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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Sri Lanka in talks with IMF for longer term program

Sri Lanka in talks with IMF for longer term program

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Manager - Equity Analytics
Manager - Equity Analytics
22, 2012 (LBO) - Sri Lanka is to begin talks with the International
Monetary Fund for an 'Extended Fund Facility' which involves the
granting of long term economic liberties to citizens and taking deeper
measures to prevent economic shocks that hurt people.

A 2.5 billion US
dollar 'Stand by Arrangement' has just ended with a fair degree of
success, rescuing the country from two standard balance of payments
crises driven by sterilized foreign exchange sales.
"The Sri Lankan authorities now look forward to the continued close
engagement with the IMF and intend to discuss the possibility of
financial support for its economic development agenda under an Extended
Fund Facility (EFF)," Sri Lanka's central bank said in a statement.

Sri Lanka is now a heavy borrower in international markets and the
country has to avoid excessively strong state interventions that hurt
the economy and people as they may get negative reactions from both
international bond buyers and rating agencies.

Unlike domestic savers in banks or pension funds, who are cornered by
draconian exchange controls and have no escape from economic
mis-management, or expropriation through depreciation, foreign bond
buyers have clout over rulers under existing laws.

Bond buyers limit the ability of rulers to intervene in markets and
continue deceptive policies. Though they can be misled by high yields
when the penny drops, they cut losses, which can have devastating
effects on economies that do not work according ground reality.

During the last balance of payments crisis, triggered by energy price
deceptions and worsened by sterilized foreign exchange sales, the
existence of an IMF program probably helped avoid rating downgrades.

A reduction of
state interventions in the economy in the form of reducing energy price
controls and ending contradictory monetary and exchange policies in
February which resumed a suspended IMF program helped Sri Lanka retain
its rating.
Deeper reforms, especially in state enterprises which are making massive
losses and a burden on the poor, as well reducing state spending to
curb deficits could result in the avoidance of future economic crises
and result in rating upgrades.

"We may raise the sovereign rating on evidence of Sri Lanka's progress
in addressing the external weaknesses and domestic problems," Standard
and Poor's said in a statement during the launch a billion dollar bond
this month.

"Fiscal or structural economic reforms that reduce the vulnerabilities
from high debt and interest burdens and the still-narrow economic
profile would indicate such improvement."

Standard and Poor's had rated Sri Lanka at a speculative 'B+', four levels below a 'BBB-' investment grade rating.

Downgrades earned during a 2008/2009 balance of payments crisis were
largely reversed by rating agencies on the presence of the IMF,
underscoring the importance of the watchdog's presence for outsiders.

"The outlook for the sovereign rating was changed to positive in 2011,
reflecting an increasingly evident peace dividend reflected in greater
macroeconomic stability, as well as a policy orientation of fiscal
reform and economic growth that continues to be guided by an IMF
program," Moody's, another rating agency said on the same day.

"In addition, the monetary authorities have established a regulatory and
supervisory framework supportive of financial stability."

IMF also has a financial sector assessment program and regular so-called
'Article IV' consultations with the state though some of their reports
have been suppressed by authorities. Transparency has increased lately.

An IMF staff report on the last review of the current program is also awaiting publication.

"It will be important to continue macroeconomic stabilization and
structural reforms efforts, in particular maintaining exchange rate
flexibility while building international reserves, given the uncertain
global outlook," IMF's deputy managing director Naoyuki Shinohara said
in a statement Friday.

"A successor arrangement with the Fund would provide valuable support to the authorities in these endeavors."

A Stand by Arrangement is aimed at solving immediate problems that led to creation of a balance of payments crisis.

Since the late 1990s the IMF has also stayed away from putting longer
term reforms that prevent future crises into SBA's as specific
performance criteria, focusing on immediate corrective measures.

Even in Sri Lanka there have been no performance criteria on market
pricing energy and ending deceptive pricing, a simple reform that can
eliminate perhaps the most important trigger of balance of payments
crises in the island.

An Extended Fund Facility, a program originally started in 1974 shortly
after the collapse of the Bretton Woods soft-pegs and the world was just
coming into grips with floating exchange rates, can be used to support
longer term reforms.

"Given that structural reforms to correct deep-rooted weaknesses often
take time to implement and bear fruit, the EFF is longer than most Fund
arrangements—the Fund remains engaged with the member country during the
design and implementation of adjustment policies," the IMF says in an
explanatory note on its website.

"However, a maximum duration of up to four years at approval is also
allowed, predicated on, inter alia, the existence of a balance of
payments need beyond the three-year period, the prolonged nature of the
adjustment required to restore macroeconomic stability, and the presence
of adequate assurances about the member's ability and willingness to
implement deep and sustained structural reforms."

A new program is expected to be discussed with the next IMF mission to Sri Lanka due around September 2012.

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