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IMF considering options for Sri Lanka but budget gap is still wide

ECONOMYENXT – The International Monetary Fund is considering options after Sri Lanka expressed interest in a program to help address balance of payments pressure but the budget deficit for 2015 is still high, an official said.

"IMF staff is considering options for Sri Lanka, which would depend on our assessment of macroeconomic vulnerabilities, the nature and size of balance of payments needs, and government policies to address these vulnerabilities," Resident Representative Eteri Kvintradze said in an emailed response.

Sri Lanka now faced tighter external financing conditions, a slower-than-expected recovery in Europe, rebalancing in China, and geopolitical-related economic distress in some trading partners, Kvintradze said.

"Domestic macroeconomic policies are also an issue," she said. "The IMF has emphasized the need for steps to re-establish fiscal consolidation and reduce public debt—mainly by expenditure restraint and such revenue reforms as eliminating tax exemptions.

"IMF staff has some concerns with the proposed 2016 budget, which does not envisage significant consolidation relative to the expected outturn for 2015."

Balance of payments pressure comes when budget deficits expand and the Central Bank prints money to accommodate it and keep interest rates down, generating import demand exceeding inflows and also firing private bank credit over and above deposits raised.

IMF has given a stand-by loan to Sri Lanka in 2009 following a balance of payments crisis in 2008 and it was derailed in 2011 with a fresh crisis brought by fuel subsidies accommodated with central bank credit, analysts have said.

This year Sri Lanka is targeting a 5.9 percent of gross domestic product deficit, almost the same as in 2015.

The deficit soared after state sector salaries, pensions and subsidies to special interest groups were jacked up by the new administration following an election promise.

Prime Minister Ranil Wickremesinghe said earlier this week that there were unknown contingency liabilities left over by the last regime for which parliament may have to vote additional revenues later in the year to cover them.

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In March provincial elections are coming up.

Kvintradze said the IMF has not formally "entered into program negotiations" and no new missions outside of technical assistance and regular surveillance were scheduled.

Prime Minister Wickramasinghe said Sri Lanka had also sought IMF help to re-write the tax code.

He said Sri Lanka wanted to seek a ‘stand-by’ arrangement (SBA). But Sri Lanka is still paying back a stand-by loan taken in 2009.

Other facilities include an Extended Fund Facility (EFF) for longer term adjustment or a Rapid Financing Instrument (RFI).

Unlike the 2009 and 2011 balance of payments crises which came from short term fiscal damage in the form of deceptive fuel subsidies which can be fixed by price rises and rate hikes, analysts say a January 2015 budget did lasting damage in the form of state salary and pension hikes.

The rupee has so far fallen from 131 to 143 to the US dollars since the new administration came to power.

Sri Lanka’s foreign reserves fell to 6.4 billion US dollars but they were temporarily boosted with a 1.1 billion US dollar swap from the Reserve Bank of India. A dollar bond was also raised and part of the money was sterilized.

However recent data shows that money printing is continuing apace even after the bond sale and to the extent that the Central Bank does not defend the currency and lose the reserves, the printed money will generate more currency depreciation. (Colombo/Dec04/2015 – Update III)

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