ECONOMYNEXT – Sri Lanka has beat key fiscal targets set in an International Monetary Fund program for June with room to spare amid strong tax revenues, including from vehicles, official data show.
The primary balance of Sri Lanka’s central government budget was a surplus of 859 billion rupee, sharply higher than the 130 billion rupee target set in the currently applicable IMF program.
Primary Surplus
The primary balance is revenues minus expenditure before interest costs.
Countries with good non-activist central banks which provide low inflation and low nominal interest rates as a consequence usually have deficits in the primary account of the budget.
A surplus in the primary account indicates that interest costs are so large, that they are bigger than the overall deficit in the budget.
However, in IMF programs, which are made when the central bank cuts rates and triggers a balance of payment crisis, interest rates have to go up to very high levels to stop the crisis and restore the lost confidence in the currency by private credit contraction.
As a result, the correction has to come from primary or non-interest expenditures, which are under the control of the elected politicians and the Finance Ministry.
The primary surplus has come from lower than expected capital spending. Sri Lanka’s high external debt came partly from non-priority capital spending, including big buildings by the local, provincial and central governments, which were celebrated at the time as pushing up growth with capex.
Sri Lanka has to make sure that existing infrastructure, especially rural roads are maintained and there is a large capital requirement to the electricity grid to make it accommodate intermittent renewable power.
Revenue Targets
Tax revenues in the up to June 2,152 billion rupees higher than the 1,650 billion rupee floor on revenues.
However, the September target is sharply higher by 1,100 billion rupees at 2,750 billion rupees and the year-end target is 4,350 billion rupees.
Sri Lanka tends to collect large volumes of taxes in the form of excise, value added tax and import duties from imported vehicles.
Vehicles are taxed at over 200 to 300 percent of value, but are usually blocked in Sri Lanka when the central bank cuts rates with printed money under flexible inflation targeting or similar frameworks with anchor conflicts.
The reduced revenue from vehicle imports then makes a bigger hole in the budget making the central bank print more money including along the yield curve, the mist-target a ‘transmission mechanism’ in what critics call a ‘cascading policy error’.
Under flexible inflation targeting and similar frameworks (single policy rate) Sri Lanka has missed IMF reserve targets as the economy recovered in the middle of a four-year program.
The central bank then has to seek a ‘waiver’ of a quantity performance criteria to pass a review.
The depreciating currency in the meantime pushes up food and energy prices, and the resulting stabilization crisis may push up bad loans bankrupting SMEs, and increase the unemployed, making the reformist government unpopular.
When rate cuts trigger a currency crisis, the economy recovers after a 18 to 24 month stabilization crisis.
There have been concerns raised about the last rate cut, which came on top of a stagnant reserve collections and strong private credit recovery, given the experience in 2012, 2015/16, 2018 and 2019/22.
Analysts have warned that the ‘buffer’ Sri Lanka has to repay debt is the level of the interest rate structure that allows the central bank to collect reserves after keeping exchange rate stable for which deflationary policy is required.
Recent data has shown that some of the gross reserves shown have partly come from dollar rupee swaps, which impose a contingent liability on the central bank under a so-called flexible exchange rate.
Dollar rupee swaps with the central bank creates new money to temporarily push down current interest rates with deposits collected years before.
Sri Lanka’s central bank significantly outperformed the March indicative target for foreign reserves, though there are concerns that after the latest rate cut, it will be difficult to collect new reserves. Swaps do not add to IMF reserve targets.
Under the current revised IMF program, there is no obligation to reduce the domestic assets of the central bank, which analysts say may lead to missed reserve targets or insufficient reserves collected to repay debt or both.
To generate reserves a reducing ceiling on domestic assets is required. (Colombo/Aug10/2025)
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