Delaying reforms could derail Sri Lanka growth, IMF warns

ECONOMYNEXT – The International Monetary Fund (IMF) said Sri Lanka has good growth prospects if it puts its economic house in order, with government failure to complete reforms and a further downturn in exports and remittances being main risks.

“The cost of inaction is relatively high,” said Todd Schneider, the IMF mission chief for Sri Lanka. “Sri Lanka needs to do a fundamental reboot of macroeconomic policy or a ‘policy upgrade’.”

For some time, there has been “policy drift”, Schneider said in a video conference from Washington to discuss the IMF’s approval of a three-year $1.5 billion loan to Sri Lanka.

“Not embarking on a fiscal consolidation path, allowing the exchange rate to adjust, reforming state-owned enterprises (SOEs) is one of the greatest risks – because uncertainty is very negative for investment and growth,” he said

The external environment for Sri Lanka was also weaker now given the island’s dependence on exports and remittances, the IMF said.

“The cost of capital is significantly higher –not what it was two years ago. So the external environment is important for Sri Lanka in the future,” Schneider said.

The IMF said in a statement that Sri Lanka’s prospects for the medium-term appear favorable if current macro-financial imbalances can be addressed.

Economic growth is projected to rise to 5 percent in 2016, supported by a recovery in construction and sustained momentum in services including tourism, transport and IT.

“Sri Lanka’s medium-term growth prospects are generally favourable, given its strong base of human and physical capital and strategic position in a fast growing and dynamic region,” it said.

“Over the past 1-2 years, fiscal consolidation has been reversed, gross financing needs have increased sharply, public debt has risen as a share of GDP, and persistent defense of the exchange rate has reduced net international reserves by over $2.3 billion."

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“Inaction on policies and continued reliance on borrowed resources to fund fiscal deficits and defend the exchange rate is unsustainable over the medium term, and will undermine prospects for investment and inclusive growth,” the IMF said.

Key risks relate to not achieving the envisaged increase in the tax-to-GDP ratio, a further decline in growth, or additional losses from state enterprises—all of which would pose challenges for fiscal consolidation.

Schneider said IMF support came under an Extended Fund Facility instead of the more usual Stand-By Arrangement because of the nature of some of the challenges Sri Lanka is facing.

Problems like tax policy and SOE reforms cannot be solved through quick fixes and take time, he said.

“By the end of the IMF programme, Sri Lanka should have achieved greater macroeconomic stability, a solid revenue base and stronger reserves,” Schneider said.

“The IMF is already having exchanges on a weekly basis, sometimes daily basis, with the Central Bank.”

The IMF deal has conditions for the release of funds, Schneider said.

These are quantitative targets related to fiscal balance and targets for international reserves, as well as indicative targets for revenue and “structural benchmarks” like passage of laws and the publication of certain documents, he said.
 
Progress will be reviewed on a semi-annual basis, and the IMF will release funds based on Sri Lanka meeting its conditions.
(COLOMBO, June 15, 2016)
 

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