Non-implementation of fiscal reforms biggest risk to Sri Lankan economy - IMF

Executive Board of IMF approves sixth tranche under US$ 2.6bn standby facility programme


* Total disbursements now US$ 1.51bn, five more
tranches to go before pro gramme ends 1H 2012

* No inflation fears, but  Central Bank must be ready

* Good progress made by Sri  Lanka both in fiscal front and
building reserves despite  target waivers

The Executive Board of the International Monetary Fund (IMF) approved the disbursement of the sixth tranche of US$ 216.6 million under the US$ 2.6 billion standby facility arrangement with Sri Lanka in the wee hours of February 3 (Sri Lanka time) as the island-nation was making healthy progress and received waivers on two of the December targets in the process as performance trends satisfied the board. But the biggest threat to the economy was the non-implementation of fiscal reforms proposed in recent budgets.

The standby facility was approved by the Executive Board of the IMF in July 2009 as Sri Lanka faced a balance of payments crisis and with the approval of the sixth tranche on Thursday (3), the IMF was confident that that the government would successfully conclude the programme by early 2012, with healthy foreign currency reserves and a budget deficit of 5 percent of GDP, which would help bring down the public debt to GDP ration from the 80 percent it is today to nearly 60 percent.

The IMF was happy with Sri Lanka’s macro economic stability and fiscal reforms of the government, but the Sri Lanka Resident Representative of the IMF, Dr. Koshy Mathai, said the biggest risk to Sri Lanka would be the non-implementation of fiscal reforms outlined in the budgets for 2010 and 2011.

Authorities did not provide data for the fiscal targets during the programme review conducted in December, but Dr. Mathai said that indications were strong that the 8 percent deficit target for 2010 would be met.

"We did not get the necessary data to decide whether or not the December fiscal target was met, but available data suggested that Sri Lanka was likely to meet this target and therefore it received a waiver and the tranche was released," he said.

He did not elaborate on the exact numbers, but according to available Central Bank data, the government deficit for the first eleven months of 2010 reached 7.34 percent of GDP from near 9 percent during the corresponding period of 2009, a year where the budget deficit ballooned to 9.9 percent of GDP from an original estimate of 7 percent. The overall deficit for the period January-November 2010 declined 5.27 percent on faster revenue generation and slower expenditure growth, latest Central Bank data showed.

Sri Lanka’s fiscal performance has been described as the bane of macroeconomic stability, and Dr. Mathai said good progress was being made and said authorities needed to ensure that fiscal reforms would be carried out.

He said Sri Lanka’s government expenditure underwent some consolidation in 2010, but the IMF’s concern is on the revenue side as Sri Lanka has one of the lowest revenue to GDP ratios compared to most countries in the region.

Dr. Mathai said steps to simplify and broaden the tax net and removing the high incidence of tax incentives offered by the BOI were some of the proposals made by the government that were in the right direction.

He also said the Ceylon Petroleum Corporation and Ceylon Electricity Board would have to breakeven by the end of this year, which would also reduce the burden of state-owned enterprises on the public purse.

The Central Bank and a think-tank, the Institute of Policy Studies, have constantly reminded the government the need to contain its high deficits in order to bring about macroeconomic stability.

Sri Lanka did not meet the reserve targets for December but Dr. Mathai said the government offered a genuine cause for missing this target, which was good enough for the IMF to waive this too and approve the US$ 216.6 million tranche.

Last year, when the 7 percent deficit target was missed, reaching 9.9 percent, the IMF suspended the programme until it was certain the government was committed to the programme.

A communiqué issued by the IMF in Washington quoted Deputy Managing Director and Acting Chair of the Executive Board, Naoyuki Shinohara as saying, "The Sri Lankan authorities have made good progress under the Fund-supported program and macroeconomic developments continue to be favorable. Growth is strengthening; inflation remains in check, despite some pressure in food and energy prices; and imports have recovered. With strong remittance inflows, gross reserves remain at comfortable levels.

Improvements in fiscal performance are encouraging. The 2010 budget execution addressed past fiscal slippages and bolstered the credibility of fiscal policy. The 2011 budget is generally sound, and reflects the government’s strong commitment to the program’s goals.

The proposed tax reforms and reforms of the Board of Investment’s tax concession regime should result in a more efficient, transparent, and simpler tax system with a broader base. If implemented properly, these reforms should improve tax compliance and deliver durably higher revenue.

"Monetary conditions are stable, and credit has picked up. With few signs of demand-driven inflation pressures, the policy stance remains appropriate, but the Central Bank should be ready to act to head off any emerging inflation risks. The Central Bank has been building up reserves while allowing the exchange rate to appreciate. Looking ahead, however, the exchange rate will need to be sufficiently flexible in both directions to safeguard external stability.

"Financial sector reform has continued in line with the program. Going forward, reforms should focus on further strengthening the financial system and expanding funding options for the private sector, including through a deeper corporate bond market and a revamped legal framework for pension funds. " Shinohara said.

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