Shiran Fernando looks ahead to what is expected of Sri Lanka

Sri Lanka received approval from the IMF for an Extended Fund Facility (EFF) on 20 March. This marked around a year since Sri Lankan Rupee began depreciating rapidly and Sri Lanka formally approached the International Monetary Fund for assistance.

While there’s some apprehension as to whether the 17th IMF programme will yield results, it is important to understand the context of obtaining this facility as well as the salient reforms required under the EFF.

ANALYSIS On past occasions when Sri Lanka approached the IMF, it was more due to balance of payments (BoP) issues triggered by a high trade deficit that led to a drop in reserves. We saw that in the 2009-2011 and 2015/16 programmes as well.

This adjustment was mainly due to a slowdown in demand for imports through a depreciation of the currency and an increase in interest rates; and though the economy stabilised for a year or two, it wasn’t sustained.

The fundamental reason for this situation is we have often followed a macro stabilisation agenda but not the reforms that are required to unlock growth, trade and investment.

However, the 17th time is different because more than a trade deficit led BoP issue, the crisis was due to an insufficiency of dollar inflows and reserves to repay or refinance existing external debt. This led to Sri Lanka defaulting on its debt in April last year.

Therefore, this programme will entail striking a balance between the reforms under the IMF facility and the debt restructuring process that Sri Lanka will have to undertake with its creditors. The latter will have a longer time period during which policy makers will need to be consistent and not lose international credibility again.

FEATURES The programme was designed with an emphasis on reforms to be implemented in the period leading up to IMF board approval and over the next two years.

This is the thrust through which the International Monetary Fund has ensured that we implement some of the difficult reforms, which we’ve traditionally shied away from. And that’s why we have witnessed extensive changes to the tax regime already, as well as a move towards cost reflective market prices for electricity, fuel, gas and water. Though Sri Lanka received US$ 333 million upon IMF board approval, the next set of disbursements will be based on performance.

Key performance indicators (KPIs) must be met every six months (in June and December); and depending on Sri Lanka’s achievements, the disbursements will be made in September and March for the period from 2023 to 2027.

The anchor of the programme is on the fiscal front, which has historically been the country’s Achilles’ heel. A crucial target is the primary surplus of 2.3 percent by 2025 from a deficit of 3.8 percent. A primary balance is the budget deficit less interest payments on public debt – it basically shows how adequate our taxes are in meeting the country’s interest payments.

Barring 1954, 2017 and 2018, Sri Lanka has always recorded a deficit. Therefore, this sharp turnaround in the next three years is envisaged through the higher tax regime (i.e. an increased VAT rate, corporate tax at 30 percent and advanced personal income tax) and future tax changes such as the removal of certain exemptions on valued added tax.

While this is an ambitious target, it’s an important signal to Sri Lanka’s creditors that the country is taking steps to share the pain of the restructuring process and will be on the path to debt sustainability – at least in terms of interest payments.

SOE REFORMS State owned enterprise (SOE) reform is another key focus area of the programme. The losses incurred by 52 SOEs, which were considered strategic during the 2017-2021 period, amounted to Rs. 57 billion. And if the profits of state banks are excluded, the losses amount to a staggering 443 billion rupees.

Given this scenario, the focus will be on improving governance, introducing competition in monopolies and divesting where there’s no reason for the state to be in a particular commercial enterprise.

Social safety nets are also an important facet of the programme. With the pandemic and economic crisis, more people have been made economically vulnerable and fallen below the poverty line. And subsidies disbursed through the Samurdhi programme have not reached those who need them most.

As a result, this process too will undergo significant reforms; and individuals will self-register, be validated and provided with cash transfers through assistance from the World Bank and other multilateral donors.

The programme will also focus on financial sector stability, an improvement in the independence of the Central Bank of Sri Lanka through new legislation and so on.

Indeed, the IMF inflows alone won’t be sufficient to save Sri Lanka; it’s simply a lifeline through which the country can regain its credibility and ensure that it doesn’t default again.