A report by international bankers, the Citigroup, says Sri Lanka’s economy is estimated to grow at 4 percent this year with inflation averaging 3.5 percent while the budget deficit is expected to reach closer to 8.5 percent of GDP.

According to the agreement between the government and the IMF the budget deficit is expected to be maintained at 7 percent of GDP.

The IMF revised the economy’s growth forecast to 3.5 percent citing improvement in the economy after the war ended. Its earlier forecast was 3 percent growth.

According to the Department of Census and Statistics, the 12 month moving average in the rate of inflation forecast for 2009 would be 4 percent.

The Citigroup report, appearing in the Asian Edition of the group’s Emerging Markets Daily, said the government’s Letter of Intent for the USD$ 2.6 billion IMF standby facility, had no surprises but said implantation would be important.

"The document details policy changes the government intends to implement and maps out quantitative performance targets in order to secure funding," the Citigroup report said.

"While measures appear encouraging and are largely in line with expectations, we believe implementation is key. At the outset, targets are realistic, although fiscal goals may prove difficult to achieve," it said.

The report asks whether the targets set in the Letter of Intent are achievable.

"Are targets achievable? The Letter of Intent hasn’t presented any surprises, and we expect most quantitative performance criteria (such as on reserve money, foreign exchange reserves) to be met.

"However, implementing fiscal targets may be difficult, particularly given (a) higher reconstruction spending, (b) parliamentary elections, and (c) current anaemic trends in tax collections.

"We maintain our view of the deficit coming closer to 8.5 percent, GDP (growing) at 4 percent, and inflation averaging 3.5 percent in 2009," the brief report concluded.

Meeting deficit targets...

According to the Letter of Intent, the government has to maintain the budget deficit at 7 percent of GDP by the end of this year and this includes spending on development, resettlement and humanitarian activities in the once war-torn regions of the country, Brian Aitken, Mission Chief for Sri Lanka of the IMF’s Asia and Pacific Department, who was in Sri Lanka last month said.

"The government has committed itself to a budget deficit of 7 percent and there is no doubt the government would stick to this commitment. When we look at the revenue and expenditure performance so far, it is feasible that the government would achieve the deficit goal," Aitken said.

Aitken said the IMF was confident that the government would stick to its commitments when the budget for 2010 is presented in parliament this November (there is some doubt now as to whether a budget would be presented as previously planned).

"The government is committed to a budget deficit of 6 percent for 2010. However, there is flexibility to exceed this by 0.5 to 0.75 percent given the expenditure on large infrastructure projects that would commence in the North from next year," he said.

Under the IMF programme Sri Lanka is committed to increasing its revenue by 2 percent of GDP and Aitken said this could be achieved without increasing taxes or introducing new ones by bringing in reforms to the administration.

For the first seven months of this year, according to latest data issued by the Central Bank, Government revenue has declined marginally by 3.5 percent to Rs. 344.3 million from Rs. 356.8 million during the corresponding period of 2008.

On the expenditure side, Aitken said the IMF did not want expenditure cuts on healthcare, education and subsidy payments, such as for fertilizer because they were long term investments and that have to be made for the development of the country.

"But, there has to be cuts in other expenditure areas," he said.

For the first seven months of the year, total government expenditure increased by 17 percent to Rs. 641.5 million with recurrent expenditure increasing by a little less than a quarter percent from the corresponding period of 2008 to Rs. 498.9 million. But capital expenditure decreased by 2.72 percent to 142.6 million.

Reserve targets...

Under the IMF standby facility programme Sri Lanka has to build enough reserves for 3.5 months import requirements.

But Sri Lanka has already exceeded this target with reserves over US$ 4 billion after foreign inflows improved after the war but the IMF would look at foreign exchange reserves built up through export earnings and private remittances.

According to the Central Bank, total net foreign inflows to government Treasury bills and bonds since mid May 2009 to 11 September 2009 amounted to about US$ 1.2 billion and since end March 2009 to September 9, the Central Bank has absorbed US$ 1.9 million from the domestic market dealers said were short term ‘hot capital’ inflows from foreign investors in to the country’s capital markets.

While these funds could easily go out as they had come in, Aitken noted last month that the Central Bank was taking adequate measures to create a reserve cushion.

Fourth IMF loan...

Sri Lanka had gone to the IMF on four occasions previously in 1983, 1988, 1991 and 2001.

In 2001, a spike in world oil prices caused a balance of payments problem with reserves dipping to a little over US$ 1 billion.

According to Economic Reforms in Sri Lanka—Post 1977 period (published 2005) these reserves (in 2001) were enough to finance four months imports. But when reserves fell to US$ 1.4 billion in January this year it was enough to finance imports for under two months—global inflation perhaps.