Sri Lanka says will reach IMF program targets for 2019

ECONOMYNEXT- Sri Lanka says it will meet the final targets for a program set for December 2019 with the International Monetary Fund, which will end in 2020.

“The current IMF programme will have its final review by February 2020 and the authorities are certain that the performance targets for 2019 will be duly met,” the Finance Ministry said in a statement after Fitch ratings downgraded Sri Lanka’s debt in the wake of a tax cuts to have ‘fiscal stimulus.’

“Further, it is important to stress that the Government will continue its engagement with multi-lateral lending agencies.”

Sri Lanka operated an IMF program for over three years after a balance of payments crisis in 2015, triggered by dual anchor conflicts involving targeting a domestic inflation index while also targeting an exchange rate to collect forex reserves or otherwise.

In addition Sri Lanka was targeting a real effective exchange rate index in a trade-oriented Mercantilist monetary policy of depreciating the rupee and also an output gap, and further complications under so-called ‘flexible’ inflation targeting.

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The program was based on so-called ‘revenue based fiscal consolation’ involving raising taxes, but analysts hard warned that it was also riddled with dual anchor conflicts, and the central bank was not restrained by a ceiling on domestic assets to block liquidity injections and further balance of payments troubles.

Instead a forex reserve target was given a performance criteria forcing exchange rate targeting and a loose reserve money ceiling as an indicative target, which was not enough to stop liquidity injection from triggering monetary instability again.

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The inflation target was also wide enough to allow large volumes of liquidity injections to be made.

As a result a currency crises was triggered in 2018, which led to a credit crunch and a fall in revenues, which led to the missing of 2019 June primary deficit targets for which a waiver was given.

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Under the existing program which expires with a review in April, Sri Lanka was expected to post a 27 billion rupees primary surplus (deficit before interest costs).

The central bank was expected to accumulate 1.5 US dollars of net foreign reserves by December of which 971 was collected by September effectively forming an external anchor.

The program also had an inflation target of 6.5 percent by December, as a domestic anchor.

The high domestic anchor allowed the central bank to print money (or buy dollars and leave unsterilized liquidity) either because inflation was below the wide target or there was a low growth and a perceived ‘output’ gap due to the previous currency fall in a ‘monetary stimulus’.

The monetary stimulus in the form of excess liquidity and low short term rates leads to renewed currency pressure and monetary instability which leads to knee jerk rate hikes and liquidity shortages to restore the credibility of the peg, triggering another steeper output shock along with a downgrade.

The output shocks the leads to revenue falls, missing the primary surplus target, losses in state enterprises, bloating of dollar debt and fiscal stimulus by a new administration. (Colombo/Dec20/2019)

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