The recommencement of the disbursement of the IMF tranches will be positive for Sri Lanka’s B1 credit rating, restoring investor confidence and strengthening foreign exchange reserves, Moody’s Investor Services noted.

On April 2, the International Monetary Fund (IMF) resumed loan disbursement to Sri Lanka under a stand-by programme to the tune of US$ 2.6 billion that had been on hold since August 2011.

The rating agency also said that the reactivated IMF support is also a tacit endorsement of Sri Lanka’s policy initiatives since February 2012, which were taken to stem currency and foreign exchange reserve losses.
“Key corrective measures enacted by the authorities two months ago should stem foreign exchange reserve losses. In early February, regulators allowed the rupee to float, resulting in an immediate 5% depreciation against the dollar. This followed a 3% depreciation of the exchange rate in late November 2011.

IMF loan resumption

Policy rates were tightened and banks were directed to limit credit growth,” Moody’s noted.
In addition, the government raised domestic petroleum and electricity prices to pass the cost of higher international energy prices to consumers, which will both limit losses to the state energy corporations and rein in the oil import bill and the current account deficit.

The IMF referenced these adjustments in its press release announcing the completion of the seventh review and disbursal of US$ 427 million under a stand-by arrangement originally signed in July 2009.
 
In the backdrop of a balance of payment surplus and successful bond issues in the mid part of 2011, the Central Bank Governor announced that the country may not raise the next two tranches from the IMF stand-by facility.

However, a strong rebound in domestic demand, fueled by private sector credit growth of 34.5% in 2011, coupled with an upswing in Sri Lanka’s oil import bill pushing the trade deficit to US$ 5.8 billion in the second half of 2011, a 140% increase over second-half 2010, prompted the Central Bank to act otherwise.

As the Central Bank intervened by buying Sri Lankan rupees to stem downward pressure on the currency, reserves dropped by nearly US$ 1 billion from August to September, and then by a further US$ 900 million by November 2011.

Two tranches of the loan had been pending since late summer 2011 when the IMF released a statement critical of the government’s foreign exchange interventions. The stand-by arrangement has now been extended to July 2012 to allow for the eighth and final review.

For the last tranche of the loan to be released, Sri Lankan authorities will have to be prepared to adjust monetary and exchange rate policies if necessary, depending on global conditions.

“We believe the authorities will not relapse to the abandoned policy stance, as it proved unsustainable. On the other hand, the government has established a track record for gradually reining in the budget deficit, and so fiscal policy will not likely derail the IMF programme,” the rating agency noted.