Sri Lanka looks to resume deal with IMF

ECONOMYNEXT – Sri Lanka is looking to resume talks with the International Monetary Fund after a three year deal was suspended as the central bank failed to meet forex reserve targets and a constitutional crisis erupted.

"We have indicated that we would like to commence talks," State Minister for Finance Eran Wickremeratne said.

Sri Lanka had said it was about to sign the next section of the deal in late October when President Maithripala Sirisena de-stabilized the economy further by triggering a constitutional crisis.

The IMF said it was watching developments. The constitutional crisis ended in December with court ruling against the actions of President Sirisena.

However the program was already suspended by October, as the central bank failed to meet forex reserve targets in 2018 amid money printing that began around the end of the first quarter of 2018.

Sri Lanka has gone to the IMF multiple times as the country was hit by balance of payments crises due to contradictory policy of the central bank, involving defending a peg and printing money (sterilized forex sales) since it was set up in 1951.

In 2018, the pressure on the rupee emerged mainly after a rate cut and liquidity releases in March and April, which led to monetary instability and uncertainty among exporters and rupee bond investors.

Monetary instability was triggered despite cutting the budget deficit and market pricing fuel, which were politically difficult.

The finance ministry had generated a primary surplus in the budget by March.

Unlike in the past both Finance Minister Mangala Samarawera and State Minister for Finance Eran Wickremeratne had pointedly stayed away from interfering in the central bank, giving it full independence.





However the finance ministry had been pushing an enterprise credit scheme through the banking system and there was also an incident involving rupee dollar swaps with the central bank, which could be termed fiscal dominance of monetary at a stretch, analysts say.

The central bank had also made the finance ministry place controls on vehicle imports, hurting tax revenues, instead running consistent policy to prevent the re-emergence of balance of payments trouble through an unstable peg.

The IMF program was due to end in April 2019. The year end gross reserves were expected to be 9.7 billion rupees. But since liquidity injections began in March, the central bank was unable to collect reserves.

Forex reserves have fallen to about 7 billion US dollars. The central bank had spent 1.1 billion US dollars over the past three months in a cycle of peg defence and money printing.

Sri Lanka operates what is labeled a ‘flexible exchange rate’.

The ‘flexible exchange rate’ has turned out to be an unusually unstable soft-peg, where, with a loosely defined convertibility undertaking based on a real effective exchange rate, preventing a disorderly adjustment, giving forward exchange cover through swaps.

However monetary instability is now emerging just as several large debt repayments are coming.

There have been calls to reform the central bank to make it more difficult for the agency to generate monetary instability and currency depreciation.

Analysts had warned before the current three year program, that it would fail unless there was serious reform to the central bank. (Sri Lanka needs monetary reform, not just fiscal plaster)  (Colombo/Jan01/2018)

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