The burning issue of the upcoming Presidential Election has been the economy and how the different candidates plan to grow the economy in the next five years.
In order to do that, however, all should stay within the Extended Fund Facility (EFF) of the International Monetary Fund (IMF), since any deviation from the programme would be impossible due to the debt restructuring process not being complete.
However, talks of changing the Debt Sustainability Analysis (DSA) of the IMF have taken centre stage as everyone appears uncertain whether such change can take place and what the repercussions may be.
According to the DSA, Sri Lanka has agreed to keep the budget’s primary surplus at 2.3% of Gross Domestic Product (GDP) by 2025, the borrowing requirement at 13%, the public debt at 95% of GDP, and foreign debt serving at 4.5% of GDP between 2027 and 2032.
NPP claims IMF DSA outdated
The National People’s Power (NPP) economic policy states that an NPP government will renegotiate the existing IMF programme and debt restructuring to minimise the austerity measure imposed on people by demonstrating alternative means of revenue increase, fiscal consolidation, and foreign reserve building.
The NPP has said that it will expedite the external debt restructuring process by presenting a comprehensive alternate DSA and economic revival programme to external creditors and the IMF.
Speaking at the launch of the NPP economic policy on Tuesday (3), NPP Economic Council member Dr. Harshana Suriyapperuma said that Macro-Linked Bonds (MLBs) proposed by the bondholder group was not the right way forward as argued by many economists, because the IMF growth target for 2027 was 3.1% whereas the Ceylon Chamber of Commerce (CCC) was projecting a 6.5% growth for Sri Lanka by that year.
“We can see why MLBs will not provide the best benefits for Sri Lankan businesses and its citizens,” Dr. Suriyapperuma said, adding that they therefore needed to look at an alternative path to create macroeconomic stability.
He further said that in order to achieve macroeconomic stability, the NPP had a three-pronged approach which included short-term, medium-term, and long-term measures to ensure the maintenance of much-needed relief for people to ensure social stability.
Dr. Suriyapperuma added that the alternative DSA formulated by the NPP was very important as it would provide the basis for discussion, given that the underlying assumptions that had been made at the time of design had changed.
“Therefore, we need to have a new DSA to continue our negotiations in good faith in order to obtain the best outcome for Sri Lankan people and businesses,” he added.
Responding to a question by The Sunday Morning, he confirmed their belief in the feasibility of the CCC’s projected GDP growth of 6.5%, significantly ahead of existing projections considered in the DSA.
Will NPP stay within IMF parameters?
Speaking at the launch of the economic policy, NPP presidential candidate Anura Kumara Dissanayake said that the conditions of the IMF were not unfavourable to the country and that an NPP government would uphold the current agreement with the IMF.
“All the international relations of the country, including the bilateral and multilateral agreements, have now been placed inside the IMF basket. This means that the entire future programme of the country is tied up with the IMF,” he said.
Moreover, Dissanayake said that if anyone was pondering a unilateral withdrawal from the IMF programme at present, it was an abdication of accountability to the citizens of the country. Therefore, he said that they guaranteed that they had no intention of unilaterally withdrawing from the IMF.
“However, we have a number of parameters set by the IMF that we have to fulfil. We should maintain a primary account balance of 2.3% of GDP next year. By 2032, our debt ratio should be maintained at 98%. These parameters are not harmful to the country. Achieving them is not a bad thing. It’s not a bad economic goal, no matter who gives it,” he added.
He noted that an NPP government would engage in discussions and negotiations to reconcile IMF and NPP targets within the parameters and framework of the IMF programme.
IMF is ready to talk on DSA change
NPP Economic Council member Chathuranga Abeysinghe took to social media to explain how they would renegotiate the DSA with the IMF.
He said that when the economic crisis occurred in 2022, there had been no discussion between the Government, the people of the country, or the country’s industries, and that therefore, the IMF had issued them a standard developing economy DSA.
He added that since the country’s rulers had no programme to develop the country, they had been compelled to ask the IMF how Sri Lanka should develop in future, which resulted in the IMF making a prediction based on many assumptions.
The IMF projections include nominal GDP growth of 8.5% by 2027, real growth of 3.1% by 2027, inflation to be 5.2% by 2027, a primary account surplus of 2.3% by 2025, and goods exports at $ 16.3 billion and services exports at $ 8 billion by 2029.
Abeysinghe further said that the NPP had a plan for the country, according to which the growth forecast would change between 5-6%, resulting in a change in all aforementioned percentages. The NPP’s export expectation is $ 45 billion by 2030, which is a little below the targets of industrialists.
“The basis of these IMF forecasts will inevitably change and we can work with them to create an economic environment suitable for the people and industries,” he said.
Abeysinghe added that the NPP had discussed changing the DSA with the IMF thrice, adding that they were prepared to sit at the same table with the fund.
Debt talks based on IMF DSA
Speaking at the launch of the Samagi Jana Balawegaya (SJB) economic policy statement, SJB MP Dr. Harsha de Silva said the Steering Committee of the Ad Hoc Group of Bondholders had filed an amicus brief in the Southern District Court of New York to push the Government to launch the restructuring by 15 September, which demonstrated the complexity of the transaction.
He said that the Government had reached an agreement with the Official Creditor Committee (OCC) but had not signed the agreement, which had several clawback clauses.
He also said that the Government had agreed to the bondholders’ proposal following multiple discussions, which set out a nominal haircut of 28%, but noted that by 2028, depending on Sri Lanka’s progress measured in terms of US Dollar GDP, the haircut would fall to 15%.
“The IMF has to now agree that the two agreements are within the accepted DSA. Furthermore, the OCC must agree that the bondholders’ agreement is within the comparability of treatment framework,” he said.
Moreover, he added that thus far, multiple stay orders had been obtained in the aforementioned District Court, and subsequently, a decision on the Hamilton Reserve Bank case could be withheld until the Government reached an agreement with the creditors.
“These are all based on the DSA which has been agreed upon between the Government and the IMF, which will then lead to negotiations with the creditors,” he added.
DSA cannot change, IMF prog. has limits to negotiate
Dr. de Silva said that although some believed the DSA was outdated as it had been agreed upon in 2022, this was not the case.
He noted that the DSA was updated each time the Staff-Level Agreement (SLA) was signed, but observed that those updates had thus far not significantly changed the parameters of debt-to-GDP, gross finance limits, the amount of foreign debt Sri Lanka could go into year-on-year, and the gap that needed to be closed by the restructure.
“Our competitors’ economic plan notes that they can change the DSA because the CCC has said that Sri Lanka’s GDP growth could be 6.5% as opposed to the 3.1% forecast by the IMF. If the IMF agrees to the chamber’s assessment that we can create a 6.5% GDP, so be it,” he said.
He however added that the IMF was unlikely to accept the CCC’s assessment and disrupt the base document on which Sri Lanka’s entire IMF programme was structured, since it would be dangerous and irresponsible.
“What if the Hamilton Reserve Bank verdict comes through during the so-called renegotiation based on an alternate DSA?” he questioned, adding that there were certain limits within which Sri Lanka could negotiate this agreement with the IMF and creditors.
Any entity can have its DSA, but will IMF accept?
Speaking to The Sunday Morning, Frontier Research Senior Macroeconomist Thilina Panduwawala said that any entity could devise its own DSA, but the question remained as to what DSA the IMF would adopt at its next review.
He said that the IMF also updated its DSA as things evolved, adding that the DSA was based on assumptions that had been made about the future, such as primary surplus and growth, which both the IMF and Government considered feasible.
“The DSA is usually produced as a result of a compromise between the IMF team and the government team in terms of the assumptions they make for the next few years. The debt-to-GDP percentage is determined based on that,” he said.
He added that at the next review or even under a new government, a negotiation would have to take place regarding the assumptions both sides agreed on.
However, he said that the issue remained that there was a significant difference between what the IMF and Government considered feasible, which could lead to conflict in terms of reconciling those assumptions.
Panduwawala noted that the Government itself could have its own debt analysis through the Central Bank and the new Public Debt Management Office established under the Public Debt Management Act No.33 of 2024. “An entity having its own DSA is not a problem; the problem happens with the assumptions those entities bring before the next review,” he said.
IMF uses a standard model to forecast targets
Panduwawala said the IMF staff themselves used particular macroeconomic models to make certain forecasts, such as the current accounts surplus and its impact on the exchange rate. Therefore, he said that someone who was not using the same model could then outline their own prediction, while the IMF model may have a different forecast.
“This then becomes a problem as it can be a source of conflict,” he said, adding that the IMF used certain models because, ultimately, the fund also had to use something that was standardised across different countries in order to avoid haphazard application.
Will debt relief reduce if growth is increased?
Commenting on whether creditors might consider Sri Lanka as a country with a high debt-carrying capacity due to a higher growth forecast similar to what the NPP was trying to account for, Panduwawala said that if Sri Lanka had a higher growth forecast, its debt-to-GDP ratio could fall.
He explained that the DSA had a number of assumptions and if the GDP growth increased, theoretically, the debt-to-GDP ratio should fall because the denominator value would have increased.
“However, you should then also question how growth is being boosted to 6%; is it through the government borrowing more and spending, or by running a higher current account deficit? These will affect the assumptions made on the future path,” he said.
Panduwawala added that the issue with any macroeconomic assumptions was that when one assumption was changed, one would have to consider how other assumptions were affected as well. Therefore, he said that if one was considering changing the growth target to 6%, they would also have to determine the other assumptions to be factored in in order to achieve that growth.
Panduwawala added that unless in a country such as Guyana, which had recently discovered oil and could say there was a new factor due to which they could now assume higher growth, it was difficult to convince the IMF on those targets.
Further, he said that the prolonged process of debt restructuring once the DSA was changed depended on where the things had ended before the proposed change, as debt restructuring was yet to be finalised.
DSA cannot be changed: Finance Min.
Issuing a statement, the Finance Ministry said that Sri Lanka’s current economic reform programme supported by the IMF was the first time that debt restructuring comprised a major pillar of an IMF-supported reform programme undertaken by Sri Lanka.
Therefore, it said that this programme was fundamentally different to Sri Lanka’s past engagements with the IMF. In the context of debt restructuring, amendments to key programme parameters become far more complicated.
The ministry said that the IMF’s rules did not allow it to lend to countries that were deemed to have unsustainable debt. Therefore, Sri Lanka commenced the process of restructuring its debt in parallel with negotiating the macroeconomic reform programme with the IMF.
Accordingly, Sri Lanka has committed to ensuring that all restructuring agreements that it enters into with various creditors will enable public debt sustainability to be restored as assessed by the IMF.
The ministry further said that Sri Lanka’s debt sustainability was assessed in the context of the IMF’s Market Access Countries’ Sovereign Risk and Debt Sustainability Framework (MAC SRDSF).
The MAC SRDSF methodology is publicly available. This framework is developed by the IMF and is applied to all middle-income economies undergoing debt restructuring.
Near-term outcomes are determined by a multivariate logit model that takes into account the historic macroeconomic data of the country and applies stress and mitigating factors. Meanwhile, the medium-term outcomes are determined by a probabilistic fan chart considering debt and gross financing needs. Long-term outcomes build in further specific vulnerabilities to increase granularity.
“All of this goes to show that the parameters of the MAC SRDSF model are not open for negotiation. While the macroeconomic projections used in the model are informed by consultations with the Sri Lankan authorities, the outcomes are largely mechanical in nature,” the Finance Ministry said.
Further, the statement said that the projections of the model were updated regularly, particularly at the IMF programme reviews that took place every six months.
It said that the debt restructuring targets in particular, once designed, become stable parameters and could not be changed unless there was evidence of a significant change in circumstances that made the targets unviable.
The debt targets are based on sleeper parameters of the country’s debt-carrying capacity and do not change based on changes to the macroeconomic framework, including the fiscal stance.
Tax measures introduced by different camps
In order to achieve the targets set by the DSA, the authorities used taxation as a means of getting to the shorter and medium-term targets. Accordingly, all tax changes thus far have been implemented within the programme parameters in order to achieve these targets.
As such, even in future, tax changes have to take place within these targets until the DSA targets are achieved.
NPP tax relief
In its economic policy, the NPP hopes to provide tax rebates or zero-rated tariffs on selected imported inputs and capital goods used, including Temporary Import for Export Processing (TIEP) in selected local production processes, promoting both export competitiveness and stimulating domestic production and market accessibility.
The party also intends to increase the monthly Personal Income Tax (PIT) exemption limit to Rs. 200,000 from the current Rs. 100,000. Further, it plans to introduce incentives including offering a 120% deductible tax allowance for capital investments in selected sectors, aimed at accelerating production and service capabilities.
It will also implement a zero-tariff policy for exports whilst intra-port trade will be promoted with an efficient service model and tax and tariff relief provided for re-exporters with value-addition.
SJB tax relief
Through its economic plan, the SJB anticipates moving the marginal tax rate of PIT from 1% to 24% between Rs. 100,000 to Rs. 500,000 and to revert to the marginal tax rate brackets going up to 36% beyond that.
The SJB also expects to maintain Corporate Income Tax (CIT) at its current rates, but will incentivise the tradeable sector by providing a CIT incentive to exporters. Further, under an SJB government, the Value-Added Tax (VAT) will remain at 18%, while it will be brought down to 15% for selected items at the beginning and 0% for certain essential items.
The party also intends to retain the Simplified VAT (SVAT) for exporters until there is a better means of dealing with it. The SJB will relook at the Withholding Tax (WHT) to increase it to 10% from the current 5% in order to collect tax from individuals evading tax and under-reporting income.
An SJB government will also look to index the excise tax to a formula that reflects the taxes paid as prices increase.
Govt. tax relief
Speaking at the economic policy debate organised by the CCC last month, State Minister of Finance Shehan Semasinghe said that all tax-related announcements made during President Ranil Wickremesinghe’s campaign were based on the 2.3% primary balance target.
He noted that the PIT revision announced by the President was something the authorities had been discussing with the IMF since September 2023. “We initiated discussions in 2023 because we also understand the economy is growing and we need to give a substantial share of that growth back to the public,” he said.
Explaining the proposed revision, Semasinghe said that the tax-free threshold of PIT would remain at Rs. 1.2 million per annum while the tax bands would increase from Rs. 500,000 to Rs. 720,000 and the marginal tax rate at each band would remain at 6%, with the highest tax rate at 36%.
“The expectation of this relief is targeted at the mid-level,” he said.
For example, he said that a person with a monthly income of Rs. 200,000 would receive a relief of 20% and a person with a monthly income of Rs. 300,000 would receive a 25% relief, while anyone earning Rs. 400,000 per month would have a 23% reduction.
“This will cost around 0.07% of GDP and we will have compensating (revenue) measures, but we will ensure that there will be no further burden on the masses,” Semasinghe said.
Speaking in Parliament on Wednesday (4), State Minister of Finance Ranjith Siyambalapitiya said that the tax relief announced by the NPP – the PIT relief and the VAT removals – would cause a loss of Rs. 200 billion annually to the Treasury.
He said that it would cost an average of Rs. 1.5 trillion annually to increase the expenditure on health and education as proposed by the NPP.