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By Nisthar Cassim
The International Monetary Fund (IMF) is calling for prudent policies and fiscal discipline as Sri Lanka prepares for multiple elections stressing that the mandate from the latter must be used as an opportunity to accelerate structural reforms.
“It will be important to maintain prudent policies and fiscal discipline in the run-up to and after the elections. Sri Lanka still has high public debt. The Central Bank and the Treasury have been proactive in external debt financing but in the medium term Sri Lanka has large refinancing needs so prudent policies will be essential to send a strong signal to the markets,” IMF Mission Chief for Sri Lanka Manuela Goretti told the Daily FT.
In an interview on the sidelines of the recently concluded 2019 fall IMF-World Bank Annual Meetings in Washington DC, Goretti stressed that the IMF, which has an ongoing $ 1.5 billion Extended Fund Facility (EFF) program, was ready to engage with Sri Lanka authorities in the run-up to the Elections and afterwards. 
“Our advice remains prudent policies along with fiscal discipline and vigilant monetary policy to shore up market confidence. It is important to strengthen Sri Lanka’s resilience to internal and external shocks, given the country’s remaining vulnerabilities, notably the still high public debt, and relatively low buffers,” she emphasised.
The IMF official was of the view that there must be a concerted effort across all political parties to keep the country on a prudent track.
“The forthcoming election cycle can offer a window of opportunity for Sri Lanka to accelerate the reform agenda, especially structural reforms.
There is enough cross-country empirical evidence from the IMF and OECD showing that governments have a higher likelihood of achieving more reforms, at lower cost, in the first two years of a government office,” Goretti said.
She stressed that the new mandate as part of Sri Lanka’s democratic process can allow the authorities to frontload the reforms in the first two years of the administration.
“This is important in twofold. Firstly there is a fresh political mandate and secondly structural reforms take time to yield results with benefits accruing in the latter part of the term. So though there may be uncertainty with regard to elections there is also opportunities that the country can take advantage of especially when it comes to implementing key reforms,” the IMF official pointed out.
She also stressed that it was important to clearly communicate the benefits of reforms to the public. “The reform agenda must be prioritised based on the macroeconomic impact of the reforms. If the social protection initiatives are well targeted the more vulnerable segments of the society can be looked after well,” she added.
Looking ahead Goretti said it was important for Sri Lanka to focus on growth enhancing structural reforms. “This is critical to boost Sri Lanka’s competitiveness to achieve strong and sustainable inclusive economic growth which has been elusive unfortunately due to internal and external shocks. In the recent past given the immediate needs Sri Lanka had to prioritise macroeconomic stabilisation. Next challenge is the growth agenda,” the IMF Country Mission chief said.
She stressed measures must be continued to remove the large number of para-tariffs as part of a further trade liberalisation. “Stepping up trade liberalisation is priority. This will need to go hand in hand with tax reforms to ensure there is no revenue erosion,” she added.
“The other priority is governance reforms and stepping up anti-corruption efforts. Governance reforms include State sector enterprise restructuring especially in the energy/electricity sector. This must be addressed after the Elections,” she pointed out.
“Sri Lanka’s removal from the Financial Action Task Force (FATF) Grey List is a big achievement and further progress must be pursued. The exclusion is a testament to the authorities’ efforts to Anti-Money laundering and countering financing terrorism,” the IMF Mission Chief pointed out.
According to her other challenges given the aging population include the need for pension reforms as well boosting jobs for youth, economic empowerment of women and increasing educated female participation in the labour force. “As these reforms are addressed Sri Lanka needs to strengthen targeted social protection measures, helping those needed,” Goretti added.
In her view, Sri Lanka under the IMF EFF program has undertaken important tax reforms and despite weaker growth, the reforms have started to show results. Among them are revamping the tax system, the new Inland Revenue Act, VAT amendments. Their performance, she said, was significant despite the shocks faced by the country.
“Recent tax reforms will help considerably in the country’s fiscal consolidation efforts. What is important is this positive trend is supported by modernising the Customs and Inland Revenue Department. It is critical to strengthen revenue collection and fight tax evasion given the country’s large informal sector,” she added.
According to her, improved income tax has enabled the Government to buffer the shocks whilst achieving a primary fiscal surplus, which though ambitious was critical for Sri Lanka given the high public debt level.
Advancing energy reforms especially implementing the fuel pricing formula was described as “a difficult but important reform to reduce fiscal risks”, hence she commended the Government for the move. It was added that it has begun to show results with improved profitability of CPC enabling debt repayment which is a contingent liability on people.
“CEB will require some important reforms next year. Issues are twofold. Under the program, we have one benchmark which has been delayed. The benchmark refers to implementing the existing electricity pricing formula in line with market prices since CEB is running significant losses. At the same time, our recommendation to the authorities is to address the cost inefficiencies of CEB which are currently happening to make sure these are not transferred into retail prices for end-consumers.
“A broader analysis of the electricity sector in terms of pricing, governance, energy sourcing, and other pending issues, with support from the World Bank and other partners, is important to tackle the heavy losses of CEB,” she said.
Goretti, who reminded the IMF mission had reached a staff level agreement for the sixth review under the EFF last September, was also pleased with the progress of several reforms by the Central Bank in the roadmap towards flexible inflation targeting. This includes the authorities’ progress in reforming the Central Bank law with a new Act.
“This is a landmark reform from the IMF’s perspective. It brings Sri Lanka on par with best practices not only in Asia but across the world in terms of inflation targeting,” Goretti emphasised.
Another key reform was the new legislation recently approved by Cabinet to amend the Fiscal Management Responsibility Act bringing stronger rules and compliance. “This stronger framework will help anchor fiscal policy in the medium term,” she added.
Goretti also said given the seriousness of the shocks faced the 2.7% growth outlook for 2019 and 3.5% next year reflects a gradual but steady economic recovery. “Sri Lanka is a country with strong growth potential and we hope this can be realised in the medium term.”
IMF official also said compared to countries which also faced terror attacks, Sri Lanka’s recovery is commendable. “The economy has shown resilience and the recovery though gradual has been at a good pace,” she added.
It was noted that the drop in tourist arrivals which was 70% soon after the Easter Sunday tragedy has eased off and Sri Lanka was likely to end the year with a decline of less than 20% following improved security and policy response from the Government. “We believe that the tourism sector will normalise by early next year,” she added.
IMF Board to discuss SL’s next tranche in early November
The International Monetary Fund’s (IMF) Executive Board at its meeting in early November is expected to decide on the release of next tranche of the $ 1.5 billion Extended Fund Facility (EFF) arrangement for Sri Lanka.
Last month the IMF reached a staff level agreement on the sixth review under Sri Lanka’s economic reform program supported by a four-year EFF arrangement. To-date roughly $ 1.15 billion has been released and around $ 300 million is due via the sixth and seventh and final tranche.
“The IMF Executive Board will discuss the completion of Sri Lanka’s sixth review in early November, following the Staff Level Agreement reached during our September mission,” IMF Mission Chief for Sri Lanka Manuela Goretti told the Daily FT.
A positive outcome will result in the release of the sixth tranche worth around $ 150 million.
The seventh and final review is likely to be in June leading to a wrap up of the program with the release of the final tranche.
Upon request from Sri Lanka, the IMF in May this year decided to extend the EFF arrangement by a year till June 2020.
Goretti said after the October 2018 political crisis and April Easter attack, an extension was requested to provide more time to complete the reform program given the setbacks as well as a policy anchor to bridge the electoral period.
In its statement following the staff level agreement, the IMF mission said the end-June fiscal target was missed by a large margin, due to frontloading of spending from the clearing of arrears and externally-financed capital projects carried over from 2018 as well as a sharp fall in indirect revenues following the terrorist attacks.
While the program targets agreed at the time of the fifth review are no longer within reach, the authorities are committed to achieve a primary fiscal surplus of 0.2% of GDP in 2019, through implementation of remaining revenue measures in the 2019 Budget and prudent expenditure management.
Goretti said Net International Reserves (NIR) target was met in June by a good margin as the Central Bank was able to build reserves and strengthen the buffer for the economy. “September target appears to have been met as per preliminary information, despite pressured on emerging markets in August,” she said.
It was noted that the fiscal target is required to be recalibrated and revised from a primary surplus of 1.5% of GDP originally to 0.2% of GDP. “Though the target is lower than what was achieved in 2018 (0.6% of GDP) we welcome the efforts of the authorities towards achieving a primary surplus despite the sizable shortfall in indirect tax revenues and Easter Sunday setback,” Goretti said.
She said that this agreement strikes a good balance between keeping the fiscal consolidation ongoing given the high level of debt and making space to accommodate adjustments following the shocks of the Easter Sunday attacks.
