IMF backs exchange rate float

By Uditha Jayasinghe

The International Monetary Fund (IMF) yesterday backed a floating exchange rate, terming it as the “first line of defence” to protect Sri Lanka against external shocks, and called for enhanced implementation of structural reforms to speed up sluggish growth.  

IMF Sri Lanka Mission Chief Manuela Goretti, speaking to reporters, backed the Central Bank’s flexible exchange rate policy that has seen the currency drop to record lows over the last few weeks, and advocated that it be allowed to become a free float, pointing out that the rupee remains at a higher level than similar emerging markets.  The IMF is on its second year of a $ 1.5 billion Extended Fund Facility with Sri Lanka, and has completed its fourth review.  

“The program remains broadly on track with important reforms being implemented by the Government. The Central Bank has been conducting monetary policy prudently, bringing back inflation within its band and managed the recent period of market volatility. Most importantly, exchange rate flexibility needs to remain as the first line of defence in case of volatile capital outflows. The exchange rate should be allowed to adjust freely as has been done in other emerging markets, Goretti said.

“It is critical to support Central Bank efforts with fiscal consolidation and improved timelines for structural reforms,” she added, responding to questions as to why growth remained low despite the IMF program. The Government announced this week that Sri Lanka grew by 3.2% in the first quarter of 2018, a marginal decline from 3.5% in the fourth quarter of 2017.

“The Central Bank has attempted to enact a fully flexible exchange rate as market conditions change and the Central Bank should only smoothen excess volatility. When we compare Sri Lanka to other emerging markets, the rupee has been depreciating less. We don’t want to create competitiveness differentials between Sri Lanka and other markets that are letting their exchange rates adjust more to these pressures. These efforts should also be supported on the fiscal side to strengthen investor confidence, but also on growth enhancing structural reforms. So, this is a joint effort by the Central Bank and the Government,” the Missions Chief added. 

Goretti noted the Sri Lankan economy is recovering, but the country remains vulnerable to adverse domestic and external shocks, given the still sizable public debt, large refinancing needs, and low external buffers. “We think the Central Bank’s current policy stance is appropriate, but feel that that they should be vigilant about adjustment as warranted.” 

The Central Bank indicated earlier this year that it had ended its tightening bias but has since then kept rates steady. The US Fed raised interest rates last week and has indicated it is “strongly” willing to repeat the measure within the next few months. 

Performance in the first half of the EFF program has remained broadly on track, according to the IMF. Despite some implementation delays and weather-related shocks, the authorities achieved a primary surplus in 2017 through expenditure management and revenue mobilisation. 

“The authorities have achieved major milestones in their reform agenda. These include the launch of the new Inland Revenue Act, important progress with SOE and energy-pricing reforms, as well as adoption of the CBSL’s Roadmap to flexible inflation targeting. 

Going forward, the authorities should push ahead with their ‘Vision 2025’ objectives by further advancing fiscal consolidation through stronger fiscal rules and SOE governance; modernising monetary and exchange rate frameworks; accelerating their inclusive growth reform agenda through trade liberalisation, climate budgeting, and greater female labour force participation, as well as better targeted social protection programs. Keeping the reform momentum is key to increase Sri Lanka’s resilience to external shocks, and lay the foundation for more sustainable and robust growth.”

The IMF has also strongly backed adjusting power prices, which it initially said the Government had agreed to implement by September, and applauded the flexible pricing policy for fuel. 

They also underscored the importance of enhancing public investment efficiency. In this area, they emphasised the need for systematic and transparent project appraisal and selection of large scale investment projects, ensuring consistency with fiscal targets and mitigation of fiscal risks, given the country’s still high public debt. Going forward, the IMF supported the authorities’ commitment to anchor debt reduction plans through a robust fiscal rule and medium-term debt management strategy.

The IMF also encouraged the authorities to implement a restructuring plan for SriLankan Airlines to put it on a solid commercial footing, and further strengthen SOEs’ governance and transparency. The organisation also welcomed ongoing efforts to strengthen social safety nets to help mitigate the distributional impact on the most vulnerable.