Lankan economy to grow at 5.5% this year and 3% inflation: IMF

The recent International Monetary Fund (IMF) staff mission to the country has projected Sri Lanka’s economy is to grow 5 to 5.5% this year and inflation is to rise to 3% by the end of the year.

The staff mission led by Todd Schneider visited Colombo from 8-18 September to conduct routine Post-Program Monitoring discussions following Sri Lanka’s successful completion of the $ 2.6 billion stand-by arrangement in 2012.

The mission met with the Prime Minister, Government and Central Bank of Sri Lanka (CBSL) officials, as well as civil society and private sector representatives.

Issuing a statement at the end of the visit, Schneider noted that first half GDP data indicated a pickup in growth, which is likely to continue in the range of 5 to 5.5% through end-2015, driven mainly by strong growth in services and a recovery in agricultural output.

However, the increase in consumer spending created by the sharp rise in public wages and salaries has also contributed to a sizeable increase in imports of consumption and other goods, more than offsetting savings from lower oil prices.

“The resulting deterioration in the nonoil trade balance has contributed to persistent downward pressure on Central Bank foreign exchange reserves during the first eight months of the year,” the staff mission observed.

The current headline inflation of near zero is expected to end the year around 3% while Core Inflation has risen steadily since the beginning of the year, consistent with higher demand for domestic non-tradables and a gradual reduction in economic slack.

Risks to outlook are tilted to the downside with more volatile external financing conditions resulting from the expected monetary policy tightening in the US and uncertainties over growth prospects in emerging markets.

The mission welcomed the Central Bank’s recent decision to cease setting daily spot prices for the rupee and let market forces play a greater role in determining the exchange rate.

The commitment to exchange rate flexibility should continue in order to maintain competitiveness and facilitate an increase in foreign exchange reserves it said.

The mission encouraged CBSL to work toward deepening foreign exchange markets and to revitalise a review of foreign exchange controls to enable inward investment.

The mission found the overall financial system stable and current monetary stance appropriate, but recommended vigilance given rising core inflation, the resurgence of private credit and signs of receding slack in the economy.

“In this context, a tightening bias appears prudent,” it said.

The mission agreed with the authorities on the need to take immediate and credible steps to re-establish fiscal consolidation and reduce public debt.

Projecting a fiscal deficit in the range of 5.5 to 6% of GDP in 2015, higher than budgeted and financed mainly by domestic borrowing, the mission strongly recommended keeping the 2016 fiscal deficit to 5.5% of GDP.

“Looking ahead, the 2016 budget is an opportunity to shift decisively back to a durable medium-term path of fiscal consolidation and to set macroeconomic priorities for 2016 and beyond,” it said.

The mission emphasised the need to eliminate tax expenditures (exemptions, tax holidays and reduced rates) as the most important component in a strategy to make the tax system simple, fair and efficient.

The mission welcomed the authorities’ attention to the need for market-based structural reforms and efforts to reinvigorate key initiatives. Fuel and electricity pricing, subsidies, trade policy, liberalisation of factor markets (particularly land), and the investment environment are areas that could play an essential role in sustaining high rates of economic growth.

Putting state firms on a commercial footing, allowing them to make market-based financial decisions (including pricing) and subjecting them to greater financial discipline will also help to reduce risks to the budget and the financial system.

A discussion on Post Program Monitoring by the IMF’s Executive Board is expected in mid-November, 2015.