Shiran Fernando hopes that economic and fiscal policies will not be derailed by impending elections

Sri Lanka secured a staff level agreement (SLA) following the second review of its IMF programme at the end of March. This is a positive first step in the lead up to the disbursement of the third tranche, which is expected by mid-year.

When quizzed at a press briefing about the progress made following the SLA announcement, Senior Mission Chief for Sri Lanka of the International Monetary Fund Peter Breuer noted that the country’s pathway out of its crisis is “on a knife edge.”

It’s necessary for Sri Lankans to understand what that means in the context of progress made so far on some of the key indicators.

THIRD REVIEW The IMF’s SLA expressed satisfaction with the progress on growth, fiscal and inflation fronts. And it called for the continuation of the reform momentum, particularly with regard to tax revenue and the introduction of a property tax next year.

Extensive groundwork will need to be carried out prior to implementation as property taxes have had mixed results in other countries. As highlighted in the SLA, a key to this is continued progress in widening the tax base.

Since tax revenue has grown to a sizeable level, the treasury has been able to generate cash reserves that helped the Central Bank of Sri Lanka retire some local government securities when they matured at recent auctions.

This will ensure that domestic debt buildup eases over the coming months.

But before the SLA goes to the IMF main board for approval, Sri Lankan policy makers have a few remaining indicators to fulfil. One indicator that’s outstanding addresses structural benchmarks such as passing the Public Financial Management Act in parliament.

Another crucial step is to finalise the agreement with the Official Creditors Committee, which comprises bilateral debt holders, and progress to an agreement with private creditors such as the international sovereign bondholders.

Some progress on the latter was achieved at the end of March.

GROWTH TRAJECTORY The fourth quarter GDP for 2023 showed a second consecutive quarter of growth. While real GDP growth was recorded at 4.5 percent compared to the previous year, GDP in the quarter in absolute terms was where it stood in the period between 2016 and 2021.

This suggests that GDP remains below its true potential. The weak recovery of the industry sector is one of the main reasons for this.

The Purchasing Managers’ Index (PMI), which measures month on month activity in the manufacturing and services industries, notes that the improvement in economic activity in the second half of 2023 continued into the first quarter of this year.

Notably, the PMI for manufacturing increased in January and February while the index for construction shifted into expansion mode in January for the first time in two years. While these are positive signs of recovery, the outlook for key export manufacturing industries such as apparel isn’t good.

Nevertheless, and despite a slowdown in the export of goods, the currency has appreciated to under Rs. 300 to the US Dollar due to surging tourist arrivals and increased foreign remittances.

Services made a turnaround on the back of tourism as reflected in the GDP for the second half of last year and expansion of the PMI services index. The first two months of this year saw twice the number of tourist arrivals compared to 2023 – versus 2018, this is the highest recorded.

With a focus on countries such as India and the roll out of a digital marketing campaign, the number of foreign visitors to the island is likely to grow further.

REFORM PATHWAY The statement made by Breuer was in response to pending elections and the multiple viewpoints expressed by political parties as to how they would steer the country out of the economic crisis.

Indeed, the IMF believes that continuation of the reform programme (for which it is the anchor) is critical if Sri Lanka is to emerge from this crisis and avoid becoming a serial defaulter like Argentina.

As such, the International Monetary Fund has called for realistic proposals.

When both presidential and parliamentary elections were held in the past, the country pursued loose fiscal or monetary policies – and sometimes, even both. The loose fiscal policies of late-2019 was a key trigger for the economic crisis in 2022.

Likewise in 2015, there was loose policy and an increase in public relief, which eventually led to sharp currency adjustments and an IMF programme in 2016. During this period, there was an expansion in the twin deficits – i.e. the fiscal and current accounts.

This is the vicious cycle that prevents Sri Lanka from emerging from serial crises, and turning periods of stability into strong and sustained economic growth.