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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Lanka concludes IMF programme for first time, but not out of the woods

Lanka concludes IMF programme for first time, but not out of the woods

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CSE.SAS

CSE.SAS
Global Moderator
Sri Lanka has concluded an IMF programme for the very first time but the economy is still facing some serious issues.

The final tranche of US$ 415 million is available for disbursement brining the total disbursement to US$ 2.5 billion under an IMF standby arrangement entered in to 2009 for balance of payments support. Negotiations are ongoing for an extended fund facility for around US$ 500 million to support development activities in the country.

The just concluded programme was almost derailed as the authorities failed to take steps to avert another balance of payments crisis, but the programme resumed earlier this year with authorities taking steps to address the problem. This was instrumental in gaining success at the recent international sovereign bond issue, where the interest cost was a record low, although the interest premium was much higher thanks to the mismanagement of the macroeconomy.

Following the IMF Executive Board’s discussion on Sri Lanka last week, Naoyuki Shinohara, Deputy Managing Director and Acting Chair, stated:

"Following robust growth in the first quarter of 2012, activity has started moderating in response to policy tightening and weakening global demand. Headline inflation has increased, but core inflation remains relatively stable, while tighter monetary and credit policies have begun slowing credit and import growth. The external current account deficit is narrowing, and international reserves have stabilized.

"The current monetary policy stance is appropriate, and monetary conditions should remain firm in the near term given high headline inflation and possible second-round effects. With a flexible exchange rate regime, monetary policy can increasingly focus on inflation control to achieve broader macroeconomic stability while allowing the exchange rate to act as a buffer for external shocks. Foreign exchange market intervention should thus be limited to smoothing excessive volatility, and steps should be taken to gradually deepen the foreign exchange market.

"The slowdown in economic activity and declining imports are adversely affecting fiscal revenues, while interest payments on government debt are higher than budgeted. The authorities are committed to meeting their 2012 deficit target by restraining expenditure, but a redoubling of effort to strengthen revenue administration is needed. Furthermore, continued structural reforms are required to put state-owned energy enterprises on a sound financial footing.

"The ongoing FSAP update is assessing potential vulnerabilities in the financial sector. The authorities should remain vigilant for systemic risks, and recommendations in the update can be used to strengthen the financial system further.

"The Sri Lankan authorities have undertaken substantial macroeconomic policy adjustments to stabilize reserves. 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. A successor arrangement with the Fund would provide valuable support to the authorities in these endeavors."

With the country increasingly relying on international commercial borrowings, maintaining macroeconomic stability is key to brining down borrowing costs.

According to Standard and Poor’s Sri Lanka’s rating is constrained by: (1) Sri Lanka’s weak external liquidity; (2) moderately high and increasing external debt; (3) fundamental fiscal weaknesses and the attendant high public debt and interest burden; and (4) political institutions that, in some cases, lack transparency and independence.

According to Moody’s, "The rating continues to be encumbered by the reduction of its large debt overhang and the consequently large debt servicing costs. However, Sri Lanka is well-placed to grow out of its debt given its still-favorable outlook for economic growth, while the government has taken measures, such as recent tax reforms, to further strengthen its financial position.

"Moody’s assessment of event risk remains somewhat elevated, but at a moderate level in our global bond methodology framework."

According to an analysis by LBO, "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."
http://www.island.lk/index.php?page_cat=article-details&page=article-details&code_title=57423

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