri Lankan Airlines and USD 50 Mn to Mihin Lanka in 2014 to strengthen the capitalization of the two airlines.

2014 Budget Proposals

Research Team – Waruna Singappuli, Suvimal De Costa, Buddhi Mahindaratne

A Snapshot of the 2014 Budget The government is expecting achieve a budget deficit of LKR 509.2 Bn for 2013, an upward revision of 0.4% from the 2013 budget. However, this is despite the budget deficit for the first nine months of 2013 reaching LKR 491.9 Bn. Accordingly, the monthly budget deficit need to reduce by nearly 90% during the last 3 months of 2013 compared to the first 9 months. This was seen in 2012 as well where the actual deficit was 6.4% of GDP compared to the revised estimate of 6.2%. Thus, we consider the current budget deficit target for 2013 of 5.8% of GDP extremely optimistic and the actual deficit could be around 6.0%. Therefore, the ambitious deficit target for 2014 of 5.2% needs to be monitored strictly. Sri Lanka has not achieved a budget deficit below 6% since 1977. Government Revenue, Expenditure and Budget Deficit
LKR Bn 2,500 2,000 1,500 1,000 500 0 -500 2011 2012 2013 (budget) 2013 (revised) 2014 (budget) Government Expenditure Budget Deficit

-1,000 Government Revenue & Grants

Source - Budget Speech 2014

The government projects a budget deficit of LKR 516.1 Bn for 2014, up 1.4% YOY. The widening of the budget deficit (in absolute terms) is attributable to an expected LKR 273.2 Bn (16.0%) increase in government expenditure to LKR 1,985.6 Bn, against a 266.4 Bn (22.1%) increase in government revenue and grants to LKR 1,469.5 Bn. Budget Deficit as a Percentage of GDP
% 8 7 6 5 4 3 2011 2012 2013 (budget) 2013 (revised) 2014 (budget)
Source – Budget Speech 2014

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Government Revenue The revenue expected for 2013 had been revised downwards by LKR 74.8 Bn (to LKR 1,203.1 Bn). Despite improved economic activity, it is slightly optimistic considering the total revenue of LKR 783.2 Bn up to September 2013. The monthly revenue needs to increase by over 60% in the last three months of 2013 to achieve this target. Tax and Non-Tax Revenue
LKR Bn 800 700 600 500 400 300 200 100 0 Income Tax Taxes on Goods and Services Taxes on External Non Tax Revenue Trade 2014 (budget)
Source – Budget Speech 2014

2013 (budget)

2013 (revised)

Inflows from income tax is expected to rise 18.3% to LKR 283.3 Bn in 2014, while taxes on goods and services are set to rise 19.0% to LKR 688.5 Bn. Taxes on external trade is projected to increase 29.3% to LKR 302.6 Bn. Government Expenditure The total expenditure for 2013 is expected to be LKR 1,712.4 Bn which is a downward revision of LKR 73.0 Bn. The actual expenditure incurred up to September was LKR 1,275.1 Bn in line with the revised target. Public investments/GDP has come down to 5.8% from the budgeted 6.1%.

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Total Expenditure
LKR Bn 1,400 1,200 1,000 800 600 400 200 0 2012 2013 (budget) 2013 (revised) Recurrent Public Investments 2014 (budget)

Source - Budget Speech, 2014

For 2014, public investments as a percentage of GDP is expected to rise to 6.7% which is too optimistic, while recurrent expenditure is set to rise by a tamer 8.4% to LKR 1,328.3 Bn. Recurrent Expenditure
LKR Bn 500 400 300 200 100 0 Salaries and Wages Other Goods and Interest Subsidies and Services Transfers 2013 (budget) 2013 (revised) 2014 (budget)
Source - Budget Speech, 2014

Deficit Financing Net foreign financing is expected to be LKR 149.8 Bn in 2013, which is 74.2% above the 2013 budget target of LKR 86.0 Bn. Total domestic financing is expected to come down to LKR 359.3 Bn in 2013, well below the budgeted LKR 421.4 Bn. However, achieving these debt financing targets will depend on the government achieving the deficit target mentioned earlier. Meanwhile, domestic financing through bank borrowing is expected to exceed the budgeted figure by 187.7% which explains the robust market interest rates that prevailed throughout 2013.

NDB Securities (Pvt) Ltd – 2014 Budget Proposal Highlights – 21st November 2013

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Deficit Financing
LKR Bn 450 400 350 300 250 200 150 100 50 0 Total Foreign Financing Total Domestic Financing 2013 (budget) 2013 (revised) 2014 (budget)
Source - Budget Speech, 2014

Funding mix of the 2014 budget deficit is anticipated to be similar to what was seen in 2012 (55:44 mix of domestic and foreign borrowing) as opposed to a higher proportion of domestic borrowing in 2013. Foreign commercial borrowing, absent in 2013, is expected to be at LKR 97.50 Bn in 2014 making up 21.7% of total deficit financing. Impact on the stock market • • The 2% NBT to be applicable to the banking sector to all banks and financial institutions. The tax-free threshold applicable for VAT on supermarket scale retail trade to be fixed at LKR 250 Mn per quarter (as opposed to LKR 500 Mn previously). In order to prevent manipulations on the computation of turnover through exempted items, a limit of 25% of the total turnover to be fixed as exempted value from VAT in relation to such business. As an incentive to business enterprises engaged in banking, finance, insurance and manufacturing activities liable to high profit tax at 28%, a half tax holiday for a period of 3 years is proposed, to any such Company that lists its shares in the Colombo Stock Exchange in 2014. Introduce a pricing formula based on the cost structure in place of a price control on poultry to regulate pricing and to safeguard both the consumer as well as the producer. A 15% upfront tax will be imposed in the event of lease of state or private lands to foreigners. A comprehensive assessment of the underperforming plantation companies is to be undertaken. Implement a credit scheme with 8 year maturity and 6 percent interest to every company that has so far performed well, provided they commit to replant an agreed extent, are committed to ensure social development of its plantation workers and increase the volume of its value added tea exports. The present rate of 20% applicable on Telecommunication Levy will be revised to 25%.

• •

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Summary of the Budget 2011 (actual) 2012 (actual) 949.90 1,067.50 934.80 1,051.40 812.60 908.10 157.30 172.50 468.00 519.60 187.30 216.60 122.20 142.50 15.10 16.00 1,400.10 1,556.50 1,006.60 1,131.00 319.60 347.70 113.70 140.00 356.70 408.40 216.60 234.60 407.50 443.90 37.10 46.10 370.40 397.90 (14.00) (18.40) (71.80) (79.50) (450.20) (488.90) 450.20 488.90 194.00 180.70 84.50 50.60 177.60 234.40 (88.40) (183.80) 109.50 130.20 256.20 308.20 39.40 70.90 25.00 105.60 191.80 131.50 14.50 14.10 14.30 13.90 12.40 12.00 21.40 20.50 15.40 14.90 6.20 5.90 (1.10) (1.00) (6.90) (6.40) 2013 (budget) 1,277.90 1,257.90 1,132.00 221.90 632.90 277.20 125.90 20.00 1,785.40 1,267.40 414.40 140.40 444.80 267.80 529.60 59.60 470.00 (11.70) (9.40) (507.40) 507.40 86.00 86.00 234.00 (143.00) 421.40 289.40 62.00 70.00 14.70 14.50 13.00 20.50 14.60 6.10 (0.10) (5.80) 2013 (revised) 1,203.10 1,183.10 1,052.20 239.50 578.40 234.10 130.90 20.00 1,712.40 1,224.90 391.40 132.20 444.80 256.40 503.90 55.50 448.40 (16.40) (41.70) (509.20) 509.20 149.80 149.80 247.10 (97.20) 359.30 104.70 53.20 201.40 13.80 13.60 12.10 19.70 14.10 5.80 (0.50) (5.80) 2014 (budget) 1,469.50 1,437.40 1,274.60 283.30 688.50 302.60 162.80 32.00 1,985.60 1,328.30 410.60 191.80 441.00 284.70 668.50 74.10 594.40 (11.10) 109.20 (516.10) 516.10 235.50 331.50 234.00 (96.00) 97.50 280.60 129.30 51.30 100.00 14.80 14.50 12.80 20.00 13.40 6.70 1.10 (5.20)

Total Revenue and Grants Total Revenue Tax Revenue Income Tax Taxes on Goods and Services Taxes on External Trade Non Tax Revenue Grants Total Expenditure Recurrent Salaries and Wages Other Goods and Services Interest Subsidies and Transfers Public Investment Education and Health Infrastructure Other Revenue Surplus(+)/Deficit (-) Budget Deficit Total Financing Total Foreign Financing Net Foreign Borrowings Foreign Borrowings-Gross Debt Repayments Foreign Commercial Total Domestic Financing Non-bank Borrowings Foreign Investments in T Bills / Bonds Bank Borrowings Revenue and Grants/GDP (%) Revenue/GDP (%) Tax/GDP (%) Expenditure/GDP (%) Current Expenditure/GDP (%) Public Investment/GDP (%) Revenue Surplus (+)/ Deficit (-)/ GDP (%) Budget Deficit/ GDP (%) (Excluding Grants)

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