Benefits from IMF dependent on reform effectiveness: Moody’s

Moody’s Investors Service says that whether or not Sri Lanka’s (B1 negative) credit profile demonstrates a temporary or more enduring improvement from its International Monetary Fund’s (IMF) program will depend on how effectively the program’s ambitious reforms are implemented.

Moody’s conclusions are outlined in its just released report ‘Government of Sri Lanka: Reform Implementation Key to Lasting Fiscal, External Improvement from IMF Program’.

The IMF approved on 3 June a $1.5 billion three-year Extended Fund Facility (EFF) program for Sri Lanka, with the main focus on fiscal reforms, as well as reforms to the country’s state-owned enterprises (SOEs).

Moody’s report points out that the EFF program aims to address Sri Lanka’s immediate balance of payments pressure, reflected in the fall in foreign currency reserves to low levels. In conjunction with financing, the program envisages fiscal reforms to address one of the causes of Sri Lanka’s macro-economic imbalances and its balance of payments problems.

However, the report also warned that fiscal strengthening following programs was often limited and short-lived.

“All the countries in our sample were running sizeable deficits of more than 5% of GDP at the start of their IMF programs. 

Deficits generally narrowed in the first year of the programs, consistent with disbursement of loans being conditional on meeting certain targets, including fiscal goals. However, the initial narrowing tended to peter out. In our sample, only Romania, and so far, Jordan, recorded a marked and sustained improvement in its budget balance,” Moody’s said in the report. 

To assess the likely impact of the IMF program on future economic, fiscal and balance of payments developments in Sri Lanka, Moody’s examined previous IMF programs in countries facing similar external liquidity, fiscal and structural reform challenges as Sri Lanka. 

These include Stand-By Agreements with Pakistan (B3 stable, 2008), Sri Lanka (2009), Romania (Baa3 positive, 2009), Mongolia (B2 negative, 2009), Jordan (B1 stable, 2012), and Ghana’s 2009 poverty reduction and growth program. Many of these programs were followed by subsequent programs.

Based on the above examples, Moody’s found that the main impact of the program is likely to be external liquidity relief. In addition, Sri Lanka’s budget deficit is likely to narrow as the EFF garners consensus around fiscal consolidation. However, the experience of other countries shows limited and often short-lived progress in fiscal consolidation. Nevertheless, Moody’s recognises that these countries’ fiscal metrics could have deteriorated more significantly in the absence of a program.

“Therefore, in Moody’s view, while the IMF program will alleviate Sri Lanka’s external liquidity pressures, a more durable improvement in the macro-economic and balance of payments pressures will depend on the extent to which authorities can durably reverse the ongoing fiscal deterioration while improving Sri Lanka’s international competitiveness and attractiveness to foreign investors,” the statement said. 

The study underpins Moody’s view that effective policy implementation determines the extent to which a country reaps the benefits of an IMF program.