Although the US $ 1.5 billion 3-year International Monetary Fund (IMF) programme could ease Sri Lanka’s near-term financial worries, the fiscal reforms targeted through the implementation of the conditions attached to the funding package may be “hard to achieve,” a rating agency said yesterday. Fitch Ratings said the IMF funding could ease the short term balance of payment risks for the country but what is required is “sustained commitment from the authorities to address long-standing weaknesses in external and public finances.
” Moody’s Investor Services in a statement last week expressed similar sentiments, saying that the road to fiscal reforms that follows the IMF funding would remain bumpy, despite it providing a short-term breather for the country. “It (IMF funding) therefore has no immediate impact on Sri Lanka’s ‘B+’/Negative sovereign rating,”
Fitch said. “We assigned a Negative Outlook to Sri Lanka’s ratings at the same time as the downgrade on 29 February despite the likelihood of agreement with the IMF on a programme, in part because of the country’s patchy implementation record with previous programmes,” it added. The IMF last Friday said a stafflevel agreement on an Extended Fund Facility (EFF) would be considered by its executive board in early June. Sri Lanka’s previous IMF programme ended in 2012.
The programme sets ambitious fiscal targets that may be hard to achieve. It aims to slash Sri Lanka’s fiscal deficit to 3.5 percent of GDP in 2020 from a recently restated 7.4 percent last year, partly through comprehensive tax system reform. Persistently low government revenue, which has dropped to around 12 percent of GDP, is a key contributor to fiscal weakness, and implementing reforms to the tax system could be challenging.
Sri Lanka increased taxes from yesterday and slashed tax liability thresholds to prop up its coffers in line with the proposed IMF funding. But November budget of the coaling government did not outline any major tax reforms. “A significant pick-up in revenues will be required to meet the 2016 budget’s deficit target of 5.4 percent, because nondiscretionary government expenditure is high; salaries and interest payments account for almost
40 percent of the total,” Fitch said. The rating agency further said the potential crystallisation of state-owned enterprise (SOE) debt on the country’s balance sheet remains a fiscal risk. The government recently announced the absorption of the liabilities of the debt-ridden SriLankan Airlines to make it attractive for a potential business partner. Meanwhile, Fitch said an EFF could boost investor confidence and reduce Sri Lanka’s vulnerability to shifts in investor sentiment and bolster foreign exchange reserves, which stood at US $ 6.2 billion at end-March. “But refinancing risk remains high. Sri Lanka has large external debts to refinance, with over US$ 3 billion of external debt coming due in 2016 and an external liquidity ratio far below the ‘B’ and ‘BB’ category medians.” The rating agency also said the country is likely to face a period of adjustment under the IMF programme that could have a negative effect on economic performance in the short term. “Fiscal and monetary tightening could be pro-cyclical,
while the central bank’s planned shift to an inflation-targeting regime could push total public debt higher in local-currency terms if the rupee weakened, as nearly half of all public debt is foreign-currency denominated.” But successful programme implementation, according to Fitch should set Sri Lanka’s economy on a more sustainable and robust footing once the adjustment is complete.