The IMF Resident Representative in Sri Lanka says the county’s economy is stable in the short term with tremendous potential to grow while the continuance of the standby facility programme, along with long-term sustainable economic development, depends on consolidating the fiscal position.

The government has overshot the budget deficit target of seven percent of GDP for 2009, recording a deficit of 9.7 percent of GDP.

The IMF said it would discontinue disbursing the tranches of the US$ 2.6 billion standby facility programme with Sri Lanka until the next budget is presented in parliament and it gives a clear indication that an attempt is being made to reign in high deficits.

"The IMF would be in a better position to formulate a strategy when the government is in a position to show us they are committed to fiscal consolidation, and the proof of the pudding would be the 2010 budget," Dr. Koshy Mathai, IMF Resident Representative in Sri Lanka told the Island Financial Review in response to a question as to what the IMF’s response would be if the government made a request to continue the disbursements.

"At this stage, it is difficult to say what the desired budget deficit should be for 2010. What we would be looking for in the budget is for signs that the government is really committed to fiscal policy reforms, expanding revenues through tax reforms and consolidating expenditure," he said.

The 2009 deficit of 9.7 percent of GDP is a dramatic increase and Dr. Mathai said much of the spending is useful and necessary to promote economic growth but long-term sustainability requires more fiscal discipline.

If the government cannot control spending, and if revenues do not improve significantly, financing deficits could lead to macroeconomic instability in the long term.

"There are three ways in which this could happen. First, the government can resort to borrowing from international markets and this exposes the country to investor whims, or second, The Central Bank could print money and this could cause high inflation and third the government could either borrow from the domestic markets and this could lead to high interest rates. Either way it is the ordinary citizens of the country who have to pay the price," Dr. Mathai said.

The IMF believes Sri Lanka’s present macroeconomic situation is strong in the short term, and with the war over, has tremendous potential to grow further.

"In our view Sri Lanka has great prospects for unleashing its true potential," Dr. Mathai said.

This would call for government spending that would stimulate and sustain economic growth in the long term.