IMF waits on VAT

By Uditha Jayasinghe    

An International Monetary Fund (IMG) mission winding up their review of the Sri Lankan economy yesterday warned a second tranche of the $ 1.5 billion Extended Fund Facility (EFF) would be dependent on the implementation of the proposed VAT hike. 

Head of the IMF staff team Jaewoo Lee told reporters after completing the first review mission that they could not “in good conscience” recommend the release of the second tranche to the Executive Board of the IMF in November unless the Government was able to pass the VAT increase of 15% through Parliament as it would be unlikely Sri Lanka would meet its revenue target otherwise.   

However, talks between the Government and the IMF will continue in October on the sidelines of the Annual General Meeting of the IMF in Washington and the IMF will also take into account the tax policies included in Budget 2017. 

Lee also acknowledged that Sri Lanka would likely achieve the growth target of 5% and maintain it in 2017 despite a lackluster performance in the second quarter where the economy only grew by 2.6% and revenue generation concerns continued. 

“The mission commends the authorities for implementing their IMF-supported economic program under difficult circumstances, with all quantitative targets through end-June being met. However, some forward-looking aspects of the program review, mainly related to the implementation of the tax reform package, need to be addressed without further delay,” Lee said.

Even though the second tranche of the IMF facility is a nominal sum of about $ 162 million, any delay in its transfer could signal reduced confidence in Sri Lanka’s commitment to fiscal consolidation, which would in turn result in the loss of confidence of potential investors and higher interest payments when the Government reaches out to international financial markets for debt financing next year.      

“Accordingly, it is important that the Government expedites the legislative process of implementing the value added tax (VAT) amendments that are needed to support revenue targets for 2016 and 2017. The 2017 budget should also be underpinned by a well-crafted and high-quality tax policy strategy to raise Sri Lanka’s low tax revenue-to-GDP ratio.”

A key component of a wider tax policy would be concentration on direct taxes, which would require the Government to commence the legislative process for the new Inland Revenue Act which would be an important step in rebalancing the tax system toward a more “predictable, efficient and equitable structure” and in generating the needed resources in support of the country’s ambitious social and development objectives, the IMF said. 

The mission also welcomed the Central Bank’s move to preemptively raise policy rates to maintain inflation within its target band. They advocated the Central Bank should remain vigilant in monitoring inflation pressures and stand ready to tighten further should inflation or credit growth continue to rise. 

“In light of easing external pressures, the mission encourages the Central Bank to continue its effort to rebuild international reserves and maintain exchange rate flexibility to further develop the foreign exchange market. In this regard, the mission and the authorities discussed plans for a transition to flexible inflation targeting as the monetary policy framework, possibly supported by IMF technical assistance.” 

Overall, macroeconomic performance in the first half of 2016 reflected a mix of improving balance of payments, reduced growth mainly related to recent floods and slightly higher inflation, the IMF said. The mission welcomed the effective tightening of fiscal and monetary policies that contributed to improving market confidence and easing pressures on external balances. Once fiscal consolidation has been taken forward the IMF stressed it would encourage the Government to improve economic competitiveness to put growth on a sustainable path.  

“The mission also encourages the Government to make concerted efforts in implementing structural reforms in public financial management and state-owned enterprises, building on the substantial technical assistance received over the years. Renewed effort toward greater integration into regional and global supply chains, higher levels of foreign direct investment (FDI), and enhancing prospects for private sector investment are important for achieving medium-term macroeconomic objectives. Bolstering competitiveness to boost trade and private sector development will also support growth potential.”