SBA over, Govt. looks to EFF from IMF

• Final tranche of $ 415 m received bringing the total to $ 2.548 b during three years of SBA
• Govt. to stick with flexible exchange rate policy; confident of containing Budget deficit at 6.2% of GDP

With the record setting successful completion of the US$ 2.54 billion IMF’s Stand-by Arrangement (SBA), the Government has expressed keenness to go for further support via an Extended Fund Facility (EFF).

Following the eighth and final review under the SBA, the IMF on Friday said it has approved the release of the ninth and final tranche of $ 415 million, bringing the program to a close with $ 2.548 billion released since July 2009.

“We are very pleased to bring this program to a successful conclusion. The SBA has helped us to strengthen our economy and to communicate those strengths to the outside world and we look forward to continued, close engagement with the IMF,” Deputy Finance Minister Gitanjana Gunawardena and Central Bank Governor Nivard Cabraal said in a letter to the IMF Managing Director Managing Director Christine Lagarde.

“The precise modalities have yet to be worked out but we intend to discuss with IMF staff the possibility of financial support for our economic development agenda under an Extended Fund Facility,” they added.

Via the planned EFF the Government would continue to, “Prioritise macroeconomic and financial stability and growth through prudent monetary and fiscal policies, whilst also addressing pressing concerns such as state enterprise performance, revenue administration and public financial management.” Central Bank said the completion of the SBA marks the longest engagement Sri Lanka has had with the IMF and the single largest facility Sri Lanka has ever obtained from a multilateral institution.

“The key objectives of the SBA program were to rebuild the external reserves, strengthen the fiscal position, maintain monetary stability and fortify the domestic financial system,” it said.

“Sri Lanka has successfully achieved all these objectives under the program, with international reserves being built up to a comfortable level equivalent to 3.5 months of imports, containing the budget deficit, maintaining inflation at single digit levels and the stability of the financial system,” the Central Bank added.

Following are excerpts from the Government’s letter to the IMF.

Since the end of the conflict in 2009, the Sri Lankan economy has recorded undeniable success, supported by an IMF Stand-By Arrangement (SBA), Growth averaged over 8% in 2010 and 2011, inflation was brought down to the single digits and kept there for the longest period in our modern economic history, the fiscal deficit was steadily reduced, helping the debt-GDP ratio to decline and international reserves at the Central Bank were built up dramatically.

But as the economy grew, so too did imports fuelled by rapid credit growth and rising oil prices and despite the strong performance of exports and remittances, the current account deficit declined sharply last year, putting pressure on reserves. While continuing efforts to mobilise foreign capital flows to finance this deficit, in February, we also adopted a bold package of measures to contain the deficit and thus reduce the financing need. These measures included 1. the pursuance of greater exchange rate flexibility as we scaled back foreign-exchange intervention, 2. a tightening of monetary policy through rate hikes and the pursuance of strategies to moderate bank credit growth, 3. a further consolidation of fiscal policy via an increase in duties and an adjustment in energy prices to reflect international developments, which also helped to address state enterprise losses and 4. a general commitment to use all of these policy levers flexibility as required by changing economic circumstances.

Though only a few months old, the policy package has already delivered clear results. Credit growth has slowed, import growth has turned negative, and the current account deficit has narrowed. At the same time, banks have raised substantial amounts of capital abroad, there appear to be strong prospects for issuing another sovereign Eurobond in the near future and substantial foreign inflows into the stock market have materialised. The overall balance of payments should thus register a surplus in 2012, helping us increase reserve levels once again.

Further the policy measures taken have strengthened our economic fundamentals, improved our ability to absorb shocks and laid the basis for continued strong performance in years to come. Inflation may increase and growth slow in the near term, however, the policy measures undertaken should ease inflationary pressures going forward and help us to cope with the global risks and their possible impact on our economy. In this context, we will maintain exchange rate flexibility as this provides a key buffer to external shocks.

Though easing growth and imports have dampened budget revenue collection, we remain committed to achieving our 2012 budget deficit target of 6.2% of GDP through expenditure control and some revenue measures. More fundamentally, we recognise the need to strengthen revenue administration, particularly with respect to the VAT and public financial management process.

With regard to the program targets, the end June performance criterion on Net International Reserves (NIR) was observed, despite highly unfavourable valuation changes on the Central Bank’s portfolio of foreign assets and accelerated repayment of oil imports credit lines. Latest data suggest the reserve money target will also have been met. Slower growth and higher interest rates have put pressure on fiscal performance, but available data indicate we nonetheless will have met the end June benchmark on Net Domestic Financing of the Budget deficit. Cabinet approval of amendments to the Petroleum Act (structural benchmark) was received in April. Given this strong performance against program targets and our continued commitment to flexible macroeconomic policy management, we request completion of eighth and final review of the SBA.

We are very pleased to bring this program to a successful conclusion. The SBA has helped us to strengthen our economy and to communicate those strengths to the outside world and we look forward to continued, close engagement with the IMF. The precise modalities have yet to be worked out but we intend to discuss with IMF staff the possibility of financial support for our economic development agenda under an Extended Fund Facility. This would continue to prioritise macroeconomic and financial stability and growth through prudent monetary and fiscal policies, whilst also addressing pressing concerns such as state enterprise performance, revenue administration and public financial management.

We believe that the policies in this and previous letters of Intent are adequate to achieve the objectives of our economic program and we stand ready to take additional measures as appropriate to ensure achievement of the objectives. We will continue to liaise with the IMF when modifying measures contained in this letter or adopting measures that would deviate from program goals and provide the IMGF with information necessary for program monitoring.