Decisive polices needed to shore up confidence: IMF

• IMF condoles with SL on attacks, says latest tranche likely in May 
• Says initial market pressure seems contained 
• But decisive policy and security measures by Govt. important, especially for tourism 

The International Monetary Fund (IMF) has said it will continue its program, with the next tranche of the $ 1.5 billion Extended Fund Facility (EFF) to be released in May on the basis of a positive Budget but warned that even though initial market pressures appear contained Sri Lanka would need decisive policies to shore up confidence. 

Releasing short comments after Easter Sunday’s terror attacks, the IMF said it was “deeply saddened” by the attacks and the organisation joins the international community in condemning them. 

IMF Mission Chief for Sri Lanka Manuela Goretti

IMF Mission Chief for Sri Lanka Manuela Goretti said that since it began the EFF program with Sri Lanka, the country had made important progress in reforming its economy, including by revamping its tax system, strengthening social safety nets, and transitioning to inflation targeting. 

“Initial financial market pressures seem to have been contained in the aftermath of the attacks. Decisive policy and security measures by the authorities will be important, in particular for tourism, which accounts for 5% of GDP, to build on the strong performance of recent years,” she said. 

The IMF also noted the 2019 Budget approved in early April strikes a “good balance” between advancing revenue-based fiscal consolidation, which is important to shore up market confidence given Sri Lanka’s high debt and refinancing needs, while making space for macro critical capital and social spending and business friendly tax measures.

“Based on the important progress to date and the reform plans under the program, our Executive Board is expected to consider in mid-May the authorities’ request to complete the fifth review under the arrangement and extend it by one additional year until June 2020. This will provide additional time to the authorities to anchor macroeconomic stability and complete their economic reform agenda,” she added in the short statement. 

The IMF last month extended its EFF program for an extra year into 2020, a key step in keeping foreign investors involved in what so far this year has been a top-performing frontier debt market. 

However, Reuters in an analysis reported with growth, and therefore State revenues, now likely to slow significantly after the attacks, the Budget targets agreed with the IMF may have to be reviewed, and the Government is expected to resist pressure for any spending cuts before elections expected later this year. 

“The Central Bank may be forced to hike rates again this year,” Brown Brothers Harriman (BBH) Global Head of Currency Strategy Win Thin was quoted as saying in the Reuters article. The analysis also warned that with low reserves of about $ 7.7 billion the Central Bank would not be able to support the rupee and additional IMF funds may be needed if tourism revenue drops drastically. 

“With foreign reserves very low right now, the Central Bank cannot actively support the rupee.” 

After falling 16% against the US dollar last year to record lows, the rupee had gained 4.6% this year as of last week.

There is even a possibility that more IMF money may be needed if foreign investment falls, adding to the hard currency gap left by plunging tourism receipts, Reuters said.  

“If growth slows a lot more and the budget deficit assumptions need to be reassessed, then they’ll have to sit down and negotiate something more feasible,” said Capital Economics Asia Economist Alex Holmes. 

Additional debt repayments expected later this year and into next year could also prove to be challenging.  

“Given the fact they have repayments coming up for sovereign bonds, it could lead to more pressure on foreign currency reserves. So, it’s a near term negative for the tourism sector and also market sentiment as well,” said Ruchir Desai, Fund Manager at Asia Frontier Capital, who co-manages the $16 million AFC Asia Frontier Fund. 

“Valuations are cheap, no doubt... but until they get some kind of political unity which can result in stable policy-making, we will probably remain underweight (equities) until the elections.”