A senior official of the Central Bank said it was highly unlikely that the IMF would want Sri Lanka to cut welfare expenditure but containing the budget deficit and maintaining fiscal discipline were sure to be on the IMF’s list of conditions for the US$ 2.5 billion standby facility to be approved on Friday.

"The contents as laid out in the Letter of Intent are not known at the moment except to a select few but it is unlikely welfare expenditure will be cut considering the positive steps the government is taking with regard to resettling the IDPs and reviving the country’s economy through various infrastructure projects," the official told the Island Financial Review.

"But there are surely going to be some conditions with regard to the budget deficit and fiscal management. Sri Lanka will be expected to contain the budget deficit and maintain fiscal discipline and the government, through the Central Bank has already submitted, in the Letter of Intent, what it proposes to do in this regard," he said.

Government lawmakers insist that the US$ 2.5 million standby facility is not coming with too many ‘unfavourable’ conditions, considering the exceptional circumstances in which Sri Lanka has asked for an IMF loan in the midst of the global finance crisis and the need to boost the post-war economy.

"We must understand that there will be conditions, the IMF is not going to lend US$ 2.5 billion for nothing. Once the loan is granted and released in tranches, the IMF would continue to monitor Sri Lanka’s progress with regards to the conditions in the Letter of Intent," our source said.

The Executive Committee of the IMF is expected to take a final decision day-after-tomorrow but officials are confident it is a ‘done-deal’.

The loan comes with a five percent rate of interest and will be disbursed in eight instalments.

Economists said Sri Lanka’s persistent budget deficits and inherent fiscal indiscipline would have to be tackled sooner than later.

The present government made a conscientious effort to contain the country’s budget deficits and adopted a Medium Term Macro Fiscal Framework in 2007.

The deficit was 7.7 percent of GDP in 2007 and despite targeting 7 percent in 2008 the actual was the same as for 2007, 7.7 percent of GDP.

This year too, revenues have collapsed while expenditures have increased, putting pressure on the budget deficit.

While welfare expenditure would continue despite some economists arguing for reasonable reductions, the state still persists with expenditure to loss-making enterprises, and the Central Bank intimated in its 2008 Annual Report that the government should seriously consider reforms in other areas.

The following excerpts from the Annual Report show the challenges government needs to be mindful of to make good the immense potential for vibrant economic development now that the war is over.

"The potential spill-over effects of the global financial crisis may necessitate the government to adopt decisive and properly conceived responses through additional fiscal measures to mitigate such negative effects.

"Given the limited fiscal space, it is vital to ensure that measures so introduced are well targeted, temporary and contribute to stimulate economic activities without having a significant fiscal slippage," the Central Bank says.

Given the importance of developing the Northern and Eastern provinces, the Central Bank goes on to say that measures should be taken to minimize the revenue shortfall and control additional expenditure.

"It will be prudent to postpone the implementation of any new mega projects till the global economy recovers, while carrying out projects that are already in progress at a slower pace (in order) to keep domestic financing requirements in check," the bank said.

On state-owned enterprises: "The performance of some State-owned enterprises (SOEs) still remain a concern and the financial viability of major State-owned trading enterprises (STEs) remains a strain on the government budget, highlighting the necessity to introduce appropriate measures to rectify these issues," the Central Bank said.

Investor confidence...

Officials and analysts alike are of the view that once the IMF loan is approved it would improve foreign investor confidence in Sri Lanka, in fact dealers say foreign investors are keen to invest in rupee denominated Treasury bonds but are waiting for the IMF loan to come through.