Sri Lanka’s fresh IMF negotiations unlikely to be comfortable

The $ 1.5 billion International Monetary Fund (IMF) loan deal has suddenly become irrelevant after the 16 November Presidential Poll. 

The new Government has announced a stimulus package with tax cuts for a positive shock to boost faltering economic growth. Reduction of interest rates, abolishing fuel price formula, and annulling the IMF-assisted Inland Revenue Act are on the cards, top Government officials who are dealing with the economy say. 

Generally, these policies are seen against the main IMF goal – reducing budget or fiscal deficit. The then-Government’s pledge for a social market economy, which replaced its earlier laissez-faire economic concepts, did not work well. The failure was due to its indecisiveness in many crucial economic policies, especially when it was a coalition government before the last year’s political crisis. 

The IMF has been consistent on its conditions for the loan throughout. The policy framework was mainly focused on reducing fiscal deficit, increasing tax revenue, rationalising the government expenditure, and restructuring state-owned enterprises to reduce losses. The global lender has allowed Sri Lankan authorities to revise the targets after hiccups in the past in its loan programs. However, that flexibility from the IMF came after justifiable reasons and with mutual understanding after discussions between the Government authorities and IMF. 

Sri Lanka does not need any permission from IMF to formulate its economic policies. But when the $ 87 billion is in an IMF deal, it is a usual protocol to consult the global lender because of the targets and conditions for the loan. However, the sudden decision by the new Government on tax cuts and stimulus package was done unilaterally. 

“We have not had a chance to review the measures or discuss them with the authorities yet,” IMF Mission Chief for Sri Lanka Manuela Goretti said in an emailed response. “In general, any measures to stimulate investment and growth should be part of a comprehensive policy strategy that also advances fiscal consolidation and safeguards public debt sustainability, given Sri Lanka’s still high public debt and refinancing needs over the medium term.”

The loss of revenue due to the stimulus package is expected to be in the range of Rs. 500 to 800 billion, according to Treasury officials. That is around a quarter of this year’s total revenue and increase in fiscal deficit due to higher Government expenditure and reduced revenue is imminent.

Confidence returns 

Local business enterprises, however, are confident of the new Government under President Gotabaya Rajapaksa. They believe it will revive the sluggish economy. The Government change has come at time after many businesses have reportedly given up expansion plans citing expensive taxes and borrowing costs. 

The defeat of the former Prime Minister Ranil Wickremesinghe-led Government also has come at a crucial juncture when the economic growth has slumped to its lowest since a negative growth in 2001. 

The need and hopes of some new and different economic policies have come at time when the private sector credit growth has slumped to its lowest in five years while the country is facing a debt crisis, and more importantly people from every sector were complaining about economic hardships. 

It was too late for the former United National Front (UNF) Government when it executed measures to boost growth by Government-led programs like Enterprise Sri Lanka and Gamperaliya. 

The neutralising effect by former President Maithripala Sirisena led centre-left Sri Lanka Freedom Party in the coalition government with the UNF before the political crisis in October 2018 also took the toll on the economy. Easter terrorist attacks eroded the hopes the last Government had to revive the economy before the election. 

Under the last government, crucial and strategic economic and investment decisions were dragged. State-led funding was seen bad as it had a narrow space for both fiscal and monetary policy manoeuvring because it had to meet some targets set by the International Monetary Fund (IMF). 

The Wickremesinghe-led Government gave priority in meeting the IMF targets like boosting tax revenue, reducing budget deficit sometimes by curbing capital expenditure, allowing flexibility in the rupee currency, and fuel pricing formula. These policies were perceived to have implemented at the expense of economic growth. 

However, the Government policies, in line with the IMF target, have helped to instil investor confidence. The global lender’s positive appraisal helped global investors to inquire for investment options though political instability prevented them from making their pledges or inquiry into a reality. 

Policy reversal 

The new Government announced the reduction of Value Added Tax (VAT) and annulment of some other taxes within 10 days of coming to power. Unlike the Wickremesinghe Government, the new administration never waited for some clarity from the IMF on the new policies. 

The Government proved that it will give priority for what it thinks appropriate and not something an internationally reputed organisation had entered under the previous Government. Many global analysts were negative on the new Government’s decision. 

Singapore-based Capital Economics in an investor note said the tax cuts should provide a significant boost to the economy, which has been hit hard by the slump in tourism arrivals following the deadly Easter Sunday terrorist attacks. It also raised its growth forecast for 2020 to 3.5% from the previous 2.5%.

“However, the VAT cuts will put an increased strain on Sri Lanka’s public finances and could spell trouble for its relationship with the IMF. Unless Sri Lanka raises taxes elsewhere or cuts spending, the VAT cuts will lead to around $2 billion in lost revenue (around 2% of GDP) and the deficit is likely to widen to around 6.5% of GDP in 2020.” 

Officials from the Finance Ministry and Central Bank in the past have told in public that the importance of an IMF loan is not to use its money for debt repayment, but to gain international investor confidence. 

Capital Economics said missing the IMF budget deficit target of is much larger than the 5.3% could result in the IMF withholding future loan payments “unless the Government reverses course”. 

“This would risk undermining the confidence of international investors, which could cause bond yields to spike and the value of the currency to plummet,” it said, adding that there is a growing risk the Central Bank of Sri Lanka may be forced to hike rates if the currency comes under downward pressure.

World Bank Chief Economist for South Asia Hans Timmer in at a Central Bank public lecture last week said Sri Lanka’s new Government would have to undergo an “incredibly difficult balancing act” to incorporate the recently-introduced stimulus package to the system without undermining fiscal and debt sustainability.

Fitch Rating Agency just five days after the election said Sri Lanka’s Presidential Election significantly increases policy uncertainty and could prompt loosening that exacerbates fiscal weaknesses and a rollback of reforms.

When the IMF mission was in Colombo for regular discussions ahead of approval of sixth tranche of the $ 1.5 billion loan, it said the mission’s “constructive discussions with Members of Parliament from both the Government and Opposition parties provide additional assurances ahead of the elections” to remain committed to the program.

However, now the Government has taken the strong decision to go ahead with tax cuts and stimulus package without any discussion with the IMF, the upcoming discussions with the IMF are unlikely to be comfortable. Delay in disbursement of the last tranche cannot be ruled out.

(The writer is former Reuters Economic Reporter for Sri Lanka. He can be reached at [email protected])