Sri Lanka has to trim budget deficit urgently: IMF

ECONOMYNEXT – Sri Lanka has to trim its runaway budget deficit "urgently" to and raise more taxes, the International Monetary Fund said, as the central bank continued to print money to accommodate state spending, driving credit up and pressuring the currency.

An IMF mission that ended a visit to Colombo on February 05 said the budget deficit is likely to overshoot the target and the economy was at risk from the gap and the need to borrow from domestic and foreign markets.
"The mission has advised the government to urgently make a stronger effort to narrow the fiscal deficit and put the public finances on a sustainable path," a statement said.

In 2015 the budget deficit is estimated to have topped 7 percent of gross domestic product.

Sri Lanka has to focus on broadening the tax base and simplifying and making an equitable tax system and improve tax administration.

The budget for 2016 raised personal income threshold taking many rich people out of the tax net but has started raising protectionist taxes.

Sri Lanka has said it is seeking a loan from the IMF this year.

"Despite the narrowing of the current account, capital outflows have intensified and the overall balance of payments deteriorated," the IMF mission said.

"These outflows were accompanied by downward pressure on the rupee and a decline in central bank gross foreign exchange reserves mainly due to short-term capital outflows as experienced in many emerging markets."

Analysts using classical economic approach had already forecasted that capital outflows or a reduction in net inflows on the financial account will lead to a contraction of the current account deficit.

But money printing by the Central Bank (purchase of domestic assets to extend central bank credit to the banking system) will lead to reserve losses and also currency depreciation if the printed money is not mopped up through currency defence, they warned early last year.

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No benefit also could be expected to come from falling oil price of retail prices were cut, as the increase in disposable income will lead to non-oil imports either through direct consumption or through credit if the money is saved.

The IMF claimed that monetary policy was tightened at the end of the year (through a reserve ratio hike) but analysts have said that continued money printing would nullify any effect and the rupee would continue to come under pressure.

The rupee has fallen 9 percent over 2015 and the IMF said the central bank had allowed market forces to work more.

An attempt to float the rupee failed in September 2016, as no attempt was made to fix the deficit or raise interest rates high enough to curb consumption and allow the budget to be financed without printing money.

Data showed that in December forex reserves fell by a billion US dollars to 6.3 billion dollars.

“These imbalances are also set against an increasingly less benign external environment," the IMF said.

"Key risks for emerging market and developing economies relate to a weaker global growth environment, market volatility, declining commodity prices, and tighter external financing conditions in the context of global rebalancing.

"Set against such risks, the mission emphasized the urgent need for Sri Lanka to bolster its economic defenses.

Sri Lanka’s current cycle of economic problems started with a revised 2015 budget in January which raised state salaries and subsidies and was worsed by a policy rate cut in April adding monetary fuel to the fiscal fire.

Sri Lanka has a so-called soft-pegged monetary arrangement – where the central bank tries to control the exchange rate while printing money – since 1951 and the country has got into balance of payments trouble form 1952. (Colombo/Feb05/2016)
 

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