Budget 2022: Medium Term Stability in Focus – One-Off Taxes for Limited Set of Companies

Published on 15 November, 2021

Summary

What are the top stocks that are likely to benefit from the 2022 National Budget?

In a timely article, Asia Securities Research explores the key features of the new budget proposals and considers its impact on equities.

Immediate one-off impact for large companies akin to the super gains tax seen in 2015; focus on building medium term stability.
Government plans on balancing consumption driven growth with ambitious revenue targets.
If successful, the introduction of green bond financing is a potential USD inflow avenue.

The incumbent Government set out the path for reviving the post-COVID-19 economy in its 2022 National Budget last week. Faced with challenges of COVID-19 relief efforts, a gradual economic recovery hit by sporadic travel restrictions and decline in tax revenue, the new budget proposals take a medium-term view by focusing on stability, while increasing tax revenue in the near-term through one-off taxes targeting corporates that generated over LKR 2.0bn profits before tax in 2020/2021.

In the near term, the budget aims at generating a consumer led economic recovery post COVID-19. A key highlight was the government’s efforts to ensure minimal changes to the existing tax structure, notably consumption focused taxes, thereby ensuring lower impact on spending power.

The government looks to bridge the deficit completely through domestic financing. While this will reduce external debt, the method of financing is key, in our view. If the government resorts to money printing, this policy measure will see upward pressure inflation; in addition to the existing pressure from rising food inflation.

As an offshoot of the domestic financing target, we expect upward pressure on interest rates in 2022.

Another key feature is the focus on lowering expenditure towards State Owned Enterprises while increasing accountability of spending by these institutions. We believe this is a step in the right direction to lower part of the Government’s recurring expenditure. Overall, the government looks to reduce its recurrent expenditure sharply in 2022, a relatively ambitious target against the current backdrop.

While we perceive the broad tax base remaining largely unchanged to be a positive, our concern is on the government’s revenue collections in 2022, where the country gradually recovers from the impact of COVID-19. The rising cost of living owing to 1) escalating global commodity prices and 2) lower supply due to chemical fertilizer shortages is an added burden to consumers and farmers at this juncture. While the government forecasts revenue at ~12.3% of GDP (9.5% of GDP in 2021) driven by a 40.6% YoY growth in revenue collections, we expect this to be ~11.0% of GDP based on the lower-than-expected increase in the revenue base. At this point, we emphasize the need for a clearer outline of the government’s revenue collection plans to meet this ambitious target.

We expect government expenditure to reach 21.5% of GDP (against the government’s forecast of 21.1% of GDP). Our overall fiscal deficit forecast comes to 10.5% of GDP. We forecast GDP growth of ~5.1% YoY for 2022.

	IMPACT ANALYSIS
Real GDP growth (%)	Neutral - In the absence of higher income and consumption based taxes, the 2022 budget looks to support consumption driven growth. However, higher corporate taxes will be a barrier.
Headline inflation (%)	Neutral – While support to lower income earners is a positive, rising food prices remain the key concern for 2022.
Core inflation (%)	Neutral
LKR/USD (Monthly Average)	Neutral – No significant policies apart from Green bonds outlined to attract higher Dollar liquidity.
12M gov’t bond yield (%)	Negative – Upward pressure on rates with govt dependence on domestic refinancing.
Fiscal balance (% of GDP)	Neutral – While managing expenditure is a positive, widening the revenue base further is a key requirement.
Trade balance (% of GDP)	Neutral – Continued import controls and support towards the export sector a positive.
Current balance (% of GDP)	Neutral – No significant support towards tourism or remittances.
FX reserves (months of imports)	Negative – No material policies outlined to improve reserve position.

An interesting point was the government’s plans to introduce green bond financing as a potential USD inflow. If successful, this could be a potential USD inflow avenue given the challenges faced to go to international markets at this juncture.

Equities - Immediate One-Off Impact in The Near Term; Focus on Medium Term Stability

Asia Securities sees the impact of the 2022 budget as being neutral on equities in the near-term, although a one-off impact to counters affected by the tax policies may be seen.

Overall, we see the budget proposals made in positive light for majority of the sectors, including Manufacturing, Textile Fabric, Construction, Healthcare, and Renewable energy. On the other hand, sectors such as Banking and Non-bank finance Institutions would see an impact from the 2022 budget proposals.

We see the proposed “Social Security Contribution” at 2.5% on annual threshold turnover exceeding LKR 120mn affecting majority of the listed counters, and in effect brings back a similar tax to NBT. However, as this would be a pass-through tax, it is our view that corporates will take measures to pass this cost down to the end customers. However, in some cases this may not be entirely passed down amidst rising inflation and reducing buying power, and in sectors where demand is elastic.

One-time taxes proposed on highly profitable companies and the Banking and Finance sectors will have a near term impact to profitability. The most notable impact at a corporate level comes from a one-time 25.0% tax surcharge proposed to be imposed on persons or companies with a taxable income of over LKR 2,000mn. It should be noted however, that while this will see to a one-off impact to profits at the end of the financial/calendar year, the operating environment for affected counters remains unchanged. The downside we see here is the likely pullback on dividend payouts over rest of the ongoing financial year until the one-off tax is accounted for.

We expect to see investors factoring in the impact of the one-off taxes on the profitable companies to FY22E/CY21E valuations, and as such, likely to see a pullback in some of the affected counters. Furthermore, the impact will be focused on index heavy sectors such as Banking, NBFI, Manufacturing and Conglomerates. However, Asia Securities believe that the Banking and NBFI valuations have already been at a significant discount and does not warrant a further decline.

In the near term, with high single digit inflation expected to continue through the rest of 2021 and into early 2022 and interest rates expected to be maintained to promote growth, we believe equity markets will remain the preferred asset class. However, in the medium term, particularly heading into 2H 2022, we see the case for interest rates to pick up, which could impact equities negatively in the medium to long term.

Sector Impacts

Sector	Impact	Asia Securities Views
Manufacturing	Positive	The GoSL’s stance to continue to protect the local manufacturing sector remains a large positive On the back of this, we see the earnings momentum (barring one-off taxes) continuing in the future The manufacturing sector came off as one of the strongest performing sectors last financial year. As such, we expect to see the one-off tax impact on several manufacturing counters This we believe will lead to a pull back in dividend payouts for the rest of the ongoing financial year
Construction	Positive	We view the 2022 budget proposals made towards the Construction sector in a positive light; housing construction projects benefit construction-related manufacturers whose revenue mix is predominantly towards housing Local construction-related manufacturers will continue to benefit from low import competition Suspension of new office building construction for government institutions – However, we do not see this as having a large impact on the overall Construction Sector
Export Companies	Positive	We view the 2022 budget proposals towards the Export sector in positive light and believe will continue to support growth within the sector.
Healthcare	Positive	We view the proposed price mechanism for locally manufactured drugs positively. HHL has a strong local drug manufacturing business and has started test production at its new facility in Homagama. We believe counters such as ASIR will be incentivized to further expand its healthcare services across the island given the attractive concessions
Energy	Positive	With the concessions provided for renewable energy, we expect increased investments in the energy sector over the next 3-5 years It will also reduce overall energy costs of the country in the long-run
NBFIs	Neutral	Given no change in import restrictions on vehicles, we see continued pressure on net advance growth for NBFIs However, we continue to expect improving loan disbursements as growth momentum picks up against the backdrop of domestically driven growth Increase in the financial services VAT would be an added cost for the NBFIs
Insurance	Neutral	The deductions available for personal income taxes were maintained, which is a positive However, the additional taxes could lead to higher costs, depending on the mechanism of implementation
Agriculture	Neutral	Significant push for organic agri related growth and investment will be a significant catalyst for the sub sector However, concerns remain over the overall impact of these policies on the wider agriculture sector Moreover, the restriction of the importation of rubber products will benefit local producers and finished good makers
Leisure	Neutral	Although expected, there were no material proposals supportive of the overall COVID 19 impacted leisure industry in the budget With no significant changes outlined we believe the overall impact on the sector remains neutral Emphasis was mainly on developing Sri Lanka’s tourism product offering instead of more capacity building We note however that the concessionary refinancing facilities available for tourism industry stakeholders which was set to expire in September has already been extended by the government for another 9 months This will continue to be beneficial to leisure companies in terms of cashflow management Tax concessions for leisure investments of USD 10mn can be a positive if directed toward developing tourism attractions rather than more properties; i.e. adding capacity
Consumer	Neutral	There is no material impact at a consumer demand level, as the absence of tax changes and supportive concessions will help maintain purchasing power. However, counters within our coverage will see their financials impacted through the one-off surcharge and the Social Security Contribution. The Special Goods and Services Tax proposed in the 2021 budget will be implemented from Jan 2022. We believe this intended to simplify tax administration and thus will have a neutral impact.
Telco	Neutral	The impact of Special GST will be neutral Expansion of the Fiber network bodes well for SLTL given its already heavy investment into laying the coverage Better visibility into spectrum auctions, especially 5G would help level the playing field and would support DIAL’s ambition of 5G rollout
Banks	Negative	The overall focus on local production and development agenda would lead to better credit growth for the economy in CY22 However, the one-off surcharge (25% on taxable profits) would lead to a significant impact on the CY21 earnings, while the increased Financial Services VAT would lead to a relatively moderate impact of 3% - 4% on CY22 earnings The Social Security Contribution tax, if implemented in the current context would lead to ~8% - 10% hit on earnings, assuming the charge will be made on total operating income. However, the exact mechanism would need to be clarified in detailed tax proposals

*This article was originally published on the Daily FT. Asia Securities is a leading investment firm in Sri Lanka providing Investment Banking, Research, Equities and Wealth Management services to local and international corporate, institutional and individual clients. To become a client of Asia Securities, reach out via newclients@asiasecurities.lk