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Despite a delay in foreign debt restructuring and no progress in good governance, the International Monetary Fund approved the third tranche of the Extended Finance Facility. What are the implications and economic significance of this?

Third tranche

The IMF approved the third tranche—US$ 336 million—under its Extended Fund Facility on June 12, despite the delay in foreign debt restructuring, inadequate economic reforms, and no progress in good governance.

Commended

However, the IMF commended the reduction of the rate of inflation, the fiscal reforms, increased revenue collection, the economy’s growth in the second half of last year, and this year’s economic upturn.

Economic performance

The IMF said the economy’s performance under the programme was strong and all quantitative targets set for end-December 2023 were met, except the indicative target on social spending. They said that most structural benchmarks due by the end of April 2024 were either met or implemented with delay.

Foreign debt

According to the IMF, Sri Lanka has made substantial progress towards advancing debt restructuring to restore debt sustainability. It has to finalise a memorandum of understanding with the Official Creditor Committee soon and quickly enter into final agreements with the Export Import Bank of China.

Vulnerable

The IMF cautioned that the economy is still vulnerable and the path to debt sustainability “remains knife-edged.” It also underscored the downside risks of the election period, the continued recession of Western economies and the adverse impacts of the two wars.

Elections

The IMF observed that Sri Lanka faces considerable uncertainties associated with the upcoming elections and ongoing debt restructuring. It said it respected the democratic process for elections and would adapt to the results of a democratic election. However, the run-up to the elections and after could be a period of economic instability and stagnation.

Revenue

Whatever the political outcome and changes in policies, the IMF stressed that fiscal consolidation is not negotiable. IMF mission chief Peter Breur told a news conference that it was not feasible to reduce taxes by any administration as it was significant how the reduction in government revenues had contributed to a very severe crisis in Sri Lanka. Opposition political parties should come up with alternate taxation proposals that would enhance revenue.

Critical issue

This is problematic, as the two main opposition parties have said they would reduce both income taxes and indirect taxes. These parties would have to come up with a new tax system that would yield much higher revenue to ensure a lower fiscal deficit.

This is doubly difficult, as the reduction of committed expenditures on debt servicing, salaries and pensions is difficult, and the election promises would increase expenditure and reduce revenue.

Third tranche

The third tranche of US$ 336 million is indeed of economic importance. Much foreign assistance and foreign investment are expected to flow. However, critics of the IMF arrangement have said that the IMF tranche is peanuts and that we get much more from other sources.

This is a misunderstanding of the IMF’s role. It was the IMF’s involvement that brought about financial stability, enhanced the country’s reserves, and enabled essential imports. It is the IMF’s reforms, especially the reforms on governance and economic reforms, that will usher in economic stability and growth.

Elections

In any event, the elections and their outcome could affect the economy in many ways. It may even result in the abandonment of the programme, as has happened on 16 previous occasions. The economic consequences of it could be horrendous.

Uncertainties

However, the foreign debt restructuring not being completed and the uncertainty of the two elections are likely to make foreign investors wait and see till the post-election government’s policies are known.

The foreign debt restructuring that was expected by the end of June remains uncertain. The government keeps saying it is imminent. There are, however, doubts as to whether the negotiations on foreign debt restructuring are in a stalemate.

Reforms

The IMF has underscored the fundamental importance of governance reforms for the country’s economic progress, as corruption is at the root of our underdevelopment.

Governance

Although the IMF approved the third disbursement under the current programme, Sri Lanka is still falling short on the governance improvements that are foundational for its economic recovery.

Non-compliance

Verité Research has pointed out that according to the latest update of the ‘IMF Tracker’, Sri Lanka verifiably failed to meet 25 percent of the commitments due by the end of May 2024 under the programme renewed in December 2023. Of the 63 commitments due, 32 were classified as ‘met’, 16 as ‘not met’, and 15 as ‘unknown’, meaning data were not available to verify their status.

Furthermore, Verite Research explained that the prognosis of failing on governance comes from examining the 16 commitments that were ‘not met’. Seven of them were on financial management, six on financial transparency, and three on anti-corruption measures.

Corruption

Verite Research emphasised that “Sri Lanka is failing to comply with the IMF programme precisely in the areas diagnosed as the root causes of the economic crisis—problems of financial transparency, management, and corruption. Many of the unmet commitments at the second disbursement were also related to actions on transparency and anti-corruption. The expectation that Sri Lanka would solve its economic weaknesses by addressing the root causes of corruption and mal-governance” remains unimplemented.

No progress

As Verite Research has said, the economic goals “have not been realised owing to the lack of progress on governance, especially corruption.”

Concluding reflection

The IMF approving the third tranche of the EFF despite the restructuring of the foreign debt and noncompliance with several conditions is a favourable development for the economy. The external reserves of the country are expected to be boosted by foreign assistance and project loans. However, the noncompliance with the IMF conditions, could jeopardise the approval of subsequent tranches and the abandonment of the IMF arrangement for the 17th time.

Apart from fulfilling IMF conditions, the implementation of good governance requirements is vitally important for the economic development of the country. Corruption and poor governance have been the root causes of the country’s underdevelopment.

Finally, the coming months could be unconducive for the economy. The pre-election period could disrupt the reform agenda as well as economic activities. The election outcome could also usher in a period of political instability and economic inaction. The progress in economic stabilisation, growth and reforms could be undermined by these developments.