Sri Lanka has made important progress

On June 1, 2018, the Executive Board of the International Monetary Fund (IMF) completed the fourth review of Sri Lanka’s economic performance under the program supported by a three-year Extended Arrangement under the Extended Fund Facility (EFF) arrangement. Completion of this review enables the disbursement of the equivalent of SDR 177.774 million (about US$ 252 million), bringing total disbursements under the arrangement to the equivalent of SDR 715.23 million (about US$ 1,014 million).

Sri Lanka’s three-year extended arrangement was approved on June 3, 2016, in the amount of about SDR 1.1 billion (about US$1.5 billion, or 185 percent of quota in the IMF at that time of approval of the arrangement).

The Executive Board also concluded the 2018 Article IV consultation with Sri Lanka today.

Following the Executive Board’s discussion of the review, Mr. Mitsuhiro Furusawa, Acting Chair and Deputy Managing Director, said:

“Sri Lanka has made important progress under its Fund-supported program. The authorities’ efforts to improve the policy mix through fiscal consolidation, prudent monetary policy, and landmark structural reforms are supporting the economic recovery, despite recent shocks. Sustaining the reform momentum is critical to strengthen the country’s resilience to shocks, given the still sizable public debt and low external buffers, and to set the foundation for strong and inclusive growth.

“Further progress with revenue-based fiscal consolidation, supported by the new Inland Revenue Act, is needed to help safeguard important social and infrastructure spending, including in response to natural disasters. Going forward, a robust fiscal rule and medium-term debt management strategy will help place debt firmly on downward path.

“The recent approval of an automatic fuel pricing formula is a major achievement towards reducing fiscal risks from state-owned enterprises (SOEs). In this regard, it is essential for the authorities to implement an automatic pricing formula for electricity and a restructuring plan for Sri Lankan Airlines, as well as further strengthening SOE governance and transparency. The impact of the reforms on the vulnerable can be mitigated by ongoing efforts to strengthen social safety nets.

“The Central Bank of Sri Lanka should continue to manage monetary policy prudently, in the face of price shocks and market volatility. Efforts to build up international reserves should be sustained, with exchange rate flexibility as the first line of defense in response to volatile global capital flows. Upgrading the central bank law will be instrumental for the new inflation targeting framework. While financial soundness indicators remain stable, continued credit growth in the real estate sector warrants close monitoring.

“The authorities should step up implementation of structural reforms, with a focus on fostering gradual trade liberalization and the investment climate, developing a natural disaster risk financing framework, and promoting gender equality in the labor market together with well-targeted social safety nets.”

Press Release:

The Executive Board of the International Monetary Fund (IMF) today approved a 36-month extended arrangement under the Extended Fund Facility (EFF) with Sri Lanka for an amount equivalent to SDR 1.1 billion (about US$1.5 billion, or 185 percent of quota) to support the country’s economic reform agenda.

The IMF arrangement aims to meet balance of payments needs arising from a deteriorating external environment and pressures that may persist until macroeconomic policies can be adjusted. It is also expected to catalyze an additional US$650 million in other multilateral and bilateral loans, bringing total support to about $2.2 billion (over and above existing financing arrangements).

The Executive Board’s decision will enable an immediate disbursement of SDR 119.894 million (about US$ 168.1 million), and the remainder will be available in 6 installments subject to quarterly reviews.

During the same meeting, the Board also concluded the 2016 Article IV consultation. A separate press release will be issued shortly.

Following the Executive Board discussion on Sri Lanka, Mr. Min Zhu, Deputy Managing Director and Acting Chair, issued the following statement:

“Despite positive growth momentum, Sri Lanka’s economy is beginning to show signs of strain from an increasingly difficult external environment and challenging policy adjustments. The new government’s economic agenda, supported by the Extended Fund Facility, provides an important opportunity to re-set macroeconomic policies, address key vulnerabilities, boost reserves, and support stability and resilience.

“A return to fiscal consolidation, targeting a reduction in the overall fiscal deficit to 3.5 percent of GDP by 2020, is the linchpin of the reform program. Rebuilding tax revenues through a comprehensive reform of both tax policy and administration will be key in this regard, supplemented by steps toward more effective control over expenditures and putting state enterprise operations on a more commercial footing.

“Medium-term growth prospects also need to be supported through a greater role for market forces and a decisive shift toward an outward orientation. A clear commitment to exchange rate flexibility will enable adjustment to a shifting external environment while allowing the central bank to rebuild foreign exchange reserves and focus more closely on its key mandate of price stability. The economic program also supports the government’s objective of boosting competitiveness and greater integration with regional and global markets through comprehensive trade reform and improvements to the investment environment. Steadfast implementation of these reforms should strengthen Sri Lanka’s ability to attract investment, improve prospects for sustained medium-term growth, and reduce fiscal risks.”

ANNEX

Recent Economic Developments

Macroeconomic performance in 2015 reflected a positive underlying growth momentum mitigated by the negative impact of unbalanced domestic policies and an increasingly difficult external environment. Real GDP growth was 4.8 percent in 2015 (broadly unchanged from 2014), on the basis of strong growth in services (particularly tourism), continued growth in agriculture, and a positive (albeit declining) contribution from manufacturing. The negative growth in construction and weaker growth in manufacturing were indicative of a slowdown in public and private investment, as well as the negative effects of slowing world trade. The economy is currently estimated to be operating slightly below its potential, while the unemployment rate remains at 4.3 percent in end 2015, close to the historical norm.

The government fiscal deficit expanded to 6.9 percent of GDP in 2015. While revenue increased by 1.5 percentage points to 13.1 percent of GDP, this mostly reflected one-off measures and tax collections from a temporary surge in vehicle imports. Expenditures rose by 2.1 percentage points to 19.9 percent of GDP, on account of a post-election wage hike, a higher interest bill, additional spending on goods and services, and an increase in income transfer programs.

The overall balance of payments deteriorated significantly in 2015 despite an improvement in the terms of trade. The current account deficit was contained at 2.5 percent of GDP in 2015—the same level as in 2014. Capital flows have also been a key driving force behind the deterioration in the balance of payments. The capital and financial account position has weakened due to foreign exit from government securities, lower FDI inflows, and slow implementation of externally financed public and private projects. Investor sentiment has worsened, reflecting global market volatility and concern over domestic policies.

Tougher external conditions in the wake of China rebalancing and unwinding of unconventional monetary policies were not outside Sri Lanka’s past experience. However, spillovers were magnified by domestic imbalances, as evidenced by higher volatility around the two elections (January and August 2015), and the official budget passed in November 2015. The rupee continues to face downward pressure—largely reflecting capital flow developments. The foreign exchange and government bond markets were volatile in March 2016. highlighting rigidities in both systems.

Program Summary

The proposed new IMF-supported program aims to provide a policy anchor for macroeconomic stability and structural reforms, while strengthening external resiliency in a challenging global environment.

The key objectives of the program relate to fiscal policy and the balance of payments, and measures to: (a) implement a structural increase in revenues, facilitating a reduction in the fiscal deficit; (b) reverse the decline in central bank foreign exchange reserves; (c) reduce public debt relative to GDP and lower Sri Lanka’s risk of debt distress; and (d) enhance public financial management and improve the operations of state owned enterprises. The program also aims to transition toward inflation targeting with a flexible exchange rate regime and to promote sustainable and inclusive economic growth.

To achieve these objectives, the program would envisage implementation of a set of reforms under six pillars:

(i) Fiscal consolidation;

(ii) Revenue mobilization;

(iii) Public financial management reform;

(iv) State enterprise reform;

(v) Transition to flexible inflation targeting under a flexible exchange rate regime; and

(vi) Reforms in the trade and investment regime. (IMF)