Sri Lanka - Economic Update

IMF Visit - February 2020

 

In early February 2020, the IMF issued a press release following a visit by its staff to Sri Lanka for discussions on the economy.

This was the first series of meetings between the IMF and the new Rajapaksa-led administration.   

According to the IMF, the economy has been recovering from the April 2020 terrorist attacks and it is projecting real GDP growth in 2020 will be 3.7%.  

This was before the full effects the COVID-19 pandemic had been felt, however.

The projected recovery notwithstanding, the IMF has signalled that

  • Ambitious structural and institutional reforms are needed to anchor policy priorities, bolster competitiveness and foster inclusive growth
  • Fiscal prudence remains critical to support macro-economic stability / confidence, amid high levels of debt and refinancing needs

2020 Estimates

The recent recovery in the economy has been supported by a solid performance from manufacturing and a rebound in tourism and related services. 

Assuming COVID-19 has only a limited negative effect on tourism and other economic activities, the IMF staff has projected real growth to recover from an estimated 2.6% in 2019 to 3.7% in 2020.

Inflation is projected to remain at around 4.5%, in line with target. 

After a sharp import contraction in 2019, the current account is expected to widen to nearly 3% of GDP in 2020.

Fiscal Position

The IMF has warned that the primary surplus target under the Extended Fund Facility (EFF) agreed with the IMF was missed by a sizeable margin in 2019.  The actual outcome – a deficit of 0.3% of GDP – was due to weak revenue performance and expenditure overruns.

The IMF has further warned that, under the authorities’ current policies, the primary deficit could widen to 1.9% of GDP in 2020.

This is because of new tax cuts and exemptions, clearance of domestic arrears and backloaded capital spending from 2019.

According to the IMF, risks to debt sustainability and large refinancing needs are such as to make renewed efforts to advance fiscal consolidation “essential”.

Specifically, the IMF has  the following:

  • Measures to improve efficiency in public administration
  • Steps to strengthen revenue mobilisation
  • Advancing legislation to strengthen fiscal rules to anchor policy commitments and restore confidence

Monetary Policy

Net international reserves fell short of the EFF target for December by $100mn.   This followed market pressures after the Presidential election and announced tax cuts.

Although the situation had since stabilised, the IMF continues to advise that the central bank follows a prudent, data-dependent monetary policy, adjusting interest rates as economic conditions evolve, and rebuilding reserve buffers under a flexible exchange rate.

The approval of the new Central Bank Law, it says, is a “critical step” to strengthen the independence and governance of the CBSL.

Financial System

According to the IMF staff, the financial system is broadly stable, but pockets of vulnerability remain, particularly among non-banking financial institutions. 

The IMF has again warned that caps on lending rates and the loan repayment moratorium for SMEs need to be temporary if distortions and inefficiencies in the system are to be avoided.

The IMF is also advocating a modernisation of the Banking Act to strengthen and harmonise regulation and supervision. 

Resolution frameworks for deposit-taking financial institutions, it says, will help financial stability.

Other Reforms

The IMF has welcomed the authorities’ plans to improve the efficiency of SOEs.

Its staff have indicated these efforts should be supported by a visible commitment to strengthen governance and transparency, notably in the energy sector, and to tackle corruption. 

Concerted efforts are still needed to foster the business climate, promote trade openness and investment, and to strengthen infrastructure sustainably. 

As previously guided, the IMF is suggesting Sri Lanka stands to gain from greater female labour participation, enhancements in social protection and further investment in education and skills.

They published a more detailed review of the Sri Lankan economy in November 2019.  This followed the Staff’s findings of its mission last September to review progress under the EFF.

Full details are available on the IMF’s website, and were summarised in the Presentations section of the Inwa Advisers website.