Sri Lanka to approach IMF for economic bailout?

Amid rising speculation that the Sri Lankan government was mulling approaching the International Monetary Fund, a senior official has said the international financial institution, will “definitely” have a role to play post-Covid-19 economic recovery and after the authorities formulate the policy framework

Sep 22, 2021
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Sri Lanka to approach IMF

Amid rising speculation that the Sri Lankan government was mulling approaching the International Monetary Fund, a senior official has said the international financial institution, will “definitely” have a role to play post-Covid-19 economic recovery and after the authorities formulate the policy framework.

Speculations over President Gotabaya Rajapaksa’s administration going to the IMF are on the rise amid the risk of sovereign debt default and possible collapse in the rupee currency. However, the government has denied that it was going to the global lender.

The President’s Secretary P B Jayasundera, the country’s topmost civil servant and former finance secretary who has dealt with many past IMF programs, said there is nothing the IMF can do apart from cushioning the foreign exchange reserves.

“IMF will not be here to buy debts,” Jayasundera said in an interview with EconomyNext. “Everybody will ask ‘show us your plan’.”

“So if the plan is convincing, each one has a role to play in that plan. IMF has a role. But it is not a role by extending a loan.”

Ruling Sri Lanka Podujana Peramuna (SLPP)officials have said the government’s reluctance to go to the IMF now is because of adverse impacts of the global lender’s conditions including increasing state revenue and currency falls which will hit the people hard in 2024 when Sri Lanka holds presidential polls.

An IMF loan is accompanied by monetary and fiscal targets or quantitative performance criteria (PC) against which loan tranches are released to the central bank.

The loans are later repaid by pegging the exchange rate and collecting reserves through a ‘strong side convertibility undertaking’ or buying dollars from the market.

It can be easily done as long as money is not printed and liquidity is withdrawn (central bank credit is reduced), analysts say.

Sri Lanka’s economy is now struggling with a widening budget deficit and heavy external debts alongside a forex crisis, Finance Minister Basil Rajapaksa told parliament.

The government has maintained it will repay maturing debt and avoid a sovereign default with non-debt inflows.

After exiting the previous IMF program in 2019. Sri Lanka cut taxes and printed more money under President Gotabaya Rajapaksa’s “Vistas of Prosperity.”

Now the government is in the process of formulating a longer-term economic plan coupled with post-Covid-19 economic recovery.

Jayasundera said the government was making a recovery plan focusing on addressing fiscal issues, external finance, and troubled sectors and turned them into “more sensible economic activities”

“Those issues have to be addressed,” Jayasundera said.

The IMF in 2009 provided a 2.4 billion loan to reduce its fiscal gap and stabilize the currency and interest rates.

The 2009 program did not have an inflation target as one of the performance criteria directly conflicting with the foreign reserve target which required pegging, but a domestic reserve money target which was more complementary to the reserve target.

To tightly control liquidity injections and eliminate all anchor conflicts analysts say Sri Lanka needs a program with a progressively falling ceiling on domestic assets of the central bank as a performance criterion, where reserve money is only an indicative target.
 
Such a program will automatically stabilize the exchange rate and anchor inflation externally.

But Sri Lanka is now suffering from an unprecedented rise in central bank credit which has triggered forex reserves falls as the liquidity turned into external demand in the credit system. The reserves analysts say are at levels that make it difficult to credibly anchor the currency.

Following a tax cut in December 2019 and a steep fall of the currency in March 2020 Sri Lanka earned downgrades, effectively locking itself out of capital markets.

Analysts have warned Sri Lanka to be careful of more downgrades as domestic assets of the central bank continue to rise.

(SAM)