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IMF Article IV consultation on Sri Lanka: Increase State revenue and cut spending

27 Mar 2022

  • Calls for risk reduction with loss-making SOEs
  • Seeks a comprehensive debt restructuring programme 
By Skandha Gunasekara The International Monetary Fund (IMF) has released its Article IV staff consultation report on Sri Lanka and has called on the Government to increase revenue through taxes and to further curtail State expenditure while curbing corruption and mismanagement. The IMF report on Sri Lanka was released on Friday (25). The contents of the report and the Government’s lack of transparency regarding the draft was also debated at the All-Party Conference last week. The IMF has made several key recommendations: “Substantial revenue-based fiscal consolidation. Reforms should focus on strengthening VAT and income taxes, through rate increases and base-broadening measures. Fiscal adjustment should be accompanied by energy pricing reforms to reduce fiscal risks from loss-making public enterprises. Institution building reforms, such as revamping the fiscal rule, would help ensure the credibility of the strategy.” The IMF has proposed developing a comprehensive strategy to restore debt sustainability.
  • Near-term monetary policy tightening to ensure that the recent breach of the inflation target band is only temporary. Recent welcome steps to gradually unwind the CBSL’s large Treasury bill holdings should continue through close coordination with the Ministry of Finance.
  • Gradually restoring a market-determined and flexible exchange rate. To avoid disorderly movements in the exchange rate, the transition should be carefully sequenced and implemented as part of a comprehensive macroeconomic adjustment package.
  • Social safety nets should be strengthened, by increasing spending, widening coverage, and improving targeting, to mitigate the adverse impacts of macroeconomic adjustment on vulnerable groups.
The report has highlighted several risk factors, including more binding (fiscal and BoP) financing constraints than envisaged under the illustrative baseline scenario and worse-than-anticipated impact of the temporary chemical fertiliser ban on agricultural production as domestic risk while global resurgence of the Covid-19 pandemic, uncontrolled Covid-19 local outbreaks, rising commodity prices amid bouts of volatility, and higher frequency and severity of natural disasters related to climate change as external risks to the economy. The IMF has also noted: “Swift and broad-based policy actions by the authorities mitigated the impact of the pandemic on the financial sector. However, the public debt overhang and the persistent fiscal and BoP financing shortfalls pose significant financial stability risks, highlighting the need for a credible and coherent macroeconomic strategy.” It has called on the Central Bank of Sri Lanka (CBSL) to adopt a new Banking Act. “To preserve financial sector stability, the CBSL should continue to closely monitor loans under moratorium and identify vulnerabilities through stress testing. Adoption of the new Banking Act would help broaden the CBSL’s regulatory powers and upgrade its resolution framework.” “Renewed efforts are needed on growth-enhancing structural reforms, including increasing female labour force participation, reducing youth unemployment, liberalising trade, developing a wide-reaching and coherent investment promotion strategy, and reforming price controls and State-Owned Enterprises (SOEs). Efforts to strengthen governance and reduce corruption vulnerabilities should continue,” the IMF has also stated. Meanwhile, the CBSL issuing a statement has assured that it had already acted on some of the recommendations of the IMF. “Several policy adjustments as indicated in the IMF report have already been made by the Ministry of Finance and the CBSL. These include monetary policy tightening since August 2021, allowing exchange rate flexibility, removing restrictions on foreign exchange market transactions, implementing envisaged revenue enhancing measures, and allowing market-based price adjustments to key commodities.” The statement added that it was prepared to engage with the IMF but would also ensure the costs of implementing the IMF’s recommendations do not harm the general public and local businesses. According to the IMF, Sri Lanka’s projected real GDP growth for 2022 has dropped to 2.6% from 3.6% last year, while Sri Lanka’s inflation for 2022 has reached 10.5%. Sri Lanka’s foreign reserves currently stand at $ 2.2 billion and external debt at 64.2% of GDP while public debt has risen to 119.9% of the country’s GDP.  


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