Macro Analysis /
Sri Lanka

Sri Lanka: IMF concludes staff level agreement

    Lakshini Fernando
    Asia Securities
    25 September 2019
    Published by

    The sixth review of the 4-year IMF Extended Fund Facility (EFF) concluded today, with a staff level agreement in place despite the Government falling short of the end June fiscal target, in-line with our expectations. Following this agreement, if approved by the IMF board, we expect the seventh tranche to be disbursed by November. The IMF also states that at this juncture, the previous targets set for end 2019 are no longer in reach, in-line with our views expressed earlier this year. Despite the shortfall in reaching the IMF targets, the government is still focused on achieving a primary surplus of 0.2% of GDP for 2019, against our expectations of a deficit. The IMF commended the Central Bank’s monetary policy and reserve agendas but, commented that recent short-term measures in the form of directives to banks and currency intervention should be curtailed. Looking ahead, the IMF states that the authorities remain committed to continue initiatives under the IMF EFF. However, in our view, this will primarily be determined by the outcome of the upcoming presidential elections.

    IMF reaches staff level agreement; fiscal consolidation derails

    The sixth review of the 4-year IMF Extended Fund Facility (EFF) concluded today, with a staff level agreement in place despite the Government falling short of the end June fiscal target, in-line with our expectations. Following this agreement, if approved by the IMF board, we expect the next tranche to be disbursed by November.

    According to the IMF, the June targets were missed by a large margin owing to a sharp fall in revenue collections and high government spending as a result of repaying areas in capital projects, especially construction related projects. Government revenue was ~5.7% of GDP (~4.9% in 5M 2019, 6.4% in 1H 2018) in June 2019, down 4.1% YoY, while tax revenue was down 4.0% YoY. Overall expenditure was up 10.9% YoY in 1H 2019, amounting to ~9.1% of GDP (compared with ~7.7% in 5M 2019, 8.8% of GDP for 1H 2018). In our view, government expenditure will continue to increase given the implementation of the LKR 2,500/employee public sector wage hike in July.

    Revenue measures to be implemented by govt; we remain cautious

    The IMF also states that at this juncture, the previous targets set for end 2019 are no longer in reach, in-line with our views expressed earlier this year. Despite the shortfall in reaching the IMF targets, the government is still focused on achieving a primary surplus of 0.2% of GDP for 2019, mainly through the implementation of revenue measures mentioned in the 2019 budget and prudent expenditure management. These revenue measures are mainly those which are yet to be implemented from the Inland Revenue Act passed in April 2018. However, in our view, these are not likely to be passed during the remainder of this year given the run-up to the Presidential elections which are to be held on the 16th of November.

    CB initiatives commended but recent directives a concern for the IMF

    One of the key positives supported by the IMF was the Central Bank’s proactiveness in terms of data driven monetary policy management through an inflation targeting regime. The continued commitment to strengthen foreign reserves amidst a high debt repayment environment was also commended by the IMF. By August 2019, reserves stood at USD 8.5bn, covering ~5.0 months of imports.

    However, recent directives like 1) the interest rate caps on lending by banks, 2) debt service moratoriums and 3) intervention in currency markets were highlighted as key areas where the Central Bank should curtail intervention. The IMF emphasized the importance of sustaining prudent policies and implementing institutional reforms to maintain economic stability.

    Govt remains committed to initiatives; we expect this to be determined by elections

    Looking ahead, the IMF states that the authorities remain committed to continue the following initiatives 1) fiscal based consolidation in 2020, 2) in the medium term to reduce public debt through the gains achieved through higher revenue generation, 3) to revamp fiscal rules and establish an independent public debt management agency over the medium term, 4) improving financial performance of Sri Lankan airlines and 5) advancing energy sector reforms.

    In our view, these policies, especially fiscal consolidation efforts will be determined by the outcome of the upcoming presidential elections. While we expect this to continue in the event of a United National Party Government, we expect a higher level of government expenditure in the form of investments and subsidies in the event of a victory by the Sri Lanka Podujana Peramuna. We do not expect any concrete steps to be taken in terms of energy sector reforms in the near term given that this may not be a high priority for a newly elected government.