Sri Lanka: Government submits 2025 budget bill, targets 6.7% of GDP deficit
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
The government submitted the 2025 budget bill to the parliament, aiming for a 6.7% of GDP fiscal deficit, according to the?2025 budget draft. The deficit is only marginally lower than the 6.8% estimate in 2024, though it continues the fiscal consolidation over the past couple of years.
Revenues
Total revenues and grants are projected to rise by 23%, mostly on the back of higher tax revenues. Both direct and indirect tax revenues are forecast to rise at a double-digit pace, with non-tax revenue growth seen particularly strong at nearly 26%. This is largely in line with the recovering private consumption. Revenues from customs and levies will also rise at a very sharp pace.
Overall, the revenue growth rates will slow down compared to 2023, though nominally the expansion will be roughly the same. This means that total revenues will have risen by 65-70% in just two years. If the government keeps this pace of revenue growth, total revenues would likely double in 2026 compared to the 2023 levels.
Expenditure
On the other hand, total expenditure is also projected to grow by 17.3%, again rather robust growth, though below the revenue growth rate. This reflects both higher spending on salaries, as well as interest expenditures. Subsidies and regional transfers are also forecast to grow by 11% next year, with the government also increasing the social safety net.
As a result, the fiscal deficit is set to expand by 7.8% to LKR 2.2tn, close to the nominal deficit in 2023. This largely suggests that the government counts on revenue growth to lower the fiscal deficit, with no fiscal consolidation on the expenditure side.
Deficit financing
The deficit will be financed mainly by domestic borrowing, while foreign borrowing will be used for maturing debt payments. This marks a shift from 2024 when the government had to repay part of the maturing foreign debt through domestic debt issuance. As a result, domestic financing will drop by more than 50%, which should help lower yields.
We remind that the government regularly places T-bills and bonds on the domestic market, with demand recovering after the government lost access to bond markets three years ago.
Overview
We see moderate risks with the budget execution this year, given the ongoing overreliance on revenue growth in order to meet the deficit targets. On the revenue side, there would be some slowdown in revenue growth compared to 2024, but still, the expansion is more than robust.
There certainly are downside risks associated with the revenue projections, particularly with the absence of major tax reforms in 2025. However, the government likely counts on the carryover effect from previous tax hikes in 2022-2024. Those will certainly boost tax revenues as the government has previously raised the VAT rate from as low as 8% in 2022 to 18% in 2024, while income and corporate tax rates also increased in the period.
On the other hand, there is little leeway on the expenditure side as the government seems not to have left much space for spending cuts in case revenue collection goes south. Moreover, it will be difficult to cut wages or reduce the social safety net, despite that the president is early in his term.