The IMF has indicated satisfaction at the country’s economic performance. The IMF mission’s first review of the Sri Lankan economy after the granting of the Stand-By facility appears to be one of approval of the government’s measures thus far. The statement indicates the IMF is quite satisfied that the government has taken steps to meet with the conditions of the Stand-By Arrangement that was approved last July. In the view of the IMF “Recent economic developments have been stronger than expected. Economic growth is now projected at 3½ percent in 2009 relative to 3 percent at the time of the programme’s approval. Inflation remains subdued and is expected to remain in single digits in 2009. Exports have showed signs of recovery in recent months.” This is the first review and there would be seven quarterly reviews over the next 18 months.
The IMF appears quite content with the government’s policy stance. The IMF statement says: “The government’s policy approach has been in line with the programme, and performance based on its July targets has been broadly satisfactory. Net international reserves continue to show impressive growth driven by an increase in investor confidence and stronger than expected remittances. The central bank’s actions to rebuild reserves while reducing policy interest rates are welcome. The recent recovery in budget revenue has improved the fiscal outlook.” This is indeed a good report of progress.
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The increase in reserves to over US$ 4 billion is better than expected. This increase in reserves has been achieved by the IMF loans, borrowing from abroad, a lower trade deficit, increased private remittances and investment inflows. Private remittances that were continuing to increase at around 5 percent in the early part of the year have increased to 6.5 percent in July. This has resulted in the trade deficit being more than offset by remittances to yield a balance of payments surplus in the first seven months. The balance of payments surplus is likely to be enhanced by other capital inflows. It is also important and significant that the reserves are a net surplus.
There are other aspects on which the attitude of the IMF has to be gauged by reading in between the lines. It refers more to promises and assurances rather than actual policy implementation. The statement says “Looking forward, the government has reiterated its commitment to the policy measures laid out in the Memorandum of Economic and Financial Policies, including a further increase in net reserves and additional steps to strengthen the financial sector.” This is perhaps a diplomatic way of saying the government has only made promises.
The most significant issue, as we pointed out last week, is fiscal consolidation. Bringing down the fiscal deficit to manageable proportions is vital and the IMF has insisted that the deficit be brought down to 7 percent of GDP this year and progressively reduced to 5 percent in 2011. Given the increase in government expenditure thus far, and a shortfall in revenue, it is difficult to expect the fiscal deficit this year to be contained at 7 percent of GDP. In the IMF’s diplomatic parlance it says: “The programme’s target of reducing the budget deficit to 7 percent of GDP in 2009 is ambitious, but the government is committed to taking whatever necessary steps to achieve this by improving tax administration to support a further increase in revenues and controlling expenditures for the remainder of the year.”
What could be achieved in fiscal consolidation in the remainder of the year is very limited. Even as a proportion of GDP the statistic is difficult to achieve as the GDP growth is expected to be only 3.5 percent and even nominal income will not rise much as inflation is expected to be of a single digit. Creative accounting could be detected by the IMF that will look into the whole range of statistics including the government’s commitments and borrowings.
There are various assessments of the expected budget deficit based on the figures of the first half’s revenue and expenditure. All these place the projected deficit to be more in the region of 8 percent than 7 percent. If this were to be the case, will the IMF, despite its approving comments on the economy withhold the other instalments of the loan facility? Such a step would be a serious set-back not merely owing to the financial loss but the erosion of international confidence in the wake of such a development. With the prospect of GSP plus status being removed by the European Union countries, it would be a double blow. Therefore, in as far as Sri Lanka is concerned, this should be avoided at all costs. We must continue to obtain the IMF facility.
How could the country achieve a resolution of the problem? Since three fourths of the year has already lapsed the leeway is limited. This is especially so as government expenditure has ballooned already and the committed expenditures for the rest of the year are unavoidable. Hopefully measures taken by the Department of Inland Revenue to increase revenues will bear some fruit, yet any expectation of a substantial increase by year’s end is too much to expect. Improved measures to increase tax compliance and reduce tax avoidance and tax evasion may have a better result next year.In this situation the strategy available to the government is to convince the IMF that it has taken steps to bring down the deficit and it will take further measures to cut wasteful expenditure and increase government revenue. Mere promises and sweet words are not likely to convince the IMF of this.
The government would have to demonstrate their intent with specific measures. These measures may have to be put in place immediately.It is in the interest of the country to retain the Stand-By Arrangement with the IMF and obtain the remaining tranches of the agreed facility of US$ 2.6 billion. Forfeiting these finances would deprive the country of resources and strain the country’s external finances again. At a crucial juncture in the economy when peace offers prospects of rapid economic growth, the country should not get into an external finance constraint once again. It is vital that measures are taken to ensure the confidence of the IMF. Any other strategy would be imprudent. |
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