SEALING THE BAILOUT

Shiran Fernando assesses the road map outlined for Sri Lanka

Sri Lanka’s economy received some positive news on 1 September with the announcement that the government had reached a staff level agreement (SLA) with the IMF. This is the first step to establishing a programme with the International Monetary Fund.

It’s also the beginning of a journey of economic reforms that need to be implemented so the country doesn’t fall back into being unable to pay for essential imports and refinance its debt.

While this SLA will pave the way for Sri Lanka’s 17th IMF programme, there’s more to be done this time around to ensure that it is implemented to a satisfactory conclusion.

The SLA in the main is an agreement between the technical teams of the IMF and two Sri Lankan governmental agencies (the Central Bank of Sri Lanka and Ministry of Finance). It puts in place an overall framework for a proposed four year Extended Fund Facility (EFF) of approximately US$ 2.9 billion.

This requires the approval of the IMF’s board since Sri Lanka is subject to two main criteria.

One is that the 2023 budget (to be presented in November) will be in line with the fiscal consolidation agreed by and between both parties.

The second is that Sri Lanka will have to have assurances from its creditors (both bilateral and international sovereign bondholders) that they will support its debt restructuring efforts, which will enable the country’s external burden to be sustainable again.

Subject to these conditions, Sri Lanka will be able to secure the IMF board’s approval for the disbursements of funds by the UN agency. Receiving such funds will depend on how successful the authorities, and their legal and financial advisors, will be in negotiating with the country’s creditors.

Zambia, which also faced a sovereign debt crisis, secured an SLA in December 2021 but received board approval only by the end of August this year. While other countries such as Ecuador have managed in recent times to move from SLA to IMF board approval more rapidly, Sri Lanka is hoping for the same by this December.

The key reform envisaged in the bailout programme will be a fiscal path in restoring higher revenue and lowering deficits.

A key target for debt sustainability is the primary deficit, which comprises the budget deficit minus interest expenditure that’s projected to change from a negative four percent of GDP this year to a surplus 2.3 percent by 2025.

This is on the back of raising tax revenue, which is among the lowest in the world, and prudent expenditure management.

To achieve this, the 2023 budget proposals will be critical as they outline the programme the government is looking to implement. Some of the higher personal and corporate tax income increases announced in May are expected to be finalised in October.

The other focus will be to mitigate losses incurred by state owned enterprises (SOEs) and ensure they contribute to government revenue without being a burden on the economy. For this, the IMF outlined that it will be looking at cost recovery-based pricing for fuel and electricity.

We have already seen a pricing formula being announced for fuel with two reviews a month. For electricity, we saw the first increase of tariffs since 2013 in August. Both utilities will need to adopt a transparent formula, which will be continuously actioned.

During the last IMF programme in 2016, a formula for fuel was introduced but then discontinued with the change of government.

Beyond these IMF-related targets, Sri Lanka will need to implement a credible reform programme for its main loss making SOEs such as the Ceylon Petroleum Corporation (CPC), Ceylon Electricity Board (CEB) and SriLankan Airlines. These three SOEs are res­ponsible for 97 percent of losses incurred by the 52 entities monitored by the Ministry of Finance.

With the price increases, the government will need to ensure that more people don’t fall into poverty and a targeted social safety net is established. Presently, programmes such as Samurdhi, which provide allowances for some 1.8 million people, will need to be better targeted and include those who may need support now, compared to a few years ago.

The staff level agreement also outlined the need for new legislation to strengthen the independence of the Central Bank of Sri Lanka so that it doesn’t continue to finance the government by printing currency. It also recognised the need to reduce exposure to corruption through an appropriate legal framework.

Beyond this, other standard IMF-related provisions on building dollar reserves, restoring a market determined and flexible exchange rate, and ensuring price stability through data driven policy action will be emphasised in the programme.

The SLA was timed in line with the interim budget for 2022, which echoed much of the IMF-related framework.

While the next four years will be challenging in terms of meeting the IMF targets, we have to see through the programme and implement the UN agency’s reforms in full.