Sri Lanka makes significant progress on important reforms, work on full recovery remains – IMF staff

In March this year, the IMF Executive Board approved a 48-month extended arrangement under the Extended Fund Facility (EFF) in the amount of about US$3 billion to Sri Lanka, which had been hit by a catastrophic economic and humanitarian crisis. It was aimed at restoring the country’s macroeconomic stability and debt sustainability, mitigate the economic impact on the poor and vulnerable, safeguard financial sector stability, and strengthen governance and growth potential. Photo of Colombo courtesy of IMF Facebook.

KUALA LUMPUR, Sept 27: The people of Sri Lanka have shown remarkable resilience in the face of enormous challenges and the country has made commendable progress in implementing difficult but much-needed reforms, a statement from an International Monetary Fund (IMF) mission team to the country’s capital, Colombo, said today.

“These efforts are bearing fruit as the economy is showing tentative signs of stabilization. Inflation is down from a peak of 70 percent in September 2022, gross international reserves increased by $1.5 billion during March-June this year, and shortages of essentials have eased.”

The statement was issued by Peter Breuer and Katsiaryna Svirydzenka, who led the IMF staff team to Colombo from Sept 14-27 to discuss economic and financial policies to support the approval of the First Review of the program under IMF’s Extended Fund Facility (EFF) arrangement.

The team had discussions with the Sri Lankan authorities on economic performance and policies underpinning the first review under the EFF arrangement.

Nevertheless, despite early signs of stabilization, full economic recovery is not yet assured, the statement said.

“Growth momentum remains subdued, with Q2 real GDP contracting by 3.1 percent on a year-on-year basis and high-frequency economic indicators continuing to provide mixed signals. Reserve accumulation has slowed in recent months.

“Sustaining the reform momentum is critical to put the economy on a path towards lasting recovery and stable and inclusive economic growth. The authorities have met the program’s primary balance targets and remain committed to this important pillar of the program so as to support their efforts to restore debt sustainability.

“However, revenue mobilization gains–while improved relative to last year–are expected to fall short of initial projections by nearly 15 percent by year end. While partially due to economic factors, the onus of fiscal adjustment would fall on public expenditure if there were no efforts to recoup this shortfall.

“This could weaken the government’s ability to provide essential public services; and undermine the path to debt sustainability. To increase revenues and signal better governance, it is important to strengthen tax administration, remove tax exemptions, and actively eliminate tax evasion.

“Against continued uncertainty, it also remains important to rebuild external buffers by strong reserves accumulation. Building on the Central Bank of Sri Lanka’s success in controlling inflation, refraining from monetary financing will help keep inflation in check. Other challenges include maintaining cost recovery of electricity pricing.

“The government has made steady progress on structural reforms. Key legislations passed in Parliament, including the new Central Bank Act and the Anti-Corruption Act, could improve governance if implemented effectively. The IMF Governance Diagnostic report would inform future reform measures to strengthen governance when published. A new welfare benefit payment scheme was enacted with new eligibility criteria that aims to improve targeting, adequacy, and coverage of social safety nets. To ensure financial stability, steps were taken on conducting bank diagnostics, developing a roadmap for addressing banking system capital and liquidity shortfalls, and improving the bank resolution framework.

“The authorities have also made headway on regaining debt sustainability through the execution of the domestic debt restructuring and advancing discussions with external creditors. As Sri Lanka is restructuring its public debt which is in arrears, Executive Board approval of the first program review requires the completion of financing assurances reviews. These financing assurances reviews will focus on whether adequate progress has been made with debt restructuring to give confidence that it will be concluded in a timely manner and in line with the program’s debt targets.

“Discussions are on-going, and the authorities are continuing to make progress on their plans for revenue mobilization targets, anti-corruption efforts, and other important structural reforms.”

Among others, the IMF team held meetings with President and Finance Minister Ranil Wickremesinghe, Central Bank of Sri Lanka Governor Dr. P. Nandalal Weerasinghe, other ministers, senior government officials as well as Parliamentarians, representatives from the private sector, civil society organizations, and development partners.