VZCZCXRO1840
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DE RUEHLM #1123/01 3441154
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R 091154Z DEC 08
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UNCLAS SECTION 01 OF 05 COLOMBO 001123 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS AND EEB/IFD/OMA 
STATE PASS USTR FOR ADINA ADLER AND VICKY KADER 
COMMERCE FOR EROL YESIN, BRIAN WILLIAMS 
DOL/ILAB FOR TINA MCCARTER 
TREASURY FOR ANNE ALIKONIS 
 
E.O 12958: N/A 
TAGS: ECON EFIN PGOV MARR KMCA CE
SUBJECT:  SRI LANKA PASSES 2009 BUDGET 
 
REF:  COLOMBO 1107 
 
¶1.  Summary:  (SBU) Parliament easily passed the 2009 GSL budget on 
December 8, one month following President Rajapaksa's presentation 
of the draft on November 6.  This is Rajapaksa's fourth budget since 
coming into office in 2005 on a platform of poverty reduction, 
steering investment to disadvantaged areas, developing small and 
medium enterprises, promoting agriculture and expanding the 
government.  The 2009 budget is a continuation of these policies 
with a renewed stress on the need to defeat terrorism, bring 
development to the north and east, and improve local production. 
The overly optimistic budget, which forecasts increases in 
expenditure ($11 billion) and revenue ($7.8 billion), as well as a 
resulting deficit equal to 6.5% of GDP ($3.1 billion), fails to 
realistically take into consideration changes in the global market 
due to the economic downturn.  Although the budget review process 
was much smoother in 2008 than in previous years, passing with 126 
votes in favor and 84 against, opposition party UNP demonstrated its 
displeasure by issuing its own 2009 budget draft and circulating it 
among the media.  End summary. 
 
2009 -- MORE SPENDING, LOWER DEFICIT 
------------------------------------- 
 
¶2. (U) FISCAL DATA, 2008-2009-Economic Format:  Comparison between 
the proposed 2008 budget, the revised 2008 budget, and the proposed 
2009 budget.  Figures in parentheses represent the percentage of 
GDP.  Sources: 2008 and 2009 Budget speeches. 
 
--------------------------------------------- ---------- 
Year                 2008         2008      2009 
                 Proposed  Revised  Proposed 
--------------------------------------------- ---------- 
Billions of rupees 
 
Total Expenditure    1044 (24)  1016 (23)  1192 (22.8) 
-current              713        743        823 
-capital              335        278        371 
-other                 -4         -5         -3 
 
Total Revenue         751 (18)   709 (16)   855 (16.4) 
 
Current AC 
Surplus/Deficit   +38 (0.9)  -34 (0.8) +32 (0.2) 
 
Budget Deficit        293 (7.0)   307 (7.0)  337 (6.5) 
 
GDP Growth rate   7.5%  6.5%  6.8% 
--------------------------------------------- ---------- 
 
¶3.  (U) The 2009 budget forecasts large increases in both 
expenditure and revenue.  These increases are in line with 
inflation, currently at 16.3 percent following a high of 28 percent 
earlier this year.  In comparison with the 2008 revised budget, 
total government spending will increase 17 percent to 1.191 billion 
rupees (Rs) ($11 billion) and revenue will rise 21 percent to Rs 855 
billion ($7.8 billion), resulting in a deficit of Rs 337 billion 
($3.1 billion).  The deficit is equal to 6.5 percent of GDP, lower 
in comparison to recent deficits of more than 7.0 percent of GDP. 
However, these estimates should be viewed skeptically as the final 
numbers are traditionally quite different from the forecasts. 
 
¶4. (SBU) The budget lacks any expenditure rationalization efforts. 
Recurrent expenditure on interest payments, salaries, pensions, 
subsidies, and welfare payments will make up nearly 70 percent of 
government expenditure in 2009.  The remaining 30 percent is meant 
for capital investment.  However, since most of capital expenditure 
is financed from foreign borrowing, it is likely that 2009 capital 
spending will be significantly reduced due to current global 
financial constraints.  Also, it is customary in Sri Lanka for 
recurrent expenditure to rise and the capital expenditure to fall 
late in the year.  The Central Bank's head of research, P N 
Weerasinghe, stated publicly that while he does not see a risk in 
funds expected from donors such as the World Bank, Asian Development 
 
COLOMBO 00001123  002 OF 005 
 
 
Bank, Japan, Iran and China, about $500 million in commercial 
financing to provide counterpart funds for development projects may 
not fully materialize.  Others at the Central Bank remain very 
concerned about the difficulty to raise financing in 2009. 
 
¶5. (U) It is unlikely, as in the previous years, the government will 
meet revenue targets.  Therefore, the government forecast of a 20 
percent increase in revenue in 2009 is overly optimistic.  Revenue 
shortfalls are very likely given the global slowdown and its effects 
on Sri Lankan economy. 
 
¶6. (U) In late 2008 the government reduced capital expenditure 
drastically in order to keep the deficit intact at 7 percent of GDP. 
 Soon after the initial November 6 budget presentation, the Treasury 
imposed a spending freeze for the remainder of the year.  Revenue 
was also much lower than targeted in 2008.  Similar and additional 
cutbacks will be required early in 2009 if the government hopes to 
achieve its proposed deficit of 6.5 percent of GDP. 
 
¶7.  Note: The economic format of the budget does not include debt 
service (principle payments) of Rs 383 billion ($3.5 billion) in 
2008 and 476 billion ($4.37 billion) in 2009.  Total funding 
requirement including debt roll over will be Rs 813 billion ($7.4 
billion) in 2009. 
 
DEFENSE SPENDING 
REACHES USD 1.6 billion 
------------------------- 
 
¶8. (U) Sri Lanka - Defense budget 2006-09 
--------------------------------------------- -------- 
                         2006    2007    2008  2009 
                         Rev.  est. 
--------------------------------------------- -------- 
Defense (Rs billion)    104.8    155.7    194    177 
        ($ billion)       1.0      1.4    1.8    1.6 
 
As percent 
 of GDP                   3.6%    4.4%   4.4%   3.4% 
 of govt expenditure     14.7%   18.2%   19.1%  14.8% 
--------------------------------------------- -------- 
Source: Budget estimates 2008 and 2009, Fiscal Management Report 
2009 
 
¶9. (U) A significant expenditure item in 2009, and a key focus for 
the government, is financing for the war.  Military spending in 2009 
is budgeted at Rs 177 billion ($1.6 billion), or 3.4 percent of GDP 
and 14.8 percent of the total budget.  This actually represents a 9 
percent decrease from 2008 defense expenditures when compared with 
the revised 2008 budget forecast of Rs 194 billion ($1.8 billion). 
With the 2009 figures, the Rajapaksa administration's defense 
spending since coming to power in late 2005 is nearly USD 6 billion. 
 
 
¶10. (U) Rajapaksa's November 6 budget speech focused heavily on 
government efforts to fight terrorism and liberate the north and 
east, and the President once again called on the LTTE to lay down 
arms and join the democratic process.  In justifying large defense 
expenditures throughout the last three years and in particular in 
this budget, Rajapaksa said "we view such expenditure as a priority 
need towards establishing a stable economic environment to restore 
democracy, consolidate human rights, and achieve economic 
development... A country that is free of terrorism is also the prime 
need of private sector investors."  Rajapaksa also highlighted and 
reminded the country of the sacrifices made by soldiers fighting in 
dangerous conditions.  Salaries of soldiers were increased by Rs 
2,000 ($18.37) per month.  A further Rs 3.5 billion ($31.8 million) 
was allocated to build houses for them. 
 
FOR THE LITTLE PEOPLE, AND KEY INDUSTRIES 
------------------------------------------ 
 
¶11. (U) The budget offers some relief to various constituencies, but 
not by enough to meet expectations or challenges posed by inflation 
 
COLOMBO 00001123  003 OF 005 
 
 
and global economic turmoil.  It provides a Rs 1,000 ($9) per month 
salary increase to government servants and a Rs 560 ($5) per month 
pension increase.  This, combined with the salary increase for 
soldiers, will cost Rs 22.5 billion ($200 million) or about 2 
percent of total expenditure in 2009.  The tax burden of the private 
sector workers was reduced slightly by widening the tax brackets. 
In addition, the maximum tax rate for resident Sri Lankans providing 
international professional services was reduced from the current 35 
percent to 20 percent.  The budget increased taxes on a range of 
imports, a measure expected to aid local farmers and producers and 
save foreign exchange.  In addition, fuel prices were reduced 
slightly, but not enough to be in line with current world market 
prices.  Low income families will be given a monthly allowance of Rs 
200 ($2) for children under 5 years to buy milk powder.  Discounts 
on electricity and water bills will be given to low income earners. 
 
 
¶12. (U) The budget also offers some relief to key industries -- in 
particular tea, tourism and garments -- by providing a reduction in 
electricity tariffs applicable to tourist hotels, reductions in the 
price of furnace oil, a six month moratorium on loan repayments to 
export industries, export marketing assistance, a treasury guarantee 
for tea exported on credit terms, and a new fertilizer subsidy for 
small tea growers.  It is unclear how some of these programs, such 
as the debt moratorium and the tea export credit, will be 
implemented. 
 
¶13. (U) Rajapaksa's budget introduces new tax increases meant to 
protect local industries.  For example, import taxes increased on 
numerous products, including: wheat grain; wheat flour; imported 
grains; sugar; milk; fruits and vegetables (excluding apples); 
animal feed; paper; furniture; confectionary; salt; footwear and 
other leather products; clothing; and electrical items.  Taxes on 
some imports, already at more than 100 percent, increase further 
with these taxes.  Unfortunately, as highlighted by Ernst and Young 
Colombo senior partner Lakmali Nanayakkara, the new taxes make 
import tax calculation even more complicated, as nearly 10 different 
taxes and duties are levied on various bases. 
 
TAX BURDEN INCREASING 
--------------------- 
 
¶14. (U) While Sri Lanka's tax system is already exceptionally 
cumbersome, Rajapaksa introduced yet another new tax, the Nation 
Building Tax (NBL), further complicating the tax system.  Rajapaksa 
said the new tax should be considered as a "social contribution" to 
rebuild communities and damaged infrastructure in the north and east 
and to provide welfare for security forces.  This one percent tax 
will apply on imports, domestic production and services; it will be 
in effect for two years.  The finance sector, which is already taxed 
at over 70 percent, is excluded.  Parliament must still pass 
legislation to enact this tax.  In addition, the maximum liability 
of the Economic Service Charge increased, the telephone tax was 
extended from mobile services to fixed line, and the port and 
airport tax on imports has increased from 3-5 percent. 
 
¶15. (SBU) In a half-hearted bid to address business concerns, the 
budget proposes to appoint a (unfunded) Presidential Task Force to 
prepare a people friendly tax policy by 2010.  The government did 
reduce the standard Value Added Tax (VAT) rate from 15 percent to 12 
percent, with the aim of reducing the cost of living.  The 18 
percent VAT on luxury items remains unchanged.  However, tax experts 
have said that the reduction in VAT will not provide much relief as 
the new National Building Tax and higher import duties will make up 
for the reduction.  According to GSL estimates, the VAT reduction is 
estimated to cost the government Rs 45 billion ($409 million). 
Increases in other taxes are expected to bring Rs 75 billion ($681 
million), providing a net gain of over Rs 30 billion ($272 million) 
to the treasury. 
 
FISCAL IMPRUDENCE 
------------------ 
 
¶16. (SBU) The GSL's policy of not privatizing public enterprises 
 
COLOMBO 00001123  004 OF 005 
 
 
remains unchanged in the 2009 budget.  As a result, the government 
will continue to lose revenue as it bails out failing institutions, 
including significant losses by the Ceylon Electricity Board (CEB). 
Of particular interest is the government's decision to spend Rs 6 
billion ($54 million) to revive Mihin Lanka, a failed airline named 
for the President that was forced to cease operations in 2008 after 
only thirteen months due to significant losses.  The GSL has assured 
citizens that Mihin Lanka will be a profit making venture within 
three months of recommencing operations in December 2008; however, 
most believe it will fail again.  In the face of severe criticism by 
the opposition for funding a lost cause, the Minister of Foreign 
Affairs claimed that there was "no going back when one commences 
such large scale commercial ventures."  He added that the government 
can afford to pump six billion rupees into the project.  The budget 
also provides the government USD 5 million to build an unnecessary 
airport in President's constituency in the deep south. 
 
DEBT BURDEN 
(DOMESTIC AND FOREIGN DEBT SERVICE) 
------------------------------------ 
¶17. (U) 
                    2007    2008    2009 
Rs billions 
 
Interest payment     183     216     250 
-- Domestic          158     189     220 
-- Foreign            22      27      30 
Amortization         307     383     476 
-- Domestic          235     301     391 
-- Foreign            71      73      84 
Total                490     599     726 
--(USD Billions      4.5     5.5   6.6) 
 
Additional items: 
Oil hedging losses    -  NA 
Iranian credit line   -       NA 
 
Sources: Budget 2009, Budget estimates 2009, embassy estimates 
 
¶18. (U) According to the Fiscal Management Report 2009 issued with 
the budget, the debt/GDP ratio continues to fall.  Debt/GDP ratio is 
estimated at 78.2 percent of GDP in 2008, well below its peak of 106 
percent of GDP in 2004.  It will likely decline further to 75.6 
percent of GDP in 2009.  The decline is attributed to moderate 
growth in debt financing, high inflation, GDP growth in excess of 6 
percent, and the stability of the exchange rate.  Although debt 
ratios have been falling, this is offset by the emergence of other 
risks.  Government borrowing in foreign currency has increased. 
Foreign commercial loans have also increased.  Total debt service 
(excluding payments due for oil purchases) is estimated around 85 
percent of projected revenue in 2009; interest payments will be 
around 29 percent.  The Supreme Court, examining public interest 
litigation (see para 23), said that staggering debt service cost 
reflects the reckless and irresponsible handling of public finance 
by the Treasury. 
 
TRANSFERS 
--------- 
 
¶19.  (U) Major programs present in 2008 will continue in 2009.  The 
government will spend Rs 196 billion (up 1.1 percent from 2008) in 
welfare payments, subsidies, pensions and transfers to state-owned 
enterprises operating at a loss.  The high-cost fertilizer subsidy 
will continue.  (Note:  In 2008, the government spent Rs 27 billion 
on the subsidy; in 2009, the government will likely spend Rs 25 
billion, which will now include an extension of the subsidy to small 
tea plantations owners.)  The Samurdhi program, which provides a 
monthly cash grant to poor families, is another significant transfer 
program; however, its cost remains unchanged at approximately Rs 
11.6 billion in 2009. 
 
INFRASTRUCTURE SPENDING 
----------------------- 
 
 
COLOMBO 00001123  005 OF 005 
 
 
¶20. (U) Although many analysts have commended the government for its 
commitment to infrastructure development, in 2008 the government 
spent only approximately USD 2.5 billion in capital spending, a sum 
much smaller than budgeted.  In 2009, it has approval to expend USD 
3.3 billion.  Main projects include roads, power, and ports. 
However, taking into account a lack of liquidity in the global 
market and the fact that many of these projects are only partly 
financed by international organizations, the government will have to 
cut back if unable to raise the necessary capital to finance its 
portion of these projects. 
 
2009 Budget News and Controversy 
--------------------------------- 
¶21. (U) For the first time ever, the budgets of 21 "less significant 
ministries" were referred to a sub-committee for debate, while the 
ministries considered "important" were debated in the full house of 
the Parliament.  The sub-committee budgets were approved in 
Parliament on December 5. 
¶22. (U) The main opposition party, UNP, submitted an alternative 
budget to the press and Parliament.  The UNP, which has historically 
promoted fiscal prudence, promised large subsidies for low income 
families, massive salary hikes to state workers, additional 
fertilizer subsidies and other social welfare programs.  The party 
proposed to finance the budget through a flat consumption tax, 
foreign aid, and interest rate savings.  This alternative budget was 
not reviewed by Parliament. 
¶23. (U) The Supreme Court, examining a public interest litigation 
case, announced on November 4 that it detected flaws in the 
preparation of the budget accounts.  Specifically, expenditures 
stated in the appropriations bill did not include a debt service of 
Rs 722 billion; this amounted to an inconsistency with the 
Constitution.  The government, in its defense, said that certain 
payments allowed by specific laws are not included in the budget 
bill.  Nevertheless, it subsequently submitted a new schedule to 
Parliament containing debt service costs as directed by the Supreme 
Court. 
¶24.  (U) The opposition used the high price of fuel to attack the 
government.  Retail fuel prices were reduced slightly with the new 
budget, but -- as of December -- Sri Lanka's gasoline and diesel 
were around 400 percent and 160 percent higher than the Mean of 
Platts Singapore (MOPS) price.  This puts Sri Lanka at a 
disadvantage compared with other competitors in the region.  The UNP 
charged that the government is making a monthly profit of 50 billion 
from petroleum.  Responding to these charges the Government said the 
revenue is being used to fund infrastructure projects.  Analysts say 
there are signs that taxes on petroleum will be used as a major 
source of revenue to plug holes in the budget next year. 
 
COMMENT: 
-------- 
 
¶25. (SBU) The 2009 budget contains no real surprises.  The 
government continues to be too optimistic, with unrealistic 
forecasts of revenue (up 21 percent) and expenditure (up 17 percent) 
and deficit (6.5 percent of GDP), especially in light of global 
recessionary conditions.  The fact that it passed easily was 
expected due to the current state of the conflict.  Budget 
discussions, always highly political, included members of the 
government trying to paint those who would vote against the budget 
as unpatriotic and unsupportive of military action.  Even the UNP, 
which did vote against the overall budget, begrudgingly abstained 
rather than vote against the defense budget.  The wide margin in the 
final vote (126 for, 84 against) demonstrates support for the 
President's plan to continue the war at all costs while moving 
forward with increasingly protectionist import substitution plans 
the GSL is selling a beneficial to the "little guy."  Sri Lanka may 
face extreme difficulty in obtaining commercial loans in 2009 to 
assist in the financing of its deficit.  With a continued refusal to 
even consider IMF assistance in the future, it will need to either 
significantly revise its forecasts for 2009, or find other sources 
of funds from bilateral friends, such as China and Iran.