IMF Staff level agreement likely by July/August; Govt expenditure plans a crucial factor
The IMF team have completed a week in Sri Lanka, with discussions ongoing until the 30th of June. This follows the virtual meeting which took place from May 9th – 24th. Our discussions with those involved with the process indicate that the key focus has been on the Government’s fiscal consolidation plans, particularly to curb expenditure.
While the recent tax increases, especially the increase of VAT to 12.00% from 8.00% previously will help cash flow to some extent, our calculations indicate that total revenue from the already announced tax hikes will bring in lower revenue of approx. LKR 250bn compared with LKR 300 – 320bn expected in 2023.
While the debt restructuring process is ongoing, we expect further measures focusing on structural reforms, particularly on under-utilised/loss-making State-Owned Enterprises (SoEs) to be announced in the near term. While we acknowledge that such policy reforms are more medium-term plans, we believe an agenda with realistic timelines to implement much needed structural changes will be a key pre-requisite for a Staff level agreement (SLA).
In our view, to reach a primary surplus by 2025, the Government would need to ease fiscal pressure from SoEs through Public Private Partnerships or outright sales at this point. We also note that curbing recurrent expenditure either through interest expenses or state sector salaries/pensions would also be a focus point to reaching a sustainable fiscal position in the near-medium term. Our preliminary calculations indicate that the roll-over of Government securities look to cost the Central Bank approx. LKR 340bn, with the estimated fiscal gap at LKR 2.6tn for 2022.
At this point, we factor in the below policy changes for an SLA in the coming weeks;
Outline of SoE reform for structural changes and reduce pressure on the Government’s balance sheet
Measures to reduce recurrent expenditure including lower pressure from public sector wage bill
Potential Public Private Partnership (PPP) arrangements
70% increase in electricity prices. While we note that for the CEB to breakeven, prices must be increased 3x, this is likely to be done in a gradual process given the impact on the consumer
In-line with our view, fuel prices were increased by LKR 50.00/ltr – 60.00/ltr over the weekend. In addition, as announced by the Prime Minister, we factor in further tax reforms to be announced in August along with the interim budget for 2022.
Despite comments of a probable SLA by end June, our view is that a more realistic timeline for this is likely to be July/August, as indicated in our previous reports. This is mainly due to 1) the need to evaluate GoSL’s Debt Sustainability Analysis (DSA) by the IMF and 2) better understanding on the progress of debt restructuring talks with creditors. While we acknowledge that a complete restructuring is not required for an SLA, we believe preliminary talks are likely a requirement.
We factor in disbursements of funds through a program to materialise towards year end/early 2023 given that progress on the debt restructuring discussions is key to any disbursements.
All eyes on China as restructuring talks are yet to commence
While we note that the team of financial advisors are on-ground, our discussions indicate that talks with creditors are yet to commence. With most bilateral lenders and ISB holders having factored in a potential default by GoSL earlier on, we expect China’s stance on restructuring its debt to be the main focus. While China accounts for approx. 10.0% of Sri Lanka’s total debt, the preference from Chinese authorities have been towards refinancing rather than restructuring. China’s stance will be keenly looked at not only by ISB creditors, but also by other countries with heavy Chinese debt facing potential restructuring.
This was evident with the refinancing line offered to repay China’s upcoming debt following potential restructuring talks held earlier in March this year. A key factor for China would be its stance on other bilateral debt for countries currently facing potential default if authorities agree for a restructure for Sri Lanka’s debt. We also expect other creditors to take a wait and see approach until China’s stance is clearer.
As of end December 2021, Sri Lanka’s total external non-concessional loans amounted to LKR 3.4tn (approx. USD 9.5bn) with total commercial loans amounting to LKR 2.9tn (approx. USD 8.0bn).
Near-term essential food and fuel supply key concern; we factor in a steep impact on overall growth
While the government is in crucial talks with India, US and other bilateral lenders to seek bridging finance for essential food and fuel imports, we note that nothing has ben finalised yet. With approx. USD 4.0bn already extended through the Indian credit line so far this year, our discussions indicate that a further extension has not been finalised yet. The Central Bank has also requested for a USD 1.5bn funding line from India, which we note that a Staff level agreement is crucial for the finalisation of discussions.
Given that Sri Lanka requires USD 5.0bn in funding to supply essential imports like fuel, cooking gas and fertiliser for the next 6 months, we see further shortages in the coming months. However, steps to allow private entities to import fuel is a positive at this point.