• Outcome of IMF Board’s second review is a positive development
• IMF’s seal of ‘good housekeeping’ also gives confidence all round
• Extent of economic stabilisation in mid-June 2024 is remarkable
• However, all is not well in paradise island economy of Sri Lanka
• Crisis extracted terrible human toll; 5 million below poverty line
• 6%+ growth needed to reduce Sri Lanka’s high poverty levels
• Central Bank Act being in place is a positive development
• Political risks could derail IMF EFF and recovery beyond 2024

The outcome of the International Monetary Fund (IMF) Executive Board’s second review of the Extended Fund Facility (EFF) with Sri Lanka is a positive development which provides another $ 336 million to help Sri Lanka to implement policies to continue to stabilise the crisis-hit economy and the IMF’s seal of ‘good housekeeping’ also gives confidence to citizens, local business, investors, trading partners and creditors that Sri Lanka has been serious about implementing the EFF, asserted Economist Dr. Ganeshan Wignaraja. 

Speaking to The Sunday Morning shortly after the IMF review and the release of the third tranche of the EFF, Dr. Wignaraja emphasised that the extent of economic stabilisation in mid-June 2024 compared to the dark economic days of 2022 was remarkable and attributed the turnaround to a combination of decisive stabilisation policies by the Wickremesinghe administration and the Central Bank of Sri Lanka (CBSL), implementation of the IMF’s EFF, Indian emergency aid, and financial and technical support from many development partners. 

However, he warned that all was not well on the economic front, especially given the “terrible human toll” extracted by the economic crisis. “Middle-income poverty (measured at a $ 3.65 a day poverty line) has doubled during the economic crisis to over 25% of the population. This means that a staggering five million Sri Lankans are living below the poverty line, mostly in urban areas,” he noted, also citing rising child malnutrition levels, given that families on low fixed incomes are struggling to make ends meet and switching to less nutritious diets.

He further pointed out that although growth was expected to be in positive territory, the IMF’s forecast was for tepid growth in Sri Lanka of 2% in 2024 and 2.7% in 2025 – “well below the 6%+ growth expected in South Asian high performers like India and Bangladesh and what is needed to reduce Sri Lanka’s high poverty levels”. 

Meanwhile, Dr. Wignaraja lauded the anchoring of Sri Lanka’s macroeconomic policies in clear frameworks backed by law, as identified in the IMF second review: “A positive development is that the Central Bank Act is in place, which enables Central Bank independence. This means that the CBSL’s objective rightly becomes price stability and it stops money printing to finance the Government’s fiscal deficits. However, the Public Financial Management and Public Debt Management Bills are outstanding items.”

He however warned that political risks could derail the IMF EFF and recovery beyond 2024: “Although short on details, both the NPP and the SJB say they want to renegotiate the IMF agreement, which is causing uncertainty about the post-election direction of Sri Lanka’s economic policy if either party can form a government.”

Highlighting that the country’s economy remained very fragile, Dr. Wignaraja emphasised that constant policy reversals and economic mismanagement in the past were the very causes of economic crises in Sri Lanka, with two episodes of so-called home-grown inward-looking policies being accompanied by disastrous economic results. 

“The time is not for experimentation but for consensus and continuity on the broad macroeconomic framework,” he added.

Following are excerpts of the interview:

What is your overall assessment of the IMF Board’s second review?

The outcome of the IMF Board’s second review of the IMF EFF with Sri Lanka is a positive development. It provides another $ 336 million to help Sri Lanka to implement policies to continue to stabilise the crisis-hit economy. 

The IMF’s seal of ‘good housekeeping’ also gives confidence to citizens, local business, investors, trading partners, and creditors that Sri Lanka has been serious about implementing the EFF. 

Indeed, the extent of economic stabilisation in mid-June 2024 compared to the dark economic days of 2022 is remarkable. Petrol queues have disappeared and there are ample supplies; although the overall price level is elevated, inflation is down to single digits; the exchange rate is broadly stable; foreign exchange reserves are up to $ 5.5 billion, enabling imports; and tourists are flocking to Sri Lanka. 

The turnaround is due to a combination of (i) decisive stabilisation policies by the Wickremesinghe administration and the CBSL, (ii) implementation of the IMF’s EFF, (iii) Indian emergency aid, and (iv) financial and technical support from many development partners. 

What has Sri Lanka yet to achieve under the programme and what are the areas it should prioritise, especially given the ongoing economic vulnerabilities?

Sadly, all is not well in our paradise island economy of Sri Lanka in 2024. The economic crisis has extracted a terrible human toll. Middle-income poverty (measured at a $ 3.65 a day poverty line) has doubled during the economic crisis to over 25% of the population. This means that a staggering five million Sri Lankans are living below the poverty line, mostly in urban areas. 

Furthermore, surveys indicate rising child malnutrition levels, with families on low fixed incomes struggling to make ends meet and switching to less nutritious diets. Issues of the new poor receive attention in the second review of the IMF EEF, which states that “all quantitative targets for end-December 2023 were met, except the indicative target on social spending”. 

Additionally, growth is expected to be in positive territory, but the IMF’s forecast is for tepid growth in Sri Lanka of 2% in 2024 and 2.7% in 2025. This is well below the 6%+ growth expected in South Asian high performers like India and Bangladesh and what is needed to reduce Sri Lanka’s high poverty levels. 

One of the outstanding areas identified in the IMF second review is the anchoring of Sri Lanka’s macroeconomic policies in clear frameworks backed by law. A positive development is that the Central Bank Act is in place, which enables Central Bank independence. This means that the CBSL’s objective rightly becomes price stability and it stops money printing to finance the Government’s fiscal deficits. 

However, the Public Financial Management and Public Debt Management Bills are outstanding items. These are crucial to bring discipline and transparency in public finances to avoid repeating macroeconomic crises in Sri Lanka, to address economically irrational foreign borrowing, and to help prevent future debt distress. 

It is also important that the Government’s time-bound plan to address rent-seeking and corruption vulnerabilities be implemented to ensure efficiency and attract badly needed domestic and foreign investment. 

Beyond this, Sri Lanka also needs a growth plan to make the import-dependent economy more outward-looking and business-friendly. This economic transformation is crucial to maximise the sources of foreign exchange and to build up foreign reserves from tourism, remittances, exports of goods and services, and Foreign Direct Investment (FDI). 

What kind of an economic environment do you foresee in the event Sri Lanka successfully completes this IMF programme, despite pending polls threatening to throw a spanner in the works?

Political risks could derail the IMF EFF and recovery beyond 2024 – Presidential Elections are due in late 2024 and Parliamentary Elections in 2025. 

A doubling of income poverty since the default and dissatisfaction with the United National Party/Sri Lanka Podujana Peramuna (UNP/SLPP) Government appears to be increasing support for the Left-wing populist National People’s Power (NPP) party and the Centre-Right Samagi Jana Balawegaya (SJB). Although short on details, both the NPP and the SJB say they want to renegotiate the IMF agreement, which is causing uncertainty about the post-election direction of Sri Lanka’s economic policy if either party can form a government.

Is there really any alternative to the IMF programme, despite the positions adopted by some – especially Opposition political parties – in this regard, given Sri Lanka’s history of decades-long economic mismanagement?

The economy remains very fragile. In the past, constant policy reversals and economic mismanagement have been the very causes of economic crises in Sri Lanka. Two episodes of so-called home-grown inward-looking policies have been accompanied by disastrous economic results. 

One was in 1970-1977, which resulted in very low investment, very low growth, and very high unemployment. The other episode is late-2019 to mid-2022, which resulted in the worst economic crisis in post-independent history with a sovereign debt default, a contracting economy, and a significant reversal in gains in poverty. 

Several elements of the IMF EFF are what Sri Lanka should be doing anyway, such as ensuring an independent Central Bank, fiscal consolidation, and better government. The time is not for experimentation but for consensus and continuity on the broad macroeconomic framework in Sri Lanka. This is a lesson that can be learnt from other countries such as those in East Asia and India that have come out successfully from major crises.

Sri Lanka’s economy is still vulnerable: IMF

Following are the opening remarks delivered by International Monetary Fund (IMF) Senior Mission Chief for Sri Lanka Peter Breuer at the press briefing on Sri Lanka

Yesterday (12), the IMF Executive Board completed the 2024 Article IV Consultation and Second Review under the 48-month Extended Fund Facility (EFF) with Sri Lanka, providing the country with immediate access to about $ 336 million to support its economic policies and reforms. This brings the total IMF financial support disbursed so far to about $ 1 billion. 

The programme continues to support Sri Lanka’s efforts to restore macroeconomic stability and debt sustainability, mitigate the economic impact on the poor and vulnerable, rebuild external buffers, safeguard financial sector stability, and strengthen governance and growth potential. 

The IMF Executive Board’s approval recognises the strong programme performance. All quantitative targets were met, except for the marginal shortfall of the indicative target on social spending. Most structural benchmarks were either met or implemented with delay. 

Reforms and policy adjustments are bearing fruit. The economy is starting to recover, inflation remains low, revenue collection is improving, and reserves continue to accumulate. Real GDP expanded by 3% (Y-o-Y) in the second half of 2023. May 2024 inflation was 0.9% and gross international reserves increased to $ 5.5 billion by end-April 2024. The primary balance improved to a surplus with tax revenue increasing to 9.8% of GDP in 2023.

Despite these positive developments, the economy is still vulnerable and the path to debt sustainability remains knife-edged. Important vulnerabilities associated with the ongoing debt restructuring, revenue mobilisation, reserve accumulation, and banks’ ability to support the recovery continue to cloud the outlook. 

The key to transitioning from stabilisation to a full recovery is sustaining the reform momentum amid strong ownership by the authorities and the Sri Lankan people more broadly. We encourage the authorities to continue to build on these hard-won gains and remain steadfast on their reform commitments.

To restore fiscal sustainability, sustaining revenue mobilisation efforts, promptly finalising the debt restructuring in line with programme targets, and protecting social and capital spending remain critical. Advancing public financial management will help enhance fiscal discipline and strengthening the debt management framework is also needed. 

Monetary policy should continue to prioritise price stability, supported by a sustained commitment to refrain from monetary financing and safeguard Central Bank independence. Continued exchange rate flexibility and gradually phasing out the balance of payments measures remain critical to rebuild external buffers and facilitate external rebalancing. Restoring bank capital adequacy and strengthening governance and oversight of State-owned banks are top priorities to revive credit growth and support economic recovery.

Sri Lanka has made substantive progress towards advancing debt restructuring to restore debt sustainability. A swift finalisation of the Memorandum of Understanding with the Official Creditor Committee and final agreements with the Export-Import Bank of China remains a priority. It is also important to complete the restructuring with external private creditors consistent with programme targets. IMF staff will continue to assist the authorities with creditor coordination in line with the IMF’s policies. 

We encourage the authorities to press ahead with structural reforms to unlock long-term growth potential. Steadfast implementation of the governance reforms would support the authorities’ broader reform agenda. Key priorities include further trade liberalisation to promote exports and Foreign Direct Investment; labour reforms to upgrade skills and increase female labour force participation; and State-Owned Enterprise reforms to improve efficiency and fiscal transparency, contain fiscal risks, and promote a level playing field for the private sector. 

We would like to thank the authorities for their commitment and look forward to our continued close engagement with the authorities as well as other stakeholders in Sri Lanka.