Government raises tax following uncertainty over bond issue

The Sri Lankan government announced significant tax rises as the turmoil in the global credit markets cast a shadow over its plans to raise large sums of money through a bond issue to tackle spiraling costs and inflation.

 

According to leading global fund managers, the slump in the global credit markets and escalation of conflict between government forces and Liberation Tigers of Tamil Eelam (LTTE) may force Sri Lanka’s to delay its first overseas debt offering.

 

"All bets are off in a situation where investors are generally looking to decrease risk in their portfolios," said Joel Kim, who manages the equivalent of $10 billion at ING Investment Management in Hong Kong, the International Herald Tribune reported. "They need to wait for better market conditions."

 

Another fund manager, Clifford Lau, who manages $7.6 billion of debt at Pramerica Fixed Income in Singapore, said ‘the timing of the sale is tricky for Sri Lanka. "When there's a conflict, it is always unfavorable."

 

A series of rate increases to curb the inflation which has pushed the interest rate to 8.25% and escalation in fighting between government forces and LTTE have slowed expansion in the $26 billion economy.

 

On August 2, Sri Lanka announced it had hired Barclays Capital, HSBC Holdings and JPMorgan to help raise $ 500 million to revive the economy and to upgrade the country's infrastructure.

 

However analysts believe Sri Lanka was raising funds to sustain its war efforts and continue government subsidies to keep the cost of living down.

 

According to Fitch Ratings, which rates Sri Lanka's long-term foreign-currency debt at BB-, three levels below investment grade, a delay would worsen the government finances.

 

"The security situation remains a cause for concern and the macroeconomic environment is not encouraging, particularly in the light of the current global financial market turmoil," said Paul Rawkins, the London-based senior director of Fitch.

 

The central bank of Sri Lanka had said it would hold road shows in early September, but has yet to announced venues and dates.

In addition to unfavorable global Markets the bond issuance is also facing political obstacles with the main parliamentary opposition, the United National Party (UNP), protesting against it.

 

The UNP, which organized a protest in front of the HSBC Bank offices in Colombo last week, said that if it were to come to power it would revoke the HSBC’s local licence for helping the government with a planned $500 million bond.

Last month the UNP leader Ranil Wickramasinghe wrote to HSBC, Barclays Capital and JP Morgan stating the borrowing would jeopardise servicing of existing debt and threatening not to honour repayments on coming to power.

“This ... raises the very real prospect of a future default in the servicing of repayments to investors in this bond issue,” Wickremesinghe said in the letter.

 

“Therefore a future government formed by the UNP will not be able to honour the repayment obligations,” he added.

Tax Rise

 

Following the uncertainty over raising funds through a debt issuance, the cash-strapped Sri Lankan state has announced plans to increase the cost of mobile phones, vehicles and other items such as washing machines.

 

According to local media, the new taxes would raise billions of rupees for the government, ahead of the budget.

 

“The government is desperate for cash, so these are the various forms of ‘subtle’ taxes that come before the (November) budget,” one tax expert told the Sunday Times newspaper in Sri Lanka.

 

According to the paper, under the pre-budget bill which was passed in the parliament by 25 votes, mobile phone users will have to pay a new monthly tax of Rs 50 in addition to the ‘Cellular Mobile Telephone Subscriber Levy’ going up sharply to 7.5 percent from a current 2.5 percent. The Rs. 50 tax alone is expected to raise at least Rs, 2 billion annually.

 

The paper further reported that vehicle prices will rise with increased import duties being levied in terms of the Regional Infrastructure Development Levy of the Excise (Special Provisions) Act.

 

Under this, the current scheme of a flat rate of 2.5 percent for all vehicles will be replaced with a 2.5 percent tax on vehicles with engine capacity not exceeding 1,600 cc, 5 percent for engine capacity of between 1,600 and 2,000 cc and 7.5 percent for vehicles more than that.

 

The bill also introduces a 5% increase to import taxes, pushing it to 15%. Although, the bill doesn’t specify the items that will be affected, tax experts told the Sunday Times it will apply to a whole list of items like washing machines, air conditioners and paints. However it is not expected to apply to tobacco, cigarettes or beverages which come under the normal Excise Act.

 

A new levy called the Special Commodity Levy is also being introduced to “provide for the composite levy on certain specified commodity items in lieu of the amount chargeable on such commodity items like a tax, duty, levy, cess or any other charge.

 

“Invariably the price of the item will rise.”

 

As always, consumers and not companies will bear the brunt of these taxes as in the case of mobile phone companies which enjoy tax holidays and merely pass on these extra payments to the end user, the tax expert told the Sunday Times.

 

 

As an indication of further deterioration of its financial woes, Sri Lanka's rupee weakened to its second consecutive life closing low on Thursday.

 

The Sri Lankan rupee is steadily depreciating largely due to trade-related moves in an economy that runs a hefty trade deficit because of costly fuel imports and the impact of inflation.

 

The Colombo All Share index (CASI) closed 0.04 percent weaker at 2,531.93 points, a fall of 1.11 points, reported Reuters.

 

The CASI index has fallen around 16 percent since life highs in mid-February amid escalating war between the state and LTTE and high interest rates, which have prompted some investors to turn to fixed deposits and bonds, Reuters further added.

 

"The market ended slightly weaker on retail selling," said Susil Fernando, investment advisor at DFCC stockbrokers in Colombo.

 

The bourse is also down around 7 percent so far this year, with renewed war between the state and LTTE hurting sentiment.

 

Tourist arrivals fell 20 percent to 44,142 in July after the LTTE launched an air attacks on oil and gas facilities near the capital, Colombo.