IMF happy but watchful

• $ 427 m released to boost reserves bringing total to $ 2.13 b under $ 2.6 b SBA; balance likely in mid-July

• Emphasises Govt. has taken several positive measures to stem current account deficit, reserve loss and bolster fiscal performance

• Says recent tax hike on vehicles “unexpected” but shows Govt.’s seriousness in dealing with Balance of Payments issue; suggests broader taxation than selective ones if Govt. so desires

• Opines economy isn’t over-heated; Consolidation of new policy regime key in the short-term and sustaining growth over the long-term must be the major focus

Encouraged by recent positive steps taken by the Government to better manage the economy, the International Monetary Fund (IMF) yesterday released $ 427 million to boost the country’s reserves.

“Fundamentally we are very optimistic about Sri Lanka though since mid-last year we were concerned about the policy mix pursued by the Government and the drawdown of reserves,” IMF’s Resident Representative Koshy Mathai told journalists yesterday.

“However in recent months and weeks the Government and the Central Bank have taken numerous decisive steps to address the Balance of Payments issues. I would say these are positive steps in the right direction so that high growth levels experienced during the past two years could be sustained over the medium to long-term,” he added.

The IMF’s Executive Board on Monday considered the Government’s request to Managing Director Christine Lagarde dated 15 March and signed by Deputy Finance Minister Githanjana Gunawardena and Central Bank Governor Nivard Cabraal, for the completion of the seventh review of the $ 2.6 billion Stand By Arrangement (SBA) signed in July 2009 thereby draw $ 275.6 million as well as extension of SBA until July 2012.

The latest development brings the total drawdown under the SBA to $ 2.13 billion and the remainder will be taken following the eighth and final review in July. The IMF also approved waivers of non-observance for end-December performance criteria on Net International Reserves (NIR) and Reserve Money.

The loss of reserves or NIR from about $ 8 billion in mid-2011 to $ 5 billion by end December saw the deferment of IMF support under the SBA.  

Mathai recalled that reserves level wasn’t a key concern but the rate of rapid change was.

However the IMF recognised what it described as “broad package of measures” recently introduced to rein in the current account deficit, stem the reserve loss and bolster fiscal performance. The package included tightening of the monetary and credit policy, increase of petroleum and electricity prices and taxes and abolishment of trading band of the Rupee giving it greater flexibility.

Mathai noted that though there is room for an emerging market to have high current account deficit it was important to pursue a prudent policy mix especially taking in to account both global and local shocks.

He said that apart from substantial corrective action, of late there has been strong effort to boost capital inflows which has met with success in recent weeks especially on to the stock market.

Apart from commending the recent measures taken, Mathai welcomed the flexibility on the part of the Government to adjust policies going forward for the better. “The problem with regard to Balance of Payments was there six months ago and not six weeks ago. We are happy that as opposed to one type of policy in the recent past, the Government has opted for multiple options. We are encouraged by the progress so far and will continue to review it. The underlining strength of the economy appears good,” he added.

The Government intends to use the forthcoming Financial Sector Assessment Program (FSAP) update with the IMF to strengthen the financial system further. “However it will take time for the new monetary and exchange rate regime to become fully established,” the IMF said reiterating the Government’s standpoint as well. “The authorities will need to stand ready to adjust policies further to stabilise external reserves, especially if the global environment becomes less favourable,” IMF’s Deputy Managing Director and Acting Chair Min Zhu said in a statement following the Executive Board decision.

He also said that the Government is taking steps to mitigate the adverse impact on the most vulnerable, among which Mathai listed as expanding the kerosene coupon scheme. Zhu said continued structural reforms to place the state owned energy enterprises on a financially sound footing will reduce demands on the Budget. Mathai said one proposal is to bring pricing mechanism of fuel to be brought under the ambit of Public Utilities Commission.

Mathai during the press conference dismissed the popular assertion that the economy was overheated. “On a traditional assessment this could appear so but we haven’t seen high inflation, property or labour prices. With regard to credit-fuelled imports certainly the risk was evident. But the economy isn’t overheated,” the IMF Resident Rep opined.

He also said that the most critical challenge in the next six to 12 months is to consolidate the new policy regime and address the Balance of Payments issue. “It is also important for Sri Lanka to ensure a more sustainable and consistent growth era,” Mathai said adding that a 7% growth over the next 20 years was better than high double digit growth for just two years.

The IMF previously forecast a 7.5% GDP growth rate for 2012 but latest developments, Mathai said would require a revision in the range of 7 to 7.5%. Inflation is also expected to be higher than last year but likely to remain at mid-to-upper single digit levels, he added. With regard to the Budget deficit, IMF expects Government to remain on consolidation path towards achieving the targeted 6.2% of GDP in 2012.

Mathai also noted that the Weekend hike in taxes on import of vehicles was surprising as it wasn’t discussed between the Government and the IMF. The Opposition had alleged that the hikes akin to a mini-Budget were to appease the IMF in anticipation of SBA support.

“We weren’t expecting it (the hike in taxes) but it shows the Government treats the Balance of Payments issue seriously. However adjustment of tax rates selectively is not the most productive way. Ideally a generalised and broader process is better,” Mathai opined.

He also said that further tightening of monetary policy was desirable. He didn’t want to comment whether in April monetary policy review the Government will implement a policy rate hike but said the market had revised rates much higher than the 50 basis point increase implemented a few months ago in policy rate. “So if policy rates are revised it will be catching up with what the market has already adjusted for,” Mathai added.

With regard to slower flow of Foreign Direct Investment (FDI), Mathai said that usually expectations are high but it is domestic investment that generally leads foreign investment. Whilst noting that Sri Lanka isn’t alone in the fight for FDIs, improvement in policy consistency will also help along with other factors in a peaceful setting.