Sri Lanka - Economic and Political Update

IMF Review of Extended Fund Facility - September 2019

Yesterday, the IMF announced it had reached a staff level agreement with the Sri Lankan authorities after a sixth review of its four-year Extended Fund Facility.

In its press release, the IMF welcomed “the authorities’ commitment to fiscal discipline and institutional reforms to anchor debt sustainability, while providing space to support the ongoing recovery and social goals”.

It added that the new Central Bank Act “will be a landmark reform in the roadmap towards flexible inflation targeting, strengthening the Central Bank of Sri Lanka’s mandate, governance, accountability, and transparency, in line with international best practice”.

  • The forecast for real GDP growth in 2019 has been revised down from May’s estimate of 3.6% to 2.7%, but growth is expected to improve to 3.5% in 2020, as tourist arrivals and related activities recover.
  • Inflation is expected to remain stable at around 4.5% during 2019-20.
  • Despite a fall in tourism and remittances, the current account deficit is expected to improve to 2.6% of GDP (3.5% in 2018) on the back of lower imports and stronger exports, which have been supported by the weaker exchange rate since the end of 2018.

The IMF welcomed the authorities’ efforts to normalise the security situation after the terrorist attacks in April and to mitigate the impact of them on the economy.

Meanwhile, it has been announced that the 2019 Presidential Election will be held on November 16th.  A Parliamentary Election will follow in 2020.

Fiscal Balance

The IMF says “the protracted impact of the 2018 political crisis and the Easter attacks are significantly impacting fiscal performance”, with the end-June fiscal target being missed “by a large margin, due to frontloading of spending from the clearing of arrears and externally-financed capital projects carried over from 2018, as well as a sharp fall in indirect revenues following the terrorist attacks”.  As a result, it accepts the targets agreed in the fifth review are beyond reach.  (The target originally submitted in the 2019 budget was for a primary surplus of 1.5% of GDP.)

On the other hand, it says “the authorities are committed to achieving a primary fiscal surplus of 0.2% of GDP in 2019 through the implementation of remaining revenue measures in the 2019 budget and prudent expenditure management”.

It has also commended the authorities’ commitment to revenue-based fiscal consolidation in 2020 and over the medium term, through:

  • Broadening the tax base, enforcing compliance, and strengthening spending efficiency
  • Revamping fiscal rules and establishing an independent public debt management agency over the medium term.

It has reiterated that improving the financial performance of Sri Lankan Airlines and advancing energy sector reforms (including tackling cost inefficiencies and subsidies in the electricity sector) are critical if fiscal risks are be reduced.

Central Bank Policy

The IMF has pronounced its support for the Central Bank’s “prudent and data-driven monetary policy approach” as well as its commitment to strengthen reserve buffers.  It has added that,

  • The Central bank should continue to allow for exchange rate flexibility and limit FX intervention to smooth excess volatility
  • The temporary measures (including a debt service moratorium and caps on bank interest rates) introduced to support the tourism sector and ease credit conditions in the wake of the terrorist attacks “should be lifted as soon a credit conditions stabilise to avoid distortions to the financial system”
  • Efforts to strengthen regulatory regime for banks and non-banking financial institutions are to be welcomed
  • The Central Bank’s plans to enhance the macroprudential policy framework, stress testing capabilities and the contingency framework should contribute to financial stability
  • Progress has been made on strengthening the regime for Anti-Money Laundering and Countering the Financing of Terrorism.

 

Bolstering Competitiveness

The IMF has also welcomed efforts gradually to liberalise trade and investment, while addressing their potential impact on revenue.

These efforts need to be supported by “an unwavering commitment to strengthening governance and transparency, notably in state-owned enterprises”, as well as to tackling corruption, promoting women’s economic empowerment, and targeting social transfers to those who need them most.

 

A more detailed note on the IMF’s fifth review of the economy under the EFF was posted to this website in May 2019.

Political Developments

The 2019 Presidential Election is to be held on November 16th.

Steps were recently taken at a meeting of the Cabinet to consider abolishing the Executive Presidency, an idea that has been under consideration since January.  Seemingly, this idea has the support of the prime minister, but it is hard to see it being passed by the necessary two-thirds majority of parliament now that the election has been called.  

The current opposition party, the Sri Lanka Podujana Peramuna (SLPP), has announced as its candidate Gotabaya Rajapaksa, younger brother of Mahinda Rajapaksa, the president from 2005 to January 2015, who is now precluded from standing by the reforms instituted since then.  Gotabaya Rajapaksa is currently regarded as the frontrunner in the election, as he is expected to receive support from Sinhala voters who credit his brother with the ending of the civil war.

Although the Sri Lanka Freedom Party (SLFP), led by the current president Maithripala Sirisena, has not yet announced its decision, it is not expected to field its own candidate.  Despite the evident disagreements between President Sirisena and prime minister Wickramasinghe, the leader of the United National Party (UNP), it is conceivable that the SLFP will support the UNP and its coalition if Sajith Premadasa, its deputy leader, is selected as its candidate.  However, it is much more likely that it will side with the SLPP.

The UNP is currently split on whether to choose Mr Premadasa, its deputy leader, or the current speaker of parliament, Karu Jayasuriya, as its candidate.  (Mr Jayasuriya has the support of the prime minister’s faction within the party).  The consensus view is that only the UNP-backed candidate is likely to be able to challenge Gotabaya Rajapaksa and that the support, or otherwise, of the SLFP will be crucial to its likely success.

The UNP will likely obtain the support of the smaller parties representing the Tamil and Muslim minority populations.  It will also do its best to secure the support of the Janatha Vimukthi Peramuna (JVP). 

The campaign, as in 2015, will probably be fought on a pro-Rajapaksa, anti-Rajapaksa basis.   However, the current split in the UNP-led anti-Rajapaksa camp would seem to be one factor weakening its cause and supporting the chances of the SLPP’s candidate.