Fiscal prudence critical to support macroeconomic stability and debt refinancing: IMF

• Economy recovering from Easter attacks
• GDP growth projected at 3.7% in 2020
• Ambitious structural and institutional reforms needed 
• Warns current account deficit likely to widen to about 3% of GDP in 2020
• Due to stimulus primary deficit projected to widen to 1.9% of GDP this year
• Reserves fell about $ 100 m short of target in Dec.

Fiscal prudence is critically important to Sri Lanka given its high levels of debt and refinancing needs, the International Monetary Fund (IMF) has said in its latest assessment, calling for prudent monetary policy and efforts to build reserves even though growth is expected to rebound to 3.7% in 2020. 

IMF Mission Chief for Sri Lanka Manuela Goretti

A staff team from the International Monetary Fund (IMF) led by Manuela Goretti visited Colombo from 29 January to 7 February to meet with the new administration and discuss its policy agenda. The statement released at the end of the visit said the IMF staff team had constructive discussions with the Sri Lankan authorities on recent economic developments and the country’s economic reform agenda. 

However, the statement warned that given the high level of public debt and refinancing needs in the country, ensuring macroeconomic stability calls for fiscal consolidation, prudent monetary policy, and sustained efforts to build international reserves. 

“Ambitious structural and institutional reforms remain critical to raise the country’s growth potential and promote inclusiveness,” the statement said. 

The economy is gradually recovering from the terrorist attacks last April. Real GDP growth is estimated at 2.6% in 2019. The recovery is supported by a solid performance of the manufacturing sector and a rebound in tourism and related services in the second half of the year. 

“High frequency indicators continue to improve and growth is projected to rebound to 3.7% in 2020, on the back of the recovery in tourism, and assuming that the novel coronavirus will have only limited negative effect on tourism arrivals and other economic activities. Inflation is projected to remain at around 4.5%, in line with the Central Bank of Sri Lanka (CBSL) target. 

After a sharp import contraction in 2019, the current account deficit is expected to widen to nearly 3% of GDP in 2020,” the statement added. 

Preliminary data indicate that the primary surplus target under the program supported by the Extended Fund Facility (EFF) was missed by a sizeable margin in 2019 with a recorded deficit of 0.3% of GDP, due to weak revenue performance and expenditure overruns. 

Under current policies, as discussed with the authorities during the visit, the primary deficit could widen further to 1.9% of GDP in 2020, due to newly implemented tax cuts and exemptions, clearance of domestic arrears, and backloaded capital spending from 2019, the IMF warned.  

“Given risks to debt sustainability and large refinancing needs over the medium term, renewed efforts to advance fiscal consolidation will be essential for macroeconomic stability. Measures to improve efficiency in the public administration and strengthen revenue mobilisation can help reduce the high public debt, while preserving space for critical social and investment needs. Advancing relevant legislation to strengthen fiscal rules would anchor policy commitments, restore confidence, and safeguard sustainability over the medium term.”

The CBSL should continue to follow a prudent and data-dependent monetary policy and stand ready to adjust rates to evolving macroeconomic conditions. Net International Reserves fell short of the end-December target under the EFF-supported program in 2019 by about $100 million amid market pressures after the Presidential Elections and announced tax cuts. 

However, conditions have since stabilised. Renewed efforts are needed to rebuild reserve buffers to safeguard resilience to shocks, under a flexible exchange rate. Approval of the new Central Bank Law in line with international best practices is a critical step to further strengthen the independence and governance of the CBSL and support the adoption of flexible inflation targeting.

“The financial system remains broadly stable, although some pockets of vulnerability remain, especially among non-bank financial institutions. Caps on lending rates and the loan repayment moratorium for Small and Medium Enterprises (SMEs) should be temporary, to avoid unintended distortions and inefficiencies in financial intermediation. Modernising the Banking Act, with a view to strengthening and harmonising regulation, supervision, and resolution frameworks for deposit-taking financial institutions would help safeguard financial stability.” 

The IMF called on authorities to move ahead with growth-enhancing structural reforms to fully harness Sri Lanka’s economic potential and foster greater social inclusion. The team welcomed the authorities’ plans to enhance the efficiency of state-owned enterprises, enabling them to operate on a sound commercial basis. These plans would need to be supported by a visible commitment to strengthen governance and transparency, notably in the energy sector, and renewed efforts to tackle corruption.

Concerted initiatives are needed to foster the business climate, promote trade openness and investment, and strengthen infrastructure sustainably, including to respond to the challenges from climate change. Sri Lanka stands to gain from greater female labour participation, enhancements in social protection, and further investment in education and skills.

The team met with the Secretary to the President Dr. P.B. Jayasundera, Central Bank Governor W.D. Lakshman, Secretary to the Treasury S.R. Attygalle, Senior Deputy Governor P.N. Weerasinghe, other public officials, representatives of the business community, civil society and international partners.