The International Monetary Fund (IMF) yesterday said they reached a staff level agreement with the Sri Lankan authorities on a 3-year programme for US $ 1.5 billion Extended Fund Facility (EFF) which will see a host of structural reforms, mainly in the fiscal side.
Besides this Balance of Payment (BoP) support moneys which will be directly going to the Central Bank to support the faltering external reserves, another US $ 650 million is forthcoming in the form of budgetary support from other bilateral and multilateral lenders such as World Bank.
The reform-packed agreement has been entered into under the premise that the government is taking all measures to fix its ailing budget by way of collecting more revenues through taxes and closing the administrative loopholes in collecting, reforming the state-owned enterprises (SoEs) and targeting subsidies. Another significant structural reform stipulated by the IMF was trade liberalization and greater flexibility of the exchange management.
“The EFF supports the authorities’ ambitious economic reform agenda for the next three years. The government’s economic program aims at fundamental changes to tax policy and administration to reverse a two-decade decline in tax revenues and put public finances on a sustainable medium-term footing,” IMF mission chief for Sri Lanka, Todd Schneider said in a statement.
The drawing of the facility in tranches is expected to begin from June once the IMF’s executive board approves the facility. The IMF’s long list of reforms is similar to a periodic dose of medicine to tame an economy which has been running amok due to bad economic governance. The last time the IMF disciplined the Lankan economy in 2009 when it struck a US $ 2.6 billion Stand-by-Arrangement to bail-out the country from a BoP crisis.
The IMF said the government aims to raise its tax-to- GDP ratio up to 15 percent and reduce the fiscal deficit to 3.5 by 2020. The tax-to-GDP ratio is now at 12 percent significantly lower from the countries at a similar stage of development and the budget deficit for 2015 was 7.4 percent – overshot by a larger margin. Sri Lanka’s budget has been the main source of instability and the root cause for many economic ills. With the budget presented in November 2015 is now doomed, the coalition government is now planning a midyear revised budget to be presented. In boosting the revenue side reforms the government will be eliminating exemptions, holidays, and special rates to broaden the tax base and create a tax system that is simple, efficient, and more equitable while the subsidies will be targeted to protect the poor and vulnerable in the expenditure side. While the first set of reforms to Value Added Tax (VAT) is due from May 2, implementation of a new Inland Revenue Act, reform of the VAT and the customs code are also in the offing.
The government will leverage information technology to bolster tax collection and clamp down on corruption and discretionary tax treatment. The IMF wants the market forces to prevail in running SOEs and to limiting their dependency on public finances.
The first of such reforms began from the announcement of the treasury’s readiness to take over accumulated debt of the national carrier, Sri Lankan Airlines and to run the airline as a public-private partnership. The pricing of fuel and electricity will be guided by the market but will subsidize for the poor and vulnerable. In what could be termed as the most detailed statement from the IMF on what the government should and would do as a part of the EFF deal, Schneider said the deal would help the government achieve ‘lift off’ of the economy and fully tap Sri Lanka’s significant economic potential.
IMF money will ease financing pressure – Moody’s
Shortly after the IMF announcing its deal with Sri Lanka, rating agency, Moody’s Investors Service said the IMF money and other funds in the form of budgetary support which are forthcoming could ease off the immediate financing pressures but warned of bumps implementing the fiscal reforms.
While the tax hikes, SoE reforms and targeted subsidies are measures which will ensure sustainability of the economy, the implementation of such policies are politically challenging, history has shown.
“First, programme disbursements together with forthcoming multilateral and bilateral loans will provide external liquidity to ease immediate financing pressures. It could reverse the decline in official foreign-exchange reserves and reduce Sri Lanka’s vulnerability to a sudden stop in capital inflows,” said Moody’s Senior Vice President, Sovereign Risk Group and the lead sovereign analyst for Sri Lanka, Marie Diron.
The facility comes in the wake of the Lankan sovereign credit profile is increasingly coming under pressure from its large fiscal deficits, high debt levels and poor debt affordability but Moody’s sees the upside of the country’s credit profile if the reforms could address the fiscal and external imbalances. Diron also said the fund arrangement would also alleviate debt servicing pressures as the financing is likely to be at more favorable terms than raising the moneys through capital markets.
Sri Lanka is to leverage the engagement with the IMF to tap development funding and capital market financing as the Central Bank aims to raise US $ 3 billion in a one or more sovereign issues. He also said if the agreement restores investor confidence in Sri Lanka’s policy framework, it could ultimately support more stable private external inflows, such as FDI. “However, we expect bumps in the fiscal consolidation path due to difficulties in implementing revenue raising measures and the possible crystallization of some contingent liabilities,” cautioned Diron.
