IMF paints rosy picture

Resident Rep predicts prosperity; urges for fiscal reforms

By Cheranka Mendis

IMF Resident Representative Dr. Koshy Mathai on Wednesday painted a rosy picture of the country’s economic prospects, saying that this could be a “transformational moment”.

Speaking at a luncheon meeting of the Rotary Club of Colombo West, Mathai said the IMF had in the past expressed concerns about Sri Lanka’s fiscal policy, as last year’s fiscal deficit exceeded the seven per cent of GDP target and ended up close to 10 per cent.

Dr. Mathai said, however, that the Government’s phased fiscal deficit reduction was now on track with the Government giving fiscal reforms top priority with a target of bringing down the deficit to eight per cent this year and then five per cent by 2012.  He emphasised that fiscal discipline was crucial for maintaining macroeconomic stability, delivering economic growth and raising the living standards of ordinary people.

Dr. Mathai praised the Government for how it was planning to deliver the eight per cent of GDP fiscal deficit this year, noting that while many countries artificially inflate revenue to unrealistic levels or severely cut the capital spending envelope in order to show reduced deficits, Sri Lanka had avoided these chaotic measures.

He noted that the five per cent deficit target was originally supposed to be reached in 2011 and would now be delayed by one year. However, despite this delay, the planned deficit reduction would still be sufficient, on conservative assumptions about growth and interest rates, to bring Sri Lanka’s debt-GDP ratio of 86 per cent down substantially within a few years.

He said that the IMF programme focused on reserve accumulation at the CBSL, monetary policy, and fiscal policy.                         

The IMF had a few concerns on the first two fronts and he acknowledged that the fiscal deficit outturn in 2009 drove a pause in the IMF programme with Sri Lanka.

“That is now no more. In our view, the 2010 Budget and the related policy package that the Government is undertaking represent major progress toward strengthening Sri Lanka’s public finances.”

Budget 2011: IMF expectations

“The Government’s strategy seems reasonable and is supported by useful structural reforms,” he said, adding that all eyes were now on the 2011 Budget (to be announced on 22 November).

What the IMF is keen to hear about is tax reforms, likely to be based on the recommendations of the Tax Commission.

According to Mathai, the IMF is keen to see how the Government delivers on its stated intentions of broadening the tax base, simplifying the system, creating a balance between indirect and direct taxes, improving tax administration and raising revenue.

Improvement in infrastructure will also be a catalyst in growth and the Fund is awaiting the reconstruction spending in the upcoming budget. Latest records mentions that the IMF estimates total reconstruction expenditure at Rs. 295 billion (US$ 2.5 billion) during the 2010-2012 period. This is said to be approximately 1.3 per cent of GDP.

“We also hope to see an increase in revenue. In Sri Lanka the revenue take is very low – in the14-15 per cent range – while most countries under the same economic conditions and labelled as emerging economies have a revenue of 17- 18 per cent,” Mathai said.

He noted that the Government had targeted increasing revenues to 16.5 per cent in a couple of years.

Reducing losses of State-owned enterprises such as the Ceylon Petroleum Company (CPC) and Ceylon Electricity Board (CEB), which have complicated fiscal and macroeconomic management, must also be looked at.

“The Government seems to be taking actions in this area and we are confident that it would be looked into,” Mathai asserted.

Sri Lanka’s growth

Mathai believes that 2010 is the “moment of the Sri Lankan economy”. Growth, which is most likely to be private sector-driven, will still need the State to create the enabling conditions. Most significantly, he highlighted the importance of maintaining macroeconomic stability, which could be aided by strengthening the fiscal position, as the Government has outlined.

However, building up physical and human capital, reforming the tax system, improving the investment promotion regime and reforming SOEs would also help lay the basis for sustainable growth.

While noting that the IMF was usually a “glass half empty organisation” since its job was “to caution about risks,” Mathai said that in the Sri Lankan case “it is hard not to be a cheerleader — prospects really seem to be quite strong.”

What Sri Lanka does right

Mathai also credited the Central Bank of Sri Lanka for most of its decisions on the monetary front and external front. “When the Sri Lankan rupee came under pressure, CBSL supplied dollars to the market, which was a sensible thing to do and was largely successful in stemming the depreciation.”

However, this was at the cost of two-thirds of CBSL reserves. However, with the end of the war and the change in investor sentiment, international reserves have also increased dramatically and are now around US$ 7 billion at the Central Bank.

“While reserve accumulation was a major focus at the beginning of the programme, we now have the luxury of thinking more about medium-term challenges for the economy stemming from the fiscal position.”

He also mentioned the IMF’s satisfaction with Sri Lanka’s monetary policy: “While the IMF usually encourages central banks to tighten monetary policy, in the Sri Lankan case the advice was the opposite for much of last year, as the IMF was more concerned about sluggish credit growth rather than about inflation or overheating. Now the IMF thinks the monetary policy is in the right place.”