Sri Lanka strikes US1.5bn EFF reform deal with IMF; US$650 for budget

ECONOMYNEXT – Sri Lanka has reached a three year deal to borrow 1.5 billion US dollars from the International Monetary Fund which boost tax collections and state enterprises losses, which will trim the budget deficit and stabilize the credit system.

In addition to the 1.5 billion US dollars going to the central bank to boost reserves under IMF’s Extended Fund Facility, another 650 million dollars in program loans will come from the World Bank, and other lenders to finance the budget directly.

Sri Lanka hopes to use the program to sell sovereign bonds in international capital markets. This year’s budget gap is expected to be brought down to 5.4 percent from 7.4 percent in 2015.

Fiscal, Trade Reform

"The government’s economic program aims at fundamental changes to tax policy and administration to reverse a two-decade decline in tax revenues and put public finances on a sustainable medium-term footing," IMF mission chief Todd Schneider said in a statement.

"The macroeconomic stability and renewed market confidence from this fundamental re-set of policies will reduce vulnerabilities, boost growth, and foster sustainable job creation."

Sri Lanka will increase tax collections to 15 percent of gross domestic product by 2020, reduce the budget deficit to 3.5 percent of GDP and aim to generate a primary surplus (deficit before interest). Sri Lanka aims primary surplus in 2018 under IMF deal, to suspend BOI law: report

Sri Lanka will re-write the income tax and customs code and use information technology extensively to plug revenue leaks by reducing administrative discretion.

Trade will also be liberalized making the economy efficient. Analysts say trade liberalization will also liberate the most vulnerable sections of the population from the grip protected big business.

Tranches of the loan will start to come from June 2015, after the IMF’s board approves the deal.

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Prior Actions

Before that Sri Lanka has to complete a series of ‘prior actions’ to make sure that the economic reform program is not de-railed.

Sri Lanka has announced valued added tax hikes – amid concern for a 15 percent VAT on education and healthcare which will hurt plans for a knowledge economy and most vulnerable sick people in society including the ageing – from May 02.

Prime Minister Ranil Wickremesinghe Sunday also unveiled plans to take-over debt of Sri Lankan Airlines find a managing partner, and suspend sweeping tax holidays under a Board of Investment law which gives wide discretion for bureaucrats outside the finance ministry to give tax holidays. (Sri Lanka govt to take-over SriLankan debt; seek managing investor: PM)

"State enterprise reform will play a key role in both limiting future risk to public finances and enhancing the role of market forces in the economy," Schneider said.

"The government is committed to dealing quickly with the legacy of Sri Lankan Airlines, which continues to represent a drain on public finances after years of mismanagement.

"Going forward, key state firms – and the government’s financial relations with such firms – will be governed transparently by annually published statements of corporate intent."

Sri Lanka will market price fuel, with subsidies for the poor.

Monetary Policy

The central bank will is to move to a ‘flexible inflation targeting regime’ with a more ‘flexible exchange regime.’

"The central bank will shift toward a flexible inflation targeting regime while also undertaking measures to help deepen foreign exchange markets and a support a durable transition to a flexible exchange rate regime," Schneider said.

Sri Lanka has a monetary regime where the central bank intervenes to prevent the currency going up generating money outside open market operations.

The central bank also prints money to repay Treasury bills outside open market operations which some analysts says will undermine any inflation targeting regime and re-create the 1980s danger of a permanently downward crawling peg (flexible exchange rate) and high inflation.

Sri Lanka’s central bank has a strong track record in delaying rate hikes and de-stabilizing the credit system.

However unlike in the 1980s there is more public awareness and early warning about the central bank’s tendency to follow loose policy and generate inflation and currency trouble.

The central bank triggered the 2015/2016 currency crisis by cutting rates in April 2015, while private credit took off and the budget deficit deteriorated. Currency defence rapidly mopped up excess liquidity and eventually forced interest rates up.

But the rupee also collapsed from 131 to 146 to the US dollar especially after currency defence was reduced and more money was printed. After the currency fell, and bank fixed deposit rates went up policy rates were raised to old level and a controversial statutory reserve ratio hike was also made.

Bank fixed deposit rates are now around 300 basis points higher from a year earlier. It also 15 months since salaries and subsidies were hiked, the economy has expanded since then and the collapsed rupee has also increased inflationary revenues. (Colombo/April29/2016)

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