Releasing a statement following the conclusion of 2013 Article IV Consultation, the global lender said Sri Lanka has achieved notable progress on a number of economic fronts in recent years despite many challenges.
Monetary policies introduced earlier in 2012 along with the support of the IMF's US$ 2.6 billion Stand-By Arrangement has facilitated the achievement of robust growth and poverty reduction in a difficult environment, the Executive Board of the IMF said.
However, the near-term outlook presents challenges, including slower growth and elevated inflation, the Board said, underscoring the need to put state-owned energy enterprises on a sound financial footing.
The Executive Directors emphasized that a new phase of reforms is needed to ensure a sustainable fiscal position, achieve low and stable inflation, safeguard financial stability, and support high and inclusive growth over the medium term.
Directors welcomed the Sri Lanka's continued efforts toward fiscal consolidation, particularly on recurrent spending, given a high public debt ratio, and supported the goal of reducing the budget deficit while clearing expenditure arrears.
Noting that revenues have fallen to very low levels, placing the burden of adjustment on expenditure, the IMF Executive Board stressed the need to broaden the revenue base and improve tax administration, including by extending the VAT fully to the retail and wholesale sectors, reforming the refund system, and revising tax holidays and exemptions to enhance space for infrastructure and critical social spending.
Pointing out that international reserves are relatively low, the director board encouraged strengthening the reserve position as circumstances permit.
They cautioned the government against introducing guarantees for foreign currency borrowing by banks, which according to the Board could undermine exchange rate flexibility, create contingent liabilities, and raise debt sustainability risks.
The Executive Board has agreed that Sri Lanka's banking system appears sound and welcomed the progress in strengthening financial sector supervision and regulation.
They called for vigilance following recent high credit growth and encouraged the authorities to draw on the recommendations of the updated Financial Stability Assessment Program to bolster financial stability further.
The Board encouraged the Sri Lankan authorities to boost competitiveness, including through strengthening trade, expanding infrastructure, and further improvements in the business climate to attract foreign direct investment. They supported the proposal for post-program monitoring.