SL misses IMF fiscal targets; but says committed to achieving primary surplus in 2019

• Staff-level agreement on sixth review reached 
• IMF cuts SL’s this year’s growth forecast to 2.7%
• Says new Central Bank Act will be a landmark reform

Sri Lanka has missed the fiscal target it had agreed with the International Monetary Fund (IMF) during its fifth review of the four-year Extended Fund Facility (EFF) programme, said a staff team from the fund, who were in Colombo from September 10 to 25, for the programme’s sixth review. 

Releasing a statement after reaching a staff-level agreement, the head of the mission Manuela Goretti said the protracted impact from the 2018 political crisis and Easter attacks in April this year had a significant adverse impact on the country’s fiscal performance. 

“The end-June fiscal target was missed by a large margin, due to frontloading of spending from the clearing of arrears and externally-financed capital projects carried over from 2018 as well as a sharp fall in indirect revenues following the terrorist attacks,” said Goretti, adding that the programme targets agreed at the fifth review are no longer within reach. 
The original US $ 1.5 billion three-year EFF programme was suspended by the IMF due to the constitutional crisis during the final three months of last year but was put back on track early this year, extending the programme by one more year, with fresh targets.  While the economy was steadied to a certain degree during the first couple of months of this year, that process hit a snag due to the terrorist attacks, which delivered a deadly blow to the nation’s economy.  

Nevertheless, the authorities have expressed their commitment to achieve a primary fiscal surplus of 0.2 percent of gross domestic product (GDP) in 2019, through implementation of remaining revenue measures in the 2019 budget and prudent expenditure management.

The IMF continues to advocate for structural reforms to improve the fiscal performance, which mainly tilts towards the revenue enhancing measures such as broadening tax net, tax compliance and state-owned enterprise reforms.

“Sustained efforts are needed to mobilise revenues, by broadening the tax base and enforcing compliance and strengthen spending efficiency,” Goretti maintained. 
“Improving the financial performance of SriLankan Airlines and advancing energy sector reforms, including by tackling cost inefficiencies and subsidies in the electricity sector, remain critical steps to reduce fiscal risks,” she added.

The IMF also welcomed the government’s plans to revamp its fiscal rules and establish an independent public debt management agency over the medium term, which is in line with the international best practices. 

Meanwhile, on the monetary side, the mission chief commended the Central Bank’s prudent and data-dependant approach to monetary policy, which will facilitate the transition to a flexible inflation targeting regime. 

She also acknowledged the bank’s commitment towards strengthening reserve buffers in line with the programme understandings. 
However, she was of the view that the Central Bank should continue to allow exchange rate flexibility, limiting its interventions in the forex markets, which is done only to smooth excess volatility. 

Commenting on the new Monetary Law Act awaiting Parliamentary approval, Goretti said, “The new Central Bank Act will be a landmark reform in the roadmap towards flexible inflation targeting by strengthening the CBSL’s mandate, governance, accountability and transparency, in line with international best practice.” 
Further commenting on the financial sector interventions by the Central Bank in recent times, the IMF said those should only be limited to temporary measures to avoid distortions to the financial system. 

The Central Bank gave debt-service moratoriums to the tourism sector and imposed bank interest caps to ease credit conditions. In its latest move, the Central Bank this week ordered licensed commercial banks to reduce their lending rates effective from October 15, 2019, at least by 2 percent.

“These exceptional measures should be lifted as soon as credit conditions stabilise to avoid distortions to the financial system, amid weaker credit quality and falling profitability.”
Given the developments, the IMF revised down Sri Lanka’s growth expectation to 2.7 percent in 2019, which is projected to improve to 3.5 percent in 2020, as tourism and related activities gradually recover. 

The multilateral lender also expects the inflation to remain stable at around 4.5 percent during 2019-20, which is also the desired range of the Central Bank. 

“Despite the recent fall in tourist arrivals and remittances, the current account balance is projected to improve to 2.6 percent of GDP in 2019 on the back of lower imports and stronger exports supported by the exchange rate correction in late 2018,” Goretti added.