The current IMF-EFF arrangement spans 48 months with the total disbursement amounting to SDR 2.286 billion (about US$ 3 billion) to be utilised for budget support for the Government.
However, the proceeds under the EFF would also help cushion the BOP bysupplementing the Gross Official Reserves (GOR). The disbursement will be equally divided into nine tranches subject to semi-annual reviews and subsequent Executive Board approvals.
The first tranche was received in March 2023 immediately following Board approval. The program aims at restoring macroeconomic stability at large.
This overall economic stability is designed to be achieved through building strong pillars on critical areas of restoring debt sustainability, advancing revenue based fiscal consolidation, restoring price stability and building external buffers, ensuring financial stability, reducingcorruption vulnerabilities, and raising potential growth.
Prior Actions and Structural Benchmarks
Since the commencement of negotiations for the IMF-EFF arrangement in early 2022, Sri Lanka has completed nine prior actions by March 2023 and has formulated a mechanism for meeting the structural benchmarks.
The completion of these prior actions was instrumental in paving the way for broader reforms to be implemented in the next four years under the EFF.
The prior actions that have been already completed by Sri Lanka include, obtaining Cabinet approval for revenue measures to support fiscal consolidation during 2023 in line with program parametres, obtaining Parliamentary approval for a revised 2022 budget, submission of the 2023 Appropriation Bill to the Parliament, obtaining Cabinet approval to automate monthly retail fuel price adjustment, to automate semi-annual cost-recovery based electricity price adjustment, Cabinet approval of the new Central Bank Act, Cabinet approval for the amendments to the Banking Act, strengthening key elements of the Central Bank’s crisis management powers, hiring an independent firm to conduct banking sector diagnostic exercise, and increasing policy interest rates by 100 basis points to ensure forward looking real policy interest rates are on a firm upward path.
In addition to the above, three important upfront measures were also implemented which include Parliamentary approval of the 2023 budget that was in line with program parametres, Parliamentary approval of necessary legislative revisions to implement the 2023 revenue measures, and updating the Emergency Liquidity Assistance framework for banks.
Further, Sri Lanka is required to implement several structural benchmarks related to fiscal matters, State Owned Enterprises (SOEs), social safety net reforms, and monetary and exchange rate policies and reforms related to fiscal sector and governance in the period ahead.
Monitoring of Program Progress
Performance of the EFF arrangement will be monitored in terms of a comprehensive mechanism that comprises Quantitative Performance Criteria (QPCs), Continuous Performance Criteria (CPC) related to external arrears and Article VIII obligations, Indicative Targets (ITs), and the monetary policy consultation clause.
The QPCs that Sri Lanka is expected to achieve are the requirement to generate a primary surplus in the Government’s budget, improve the gross official reserve levels by building net international reserves, and gradually phase out Net Credit to the Government by the Central Bank.
A monetary policy consultation clause (MPCC) has also been included to monitor year-on-year inflation onspecified target dates to ensure that Sri Lanka is moving on a steady disinflation path to reach the targeted level to restore price stability. Further, ITs have been specified mainly on central government tax revenue social safety net spending, cost of non-commercial obligations for fuel and electricity as well as on treasury guarantees.
In order to ensure the achievement of objectives envisaged in attaining debt sustainability, the progress on the debt restructuring will be assessed at each program review, with a view to completing debt restructuring within a reasonable time frame.
The program is expected to trigger additional financing assistance with budget support from the World Bank and the Asian Development Bank of US$ 3.75 billion, of which US$ 900 millionis expected in 2023.
It is also expected that with the recovery in the economy and build up of buffers, Sri Lanka would be able to access international markets to raise funds in terms of sovereign bond issues in 2027. These resources, together with external public debt service relief, will close the external financing gap and allow Sri Lanka to rebuild gross international reserves. Some of the key expected outcomes of the IMF-EFF arrangement are as follows:
Achieving debt sustainability
To achieve debt sustainability, Sri Lanka needs to achieve specific debt financing and debt servicing related targets. Further, the debt restructuring process will be guided by quantitative targets developed under the IMF Sovereign Risk and Debt Sustainability Framework (SRDSF) in order to ensure debt reduction, manage rollover risks, avoid a renewed buildup of external pressures from debt service needs, and ensure that financing gaps during the program period are closed.
Meeting these requirements would ensure Sri Lanka’s public debt returning to sustainable levels in the eyes of creditors and the international community, thus easing difficulties and risk premia attached to Sri Lanka’s future borrowings.
The debt sustainability targets as per the Debt Sustainability Analysis (DSA) carried out by the IMF that needs to be achieved by Sri Lanka through the debt restructuring process are as follows: – Debt stock: Public debt to decline below 95 per cent of GDP by 2032.
* Post-program gross financing needs: Average annual gross financing needs of the central Government in 2027-2032 to remain below 13
per cent of GDP. – Post-program forex debt service: Annual forex debt service of the central government to remain below 4.5 percent of GDP in each year over 2027-2032.
* Program financing gaps: Debt service reduction during 2023-2027 to be sufficient to close external financing gaps.
* Improved fiscal performance and discipline:
It is expected that the Government will persist with its fiscal consolidation efforts to meet the fiscal targets through revenue enhancement measures and rationalisation of expenditure further. In the meantime, unwarranted leakages from the fiscal revenue are addressed through the envisaged broad-based program for SOEs.
* Legislative changes for enhanced governance and accountability framework: New pieces of legislation, such as the Central Bank Act, Banking Act, and other revisions to existing legislations are expected to strengthen the institutional and regulatory framework relating to the economic management of the country. A new anti-corruption law is to be introduced harmonising the United Nations Convention against Corruption, the first such law in South Asia, providing for the creation of an independent Anti-Corruption Commission.
Reforming social safety nets
Despite an increase in social safety nets related spending and beneficiaries in recent years, it has been identified that there is significant scope for improvement regarding the coverage and selection.
Considering the issues prevailing in the existing social safety nets framework, the IMF-EFF arrangement has specified certain institutional reforms to improve efficiency, coverage, and targeting of social safety net program.
Restoring price stability
The Central Bank is expected to restore price stability by driving inflation in a steady disinflation path to bring it back to the targeted range under the Flexible Inflation Targeting (FIT) framework through appropriate monetary policy actions.
As a part of this process, monetary financing to the Government is expected to be phased out. Strengthening financial institutions and financial system stability:
The IMF is of the view that Sri Lanka’s financial system is heavily exposed to the public sector, moderately capitalised, and could face material capital and forex shortfalls following a debt restructuring. Consequently, there is a possibility that banks could face significant capital and forex shortfalls as a result of a sovereign debt restructuring.
Therefore, plans are under way for the capital restoration of systemic banks following asset quality reviews to strengthen the resilience of the state owned banks.
In addition to these specific benefits, the IMF supported program would bring several positive spill overs to the economy through improved investor confidence, possible sovereign rating upgrades, and reopening of access to markets, among others.
Also, in view of the maintenance of political and social stability during the program period, especially considering the possible initial unpopularity of the reform measures and consequent public dissent, public awareness of how initial sacrifices would lead to long term economic benefits needs to be created.
The success of the IMF-EFF arrangement will largely rest on the extent to which the long neglected structural reforms are implemented. The structural reforms are anticipated to boost the competitiveness of the economy, provide a foundation for productivity enhancement, increase the efficiency in resource utilisation, and thereby enhance the growth potential.
The severity of the current economic crisis faced by Sri Lanka highlights the importance of addressing the longstanding structural issues in a sustainable manner beyond the reforms agenda in the IMF program through national policies formulated in consultation with stakeholders and free from political influences with vested interests.
The reforms agenda should focus on improving the productivity and output of the economy through technological innovations and increased economic connectivity to the world over trade and investment, by enhancing diversity in merchandise exports and potential services export sectors including tourism, IT/ BPO sectors, and attracting FDI.
It is also necessary to strengthen legal frameworks to ensure public accountability of state institutions, exercising available legal powers in policy formulation and implementation by relevant authorities to ensure lasting economic welfare in the country. These would complement the reforms agenda in the IMF-EFF arrangement to ensure that Sri Lanka attains and sustains macroeconomic stability in the earliest possible time frame. Despite being part of 16 programs since the first been successfully implemented by authorities.
This has been mainly due to the lack of commitment to meeting the conditionalities attached to such programs, especially those related to structural reforms, which required painful macroeconomic adjustments and unpopular policies.
Therefore, it is imperative that Sri Lanka internalises these reforms in its policy formulation and implements the major areas of reforms in the current IMF program as well as reforms beyond the program to help the economy transform into greater stability and a higher growth path at the earliest while circumventing the need for repeated access to IMF bailouts and rounds of debt restructuring in the future.
