Strong commitment to medium-term debt reduction

Sri Lanka's recent budget would help the country's 'BB'' sovereign rating, Fitch Ratings said in a media release.

According to the rating agency, the budget shows a strong commitment to medium-term debt reduction.

"The ability to maintain the fiscal consolidation trend provides support to Sri Lanka's 'BB-'/Stable sovereign rating. At the same time, its fiscal deficits and government debt burden still stand at relatively high levels," it said.

Sri Lanka has raised a series of taxes and also trimmed some subsidies amid an economic downturn that had reduced revenue. Provisional data showed that Sri Lanka is set to reduce its budget deficit to 5.8 percent of gross domestic product this year from 6.4 percent in 2012.Fitch sources said authorities are hoping to reduce the budget deficit to 5.0 percent of GDP in 2014 and 4.4 percent in 2015 and 3.8 percent in 2016. The debt burden is targeted to fall to 78 percent. But it was still higher than the 'BB' rated debt of 35 percent in other countries. Risks to the path of sustained debt reduction arise from the efficacy of ongoing revenue reforms, and the high level of foreign currency debt, according to Fitch sources.

The medium-term fiscal consolidation plan is heavily reliant on raising the share of revenue in GDP. This could prove difficult to achieve, as efforts have already been undertaken to broaden the tax base, ensure greater compliance, and limit exemptions (since 2011), but are yet to demonstrate significantly positive benefits.

Sri Lanka has reduced its budget deficit in the past few years despite falling state revenues which analysts say is the highest quality fiscal adjustment.

Despite the state having a history of running a deficit in the current account of budget by expanding the public service and subsidies to state enterprises even when revenue to GDP was close to 20 percent, some policy advocates in Sri Lanka have called for a higher tax take.In East Asia many countries with higher revenue to GDP have state enterprises which run surpluses and pay taxes, the release said.

Fitch said that medium-term fiscal improvements will rely heavily on raising the tax take, which could be difficult.In the light of these risks, expenditure restraint will prove crucial for any medium-term fiscal consolidation effort.

One positive development has been that state-owned enterprises have become more profitable than in earlier years. This limits a potential drain on public finances. Lower operating deficits by the government, in particular, ought to shore up domestic savings rates.