IMF completes review on Sri Lanka program, warns on budgets

ECONOMYNEXT – The International Monetary Fund has completed a review on a program with Sri Lanka despite missing a revenue target, saying fiscal discipline critical as the island heads for presidential elections with candidates promising subsidies and tax cuts.

“Sustaining fiscal policy discipline remains critical to strengthen resilience and support growth, as important downside risks remain, amid heightened external and domestic uncertainty,” Mitsuhiro Furusawa, Deputy Managing Director said in a statement.

Sri Lanka’s growth has stalled after a currency collapse in 2018, which saw the rupee fall from 153 to 182 to the US dollar, triggered by liquidity shocks in the course of targeting a call money rate and an unstable exchange rate peg at the same time.

Sri Lanka has a so-called ‘flexible exchange rate’ which is a highly non-credible peg involving collecting a forex ‘reserve buffer’ which injects base money in direct conflict with an inflation targeting arrangement involving a domestic anchor.

A complete meltdown was avoided by tighter liquidity after credibility was lost in the peg, which has triggered a negative output shock, bad loans and a hit on revenues as consumption and imports fell, analysts have said. India is suffering similar effects.

IMF said growth is likely to be 2.7 percent for 2019, and 3.5 percent in 2020.

“Further progress in the structural reform agenda is essential to bolster competitiveness and achieve stronger and inclusive growth,” Furusawa said.

“Efforts should focus on liberalizing trade, by gradually removing para tariffs while addressing their revenue impact…”

The IMF is disbursing about 164 million US dollars under the program (118.5 mn special drawing rights) out of a total of 1.31 billion US dollar program (952.2 million US dollars).

“The Central Bank of Sri Lanka should maintain a data dependent monetary policy,” Mirusawa said.

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“The new Central Bank Act will be a milestone reform towards the adoption of flexible inflation targeting.

“Efforts to build reserves should be sustained to protect the economy against shocks, allowing for exchange rate flexibility in the event of market pressures.”

There have been concerns that Sri Lanka’s long running balance of payments troubles which come from targeting dual anchors (chasing a domestic inflation target while trying to collect forex reserves) will not end under the program and monetary indiscipline would continue with even weaker rules on the central bank.

Under the new law both the inflation targeting and exchange rate targeting is ‘flexible’. (Colombo/Nov02/2019)

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