Wednesday, August 16, 2017

Mixed Reviews on Sri Lankan Economy - IMF

  • ·         Projects 4.7% growth for 2017, higher than Central Bank
  • ·         Renews warning on public debt challenge; inclusive of contingent SOE liabilities public debt is 94% of GDP
  • ·         Lower the public debt to GDP ratio to 76% of GDP by 2020 under the programmed fiscal consolidation


In its latest Staff Country Report released on Friday, the IMF gave a detailed analysis on the Sri Lankan economy and praised its resilience in 2016 and conceded that, where targets were missed, authorities took meaningful action. However, it pointed out, further monetary tightening would head off the second-round effects of currently high inflation, rein in credit expansion, and protect against potential capital outflows from further US rate hikes.
“Other measures to slow credit growth include raising the reserve requirement and employing macro-prudential instruments, such as: broader use of limits on loan-to-value ratios in vulnerable sectors, and a credit limit or increasing risk weights in the housing sector. The authorities agreed to closely monitor credit growth, particularly to ensure that credit growth was directed towards productive economic activity, and to tighten monetary policy further and use macro-prudential measures, if necessary,” the report said.

Real GDP growth is projected to recover gradually to 4.7% in 2017, supported by the continued momentum in construction and service sectors since late 2016, the IMF said. The Central Bank has already downgraded predictions to about 4.5% growth on weather related vulnerabilities triggering increased imports. Headline inflation peaked in March but will likely stay above 5% for much of the year due to high food prices and base effects from the VAT rate hike in 2016. The current account deficit is expected to widen slightly to 2.5% of GDP due to drought-driven increases in oil and food imports, and higher capital goods imports. 


IMF said public debt rose from 82 to 84% of GDP between 2015 and 2016 largely due to exchange rate depreciation and an increase in guaranteed debt. In 2017, public debt is expected to rise slightly to 85% of GDP due to still large fiscal deficit and exchange rate depreciation.
The medium-term overall deficit target of 3.5% of GDP remains appropriate for reducing the risk of debt distress, and would lower the public debt to GDP ratio to 76% of GDP by 2020 under the programmed fiscal consolidation
“If contingent SOE debt is included, total public debt would rise to 94% of GDP and decline below 90% of GDP by 2020. The likelihood of such a scenario has increased due to delays in energy pricing reform. External debt remains sustainable but is high at 57% of GDP and vulnerable to currency risks. And rollover need will increase as external sovereign debt begins to mature in 2019, calling for advance planning and medium-term debt management,” it warned.


The authorities remain committed to the economic reform program and undertook meaningful corrective actions where targets were missed. As a prior action, the new Inland Revenue Act (IRA) will be submitted to parliament. The authorities also strengthened tax administration and are conducting a diagnostic review of VAT. SOE oversight is improving, and energy pricing reforms are being recalibrated to address earlier setbacks. The Central Bank took steps to address the missed end-2016 reserve target by resuming since March 2017 the build-up of reserves.
In response to high inflation, the Central Bank tightened monetary policy in March 2017, and stands ready to tighten further should inflation or credit growth stay high. “Going forward, the reform momentum should strengthen further, building on the progress made so far. To reduce the risk of debt distress, fiscal consolidation should continue at steady pace.” This would require legislating and implementing the new IRA, strengthening the VAT system and administration, and making further progress in expenditure management and SOE reforms, the IMF advocated. Monetary policy should be tightened to rein in inflation and credit growth, and reserve accumulation should continue while allowing for greater exchange rate flexibility, it said.

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