Sri Lanka's new government will spell out populist measures to cut the cost of living when it unveils a supplementary budget on Thursday, but an absence of credible steps to boost revenue could hurt the island nation's fiscal consolidation.
The new administration of President Maithripala Sirisena, which ended the decade-long rule of Mahinda Rajapaksa, has pledged to fix a "scary" economy plagued by what it calls faulty data issued by the old government. It has promised salary hikes for state employees and tax cuts.
The government wants to save money by curbing corruption and wastage, which it said was rampant under Rajapaksa, who lost a bid for a third term in a Jan. 8 election that passed off smoothly despite fears of trouble.
The old government's 2015 budget had aimed for economic growth of 8 percent, roughly in line with an estimated 7.8 percent last year, while trimming the fiscal deficit to a 37-year low of 4.6 percent of gross domestic product from an estimated 5.2 percent in 2014.
The markets are keen to see if the government will opt for a sovereign bond issue or commercial borrowing measures to fund the fiscal deficit, said Amal Sandaratne, chief executive of Frontier Research in Colombo.
"That will have an impact on interest rates," he said. "We are also eyeing any specific new credible revenue sources."
The $76-billion economy was "in a precarious position," Finance Minister Ravi Karunanayake told Reuters this week.
Annual inflation jumped to 2.1 percent in January, after hitting a more than five-year low of 1.5 percent in December.
Analysts are wary of a revenue gap in the short term, as the government will seek to garner votes in a parliamentary poll due to be held after April 23 and meet a promise Sirisena made.
"We think growth could suffer in the medium term, due to policy uncertainty, and fiscal slippage is likely," Prithviraj Srinivas, an economist at HSBC Global Research, said in a note.
"On the bright side, the transition process is likely to be smooth and transparent if the 100-day agenda is executed."
The International Monetary Fund had put pressure on Rajapaksa's government to boost revenues by reducing the number of taxes and tax exemptions and widening the tax base.
The government will practice "strong austerity", said new central bank Governor Arjuna Mahendran, who wants the number of taxes that Sri Lankans have to pay trimmed to five from more than 20 now.
"That is the very important structural thing we have to start doing immediately," he told Reuters.
Sri Lanka's economy has grown steadily since government forces won a 26-year war against ethnic Tamil separatists in 2009. (Editing by Clarence Fernandez)