## cr18175 ## Source details **Canonical URL:** [cr18175](https://www.imf.org/-/media/files/publications/cr/2018/cr18175.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18175.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18175.pdf.json) --- ### Context and program framework - Sri Lanka requested a 3-year EFF arrangement in June 2016 to respond to a difficult external environment and unbalanced macroeconomic policies. - First phase milestones: new Inland Revenue Act, progress with SOE and energy-pricing reforms, and adoption of the CBSL’s Roadmap to flexible inflation targeting. - Program priorities: - (i) promote fiscal consolidation through revenue mobilization, more robust fiscal rules, and SOE reforms; - (ii) modernize monetary and exchange rate frameworks to rebuild buffers; - (iii) accelerate structural reforms for sustainable and inclusive growth. - Political timeline and risks: increased political uncertainty after February 2018 local elections and two cabinet reshuffles; presidential and parliamentary elections scheduled for late 2019 and 2020. ### Recent macroeconomic developments - Growth and output: - Real GDP growth slowed to 3.1 percent in 2017. - Negative output gap of 0.3 percent in 2017. - Industry grew by about 4 percent in 2017; services and agriculture began to normalize in 2017Q4. - Prices and inflation: - Headline Colombo CPI inflation peaked at 7.8 percent (y/y) in October 2017; declined to 3.8 percent in April 2018. - Core inflation was 3.5 percent in April 2018. - External sector and capital flows: - Current account deficit widened to 2.6 percent of GDP in 2017 from 2.2 percent in 2016. - Exports of goods grew at 10 percent in 2017. - Portfolio inflows rose by 79 percent (y/y) in 2017; FDI rose by 97 percent (y/y) in 2017. - Gross international reserves increased from $7.3 billion at end-2015 to $8.0 billion at end-2017; reserves at 3.6 months of imports and 69 percent of the ARA metric. - The rupee depreciated around 3 percent as of mid-May 2018. - Credit, real estate, and rates: - Credit growth decelerated to 14.7 percent (y/y) in December 2017 from a 28.5 percent peak in July 2016. - Credit to construction grew around 22.5 percent in 2017. - Land prices in Colombo appreciated by 10.4 percent (y/y) in December 2017. - Real lending rates were above 5 percent for most of 2017 and increased to about 7 percent in February 2018. ### Outlook and risks - Short-run projection: - Real GDP growth expected to rise to 4 percent in 2018; consumption expected to contribute positively, offsetting a fiscal consolidation impulse of 0.3 percent of GDP. - Medium-term projection: - Growth expected to rise to about 5 percent, with TFP growth reaching 2 percent. - Inflation projection: - Projected to decline below 5 percent—the mid-point of the CBSL target—by end-2018. - Balance of risks (tilted to the downside): - Domestic risks: implementation delays in fiscal reforms, new weather calamities, reacceleration of credit growth particularly in real estate. - External risks: tighter global financial liquidity and reversal of portfolio inflows; weaker advanced-economy growth or a slowdown in China. - Upside: stronger external demand and FDI inflows. - External position metrics: - EBA-based current account gap for 2017 estimated at -0.5 percent of GDP. - CA gap estimates suggest a small REER overvaluation of 3 percent; EBA-lite REER model suggests 14 percent. - External debt sustainable but currency and rollover risks are high given low reserve coverage and structural rigidities. ### Fiscal consolidation, revenues, and public debt - 2017 fiscal outturns: - Primary balance reached a small surplus in 2017 (from a deficit of 2.2 percent of GDP in 2015). - Improvement driven by lower current non-interest expenditure (1.7 percentage points) and higher revenues (0.5 percentage points). - Overall fiscal deficit of 5.5 percent of GDP in 2017. - Gross public debt was 84.6 percent of GDP in 2017. - Disaster-related spending of 0.4 percent of GDP accommodated via budget realignment. - Tax policy and administration: - New Inland Revenue Act (IRA) enacted October 2017 and implemented April 2018; expected to boost income tax collections by ½ percent of GDP via rationalization of tax exemptions. - 2016 VAT amendments raised the VAT rate from 11 percent to 15 percent and broadened the VAT base. - Implementation of risk-based VAT administration, roll-out of RAMIS, and introduction of spending commitment controls. - 2018 budget: - Targets a primary surplus of 1 percent of GDP. - IRA and additional measures expected to deliver 0.9 percent of GDP in revenue. - Reduction of import duties on gasoline and diesel in December 2017 expected to lower revenue by ¼ percent of GDP in 2018; shortfall to be met by reprioritizing capital spending unless revenue outturn is stronger. - Debt outlook and risks: - Gross public debt projected at 83.7 percent of GDP in 2018. - Sizable gross financing needs of around 18.6 percent of GDP in 2018 and international bond redemptions in 2019-22. - Under sustained fiscal efforts to reach an overall deficit of 3.5 percent of GDP by 2020, debt ratio expected to fall to 80 percent of GDP by 2020 and to 73 percent by 2023 under unchanged policies. - Contingent liabilities from SOEs estimated at about 11 percent of GDP in 2017. - Near-term fiscal strategy: - Authorities committed to a primary surplus of 2 percent of GDP in 2019. - Meeting 2019 primary balance target requires additional measures of about 1 percent of GDP. - Staff recommendation: focus on domestic revenue mobilization; suggested options include removing remaining VAT exemptions, expanding labor income tax withholding, and raising excise rates for fuel. - Strengthening tax compliance recommended to create space for para-tariff rationalization. ### Public investment management and PFM reforms - PIMA findings: scope to enhance public investment efficiency by: - upgrading the medium-term expenditure framework with binding multi-year spending ceilings; - introducing systematic project appraisal and selection; - strengthening commitment-based spending controls by fully rolling out ITMIS. - ITMIS and commitment control: - CIGAS modified to impose quarterly commitment ceilings (Jan-18 structural benchmark met). - Full ITMIS roll-out expected by September 2019; staggered implementation underway. - Potential reallocation uses from efficiency gains: - expand coverage of social safety nets; - accommodate gender and contingency budgeting for natural disasters; - improve public healthcare to reduce out-of-pocket costs. - Fiscal rule and consolidation paths: - Authorities plan to upgrade the Fiscal Management (Responsibility) Act (FMA); staff recommended a more ambitious consolidation path. - Staff scenario: reduction of the deficit to 2 percent of GDP by 2025 would bring the debt ratio to 50 percent by 2029 (active scenario). - Alternative: maintaining deficit at 3.5 percent of GDP from 2020 would converge debt ratio to 50 percent only in 2034. - Debt management: - Cabinet approved strategy to cope with maturing international sovereign bonds; Parliament approved Liability Management Act. - Plan to consolidate debt management functions into an independent public debt management agency and publish MTDS. ### SOE governance, contingent liabilities, and energy reforms - SOE exposure: - SOEs’ financial obligations estimated at 11 percent of GDP in 2017. - Financial losses by Sri Lankan Airlines averaged 0.1-0.4 percent of GDP per year in 2011-17. - Three major SOEs (CPC, CEB, SLA) recorded a combined loss of 0.5 percent of GDP in 2017: CEB losses 0.4 percent of GDP; SLA losses 0.1 percent of GDP; CPC small profit. - Governance progress and recommendations: - SCIs published for 5 (and later 6) major SOEs in 2017; MOF to prepare SCI compliance reports biannually. - Accelerate publication of audited financial statements to assess contingent fiscal liabilities. - Tighten selection criteria and set administrative limits on the stock of guarantees. - Energy pricing reforms: - Off-budget energy subsidies (NCOs) reached 0.2 percent of GDP in 2017Q4. - Cabinet approved an automatic fuel pricing mechanism in May 2018 with one-off increases and formula-based quarterly adjustments; targeted kerosene subsidy planned by end-May. - Bulk Supply Transaction Account (BSTA) established in May 2018; cabinet approval for automatic electricity pricing envisaged by September 2018. - Staff emphasis: recognize quasi-fiscal cost of fuel and electricity NCOs as central government expenditure; speed up social safety net reforms and establish a social registry and means-testing. ### SriLankan Airlines restructuring - Actions: - Restructuring Committee engaged an expert airline consulting firm to develop a detailed restructuring plan (updating 2015 resolution strategy) including network and fleet optimization and debt resolution. - New board appointed in March 2018; operational measures to be approved by cabinet by July 2018 (proposed SB). - Staff view: welcome progress and urge expeditious implementation to identify strategic partner. ### Monetary policy, reserves, and exchange rate framework - Monetary stance and tools: - CBSL maintained a tightening bias in 2016–17, raising the policy rate corridor three times to 7.25–8.75 percent through March 2017 and keeping real lending rates above 5 percent since mid-2016. - CBSL lowered the standing lending facility rate by 25 basis points in April 2018, narrowing the policy rate corridor. - Reserves and FX operations: - GIR declined to $6 billion by end-2016; coverage about 3 months of next year’s imports or 55 percent of the ARA metric. - CBSL resumed FX purchases as portfolio inflows recovered in March 2017, purchasing on average $200 million per month and overperformed against end-2017 NIR target. - CBSL unwound FX swaps with commercial banks from $2.5 billion at end-2016 to $1.2 billion in March 2018 (later noted as $1.4 billion end-February 2018 and $0.9 billion end-May 2018 in other sections). - Policy guidance: - Monetary policy should remain vigilant and data-dependent; staff projects inflation slightly below 5 percent by end-year. - Sustain reserve buildup to bolster ARA metrics ahead of large external debt repayments. - Exchange rate flexibility should be first line of defense in event of capital flow reversals; deepen FX market and increase two-way movements. - Legal/institutional reforms: - CBSL adopted a Roadmap for transitioning to inflation targeting and greater exchange rate flexibility by 2020. - Cabinet approved a policy note with key MLA amendments to be submitted to parliament by March 2019, including: - setting price stability as CBSL’s primary objective; - removing MOF voting rights in monetary policy formulation; - restricting CBSL’s financing of the fiscal deficit. - Plan to operationalize an RFQ system for FX interventions by December 2018 (proposed SB). ### Financial sector resilience and supervision - Banking sector metrics (2017): - Capital adequacy ratio (CAR) stabilized at 15.2 percent in 2017. - Gross NPL to total gross loans improved to 2.5 percent. - Provision coverage ratio improved to 70 percent. - NBFIs and non-bank sector: - NBFIs account for about 9 percent of total financial sector assets; CAR at 13.1 percent by end-2017. - Ten NBFIs (out of 52) are either in negative equity or show other financial strains. - Macroprudential stance and credit risks: - Credit gap estimates remain large at about 6 percent of GDP with concentration in construction. - Policy options if credit pressures reemerge: lower LTV limits; higher risk weights on mortgages and construction sector loans; debt-to-income limits on consumer credit. - Basel III migration: - Minimum CAR requirements by January 2019: 14 percent for six systemic banks; 12.5 percent for others. - Banking sector appears well prepared; contingency plans and possible consolidation recommended. - NBFI supervision and resolution: - CBSL increased end-2020 minimum equity capital requirement six-fold for NBFIs. - New Resolution and Enforcement Department established with IMF TA. - Staff recommends comprehensive oversight strategy and prompt resolution of weak NBFIs. - AML/CFT: - FIU taking measures to address FATF-identified strategic deficiencies (2017); planned legal and supervisory measures to meet FATF requirements. ### Structural reforms and inclusive growth priorities - Key areas to boost growth potential: - Trade liberalization; promote investment climate; raise female labor force participation; well-targeted social safety nets; contingency planning for natural disaster risks. - Vision 2025 objectives: - Reach upper-middle income status by 2025; transform into an export-oriented Indian Ocean hub; promote exports, fiscal discipline, price stability, and inclusive growth. - Trade, FDI, and para-tariffs: - Para-tariffs contributed 1.8 percent of GDP in 2017. - Export structure concentrated in garments, tea, and rubber products; FDI below 2 percent of GDP. - Recommendations: rationalize para-tariffs gradually and identify alternative domestic revenue sources; transition to predictable, automated trade regime with a one-stop shop for export/import processes. - Female labor force participation (FLFP): - FLFP rate fell from 41 percent in 2010 to 37 percent in 2017; male participation 75 percent in 2017. - Closing the gender gap in 50 years could raise incomes by about 21 percent by the year the gap is closed (model-based). - Recommended measures: labor law reforms for flexible work arrangements; gender budgeting; vocational training; childcare support; safe transportation; greater financial inclusion. ### Natural disaster risk and fiscal implications - Disaster costs: - Combined average annual loss from natural disasters estimated at about 0.5 percent of GDP. - High-risk events: disaster costs estimated at about 2.4 percent of GDP once every 100 years. - Fiscal impact and government programs: - In 2017, central government spent 0.4 percent of GDP to cope with floods and drought. - National Natural Disaster Insurance Scheme (NNDIS) covers households and SMEs for property losses (excluding droughts); flooding in 2016 and 2017 resulted in net losses for NNDIS. - World Bank providing TA to improve NNDIS risk management. - Government spending on natural disasters (levels preserved as presented): - 2017 Actual Rs bn: Total 53.5; Mitigation 0.4; Rehabilitation 34.4; Cash support 5.2; Insurance 5.5; Other 8.0. - 2017 Actual % GDP: Total 0.4; Mitigation 0.00; Rehabilitation 0.26; Cash support 0.04; Insurance 0.04; Other 0.06. - 2018 Budget Rs bn: Total 21.0; Mitigation 15.2; Rehabilitation 0.6; Cash support 0.0; Insurance 3.5; Other 1.7. - 2018 Budget % GDP: Total 0.15; Mitigation 0.11; Rehabilitation 0.00; Cash support 0.00; Insurance 0.02; Other 0.01. - Disaster risk financing recommendations: - From 2019, include contingency budgeting for emergency cash support and infrastructure rehabilitation. - Channel unused appropriations to build reserves for future disasters with transparency. - Make disaster insurance schemes more cost-effective; over medium term develop comprehensive disaster risk financing strategy and capacity for parametric insurance. ### Debt sustainability analysis (DSA) and stress tests - Public debt at end-2017: 84.6 percent of GDP. - Debt composition (end-2017): - Central government debt: 79.3 percent of GDP. - Government-guaranteed loans: 4.4 percent of GDP. - Outstanding Fund credit: 0.9 percent of GDP. - Domestic debt about 54 percent of central government debt. - Foreign-currency denominated debt: 50 percent of total public debt. - Baseline projections: - Public debt to GDP projection: from 84.6 percent in 2017 to 72.5 percent in 2023 under program scenario. - Gross financing needs projected: around 18.6 percent of GDP in 2018, declining to about 10 percent by 2023. - External debt to GDP projected: from 59 percent in 2017 to around 53 percent in 2023. - Stress and shock scenarios: - Stalled consolidation: if primary balance returns to historical level (-1.4 percent of GDP), debt/GDP would remain about 83 percent until 2023. - Combined shocks (primary, growth, exchange rate, interest rate): debt to GDP would reach 91 percent in 2023; gross financing needs would remain elevated at 12−14 percent of GDP in 2023. - Contingent liability shock (central government liable for additional debt of 10 percent of GDP in 2018): debt/GDP would jump to 93 percent initially and decline to 86 percent by 2023; gross financing needs 12−14 percent of GDP in 2023. - Currency risk: a 30 percent real depreciation could raise external debt to GDP to about 78 percent by 2023 (stress-test result). - DSA assessment: heat map indicates a high risk to debt sustainability; gross financing need and debt burden benchmarks exceeded during projection period. ### Program performance, monitoring, and conditionality - Program status: broadly on track despite shocks and implementation delays. - Performance criteria and indicative targets highlights: - Central government primary balance (floor): -232 Met (End-December 2017); 15 Met (End-March 2018 IT). - Program net official international reserves (floor): 2,212 2,933 Met (End-December 2017); -216 -59 Met (End-March 2018 IT). - Central government tax revenue (floor): 1,680 1,670 Not met (End-December 2017); 447 425 Not met (End-March 2018 IT). - Reserve money of the CBSL (ceiling): 967 941 Met (End-December 2017); 1,020 978 Met (End-March 2018 IT). - Cost of non-commercial obligations for fuel and electricity (ceiling): Not met for a listed test. - Structural benchmarks (selected, status): - MOF to publish detailed IRA tax manual: Jan-18 Not met (implemented with delay). Manual published in May 2018 after IRA entry into force in April. - MOF to implement IT-based commitment control system: Jan-18 Met. - Cabinet to approve debt management strategy for international sovereign bonds maturing over 2019-22: Jun-18 Met. - Cabinet to approve automatic fuel pricing mechanism: Mar-18 Not met (implemented with delay). Approved in May 2018. - CEB and PUC to establish Bulk Supply Transactions Account: Mar-18 Not met (implemented with delay). Account established in May 2018. - Approval by cabinet of policy note outlining MLA amendments: Mar-18 Not met (implemented with delay). Cabinet approved policy note in April. - Reporting and TMU: - TMU defines program NIR, performance criteria, indicative targets, and reporting timetables; program NIR measured net of FX swaps liabilities. - Reporting frequencies: fiscal within five weeks after end of each month; external and monetary within three weeks; SOE quarterly data within two months after quarter. ### Policy recommendations and priorities (staff counsel) - Strengthen institutions to promote inclusive growth and macroeconomic stability; Vision 2025 priorities: - (i) advance fiscal consolidation through revenue mobilization, a more robust fiscal rule, and stronger SOE governance; - (ii) modernize monetary, financial and exchange rate policy frameworks; - (iii) accelerate growth-enhancing structural reforms. - Revenue-based fiscal consolidation is critical to preserve space for public investment and social spending: - Further revenue mobilization needed to meet primary surplus target for 2018–19 and reduce overall deficit to 3.5 percent of GDP by 2020. - Smooth implementation of the new IRA is critical. - Complete energy pricing reforms to contain fiscal risks from SOEs; use targeted social transfers to mitigate distributional impacts. - Monetary policy: - Focus on price stability as primary objective and adjust nimbly with macroeconomic conditions. - Continue reserve buildup; use exchange rate flexibility as first line of defense against volatile global capital flows. - Planned MLA changes key to strengthen CBSL’s mandate, governance, and autonomy. - Financial sector vigilance: - Remain vigilant against systemic risk buildup and use macroprudential tools to curb excessive credit growth. - Banking sector to meet Basel III requirements and prepare contingency plans. - Subject NBFIs to similar oversight as banks and promptly resolve problem institutions. - Structural reforms to boost competitiveness: - Rationalize para-tariffs gradually while identifying replacement revenue sources. - Operationalize one-stop-shop for FDI and improve trade facilitation. - Boost female labor force participation via labor law reform, gender budgeting, childcare and transport interventions. - Develop and implement comprehensive disaster risk financing framework aligned with debt sustainability. *Source: IMF staff report (cr18175).* ### 1. Coping with Natural Disaster Risks ____________________________________________________________ 22 ### 1. Coping with Natural Disaster Risks ### Context - Sri Lanka requested a 3-year EFF arrangement in June 2016 to respond to a difficult external environment and unbalanced macroeconomic policies. - First phase of the program re-set the policy mix to support stability and resilience; milestones include the new Inland Revenue Act, progress with SOE and energy-pricing reforms, and adoption of the CBSL’s Roadmap to flexible inflation targeting. - Political uncertainty increased after February 2018 local elections and two cabinet reshuffles; presidential and parliamentary elections are scheduled for late 2019 and 2020. - Program priorities: (i) promoting fiscal consolidation through further revenue mobilization, more robust fiscal rules, and SOE reforms; (ii) modernizing monetary and exchange rate frameworks to rebuild buffers; (iii) accelerating structural reforms for sustainable and inclusive growth. ### Recent Macroeconomic Developments - Real GDP growth slowed to 3.1 percent in 2017, reflecting a contraction in agriculture due to floods and drought. - Negative output gap of 0.3 percent in 2017. - Industry grew by about 4 percent in 2017; services and agriculture began to normalize in 2017Q4. - Headline Colombo CPI inflation peaked at 7.8 percent (y/y) in October 2017; declined to 3.8 percent in April 2018. Core inflation was 3.5 percent in April 2018. - Current account deficit widened to 2.6 percent of GDP in 2017 from 2.2 percent in 2016. - Exports of goods grew at 10 percent in 2017. - Portfolio inflows rose by 79 percent (y/y) in 2017; FDI rose by 97 percent (y/y) in 2017. - Treasury bond yields declined by about 200 basis points during 2017. - Gross international reserves increased from $7.3 billion at end-2015 to $8.0 billion at end-2017; reserves remained at 3.6 months of imports and 69 percent of the ARA metric. - The rupee remained relatively stable in 2017, depreciating around 3 percent as of mid-May 2018. - Credit growth decelerated to 14.7 percent (y/y) in December 2017 from a 28.5 percent peak in July 2016. - Credit to construction grew around 22.5 percent in 2017. - Land prices in Colombo appreciated by 10.4 percent (y/y) in December 2017. - Real lending rates were above 5 percent for most of 2017 and increased to about 7 percent in February 2018. ### Outlook and Risks - Short-run projection: Real GDP growth expected to rise to 4 percent in 2018, supported by services and recovery in agriculture and industry; consumption expected to contribute positively, offsetting a fiscal consolidation impulse of 0.3 percent of GDP. - Medium-term projection: Growth expected to rise to about 5 percent, with TFP growth reaching 2 percent. - Inflation is projected to decline below 5 percent—the mid-point of the CBSL target—by end-2018. - Balance of risks tilted to the downside: - Domestic risks: implementation delays in fiscal reforms (exacerbated by political uncertainty), new weather calamities slowing agriculture and sustaining high food inflation, reacceleration of credit growth particularly in real estate increasing macro-financial vulnerabilities. - External risks: tighter global financial liquidity and reversal of portfolio inflows raising government borrowing costs and slowing reserve buildup; weaker advanced economy growth or a slowdown in China could lower exports, tourism, and FDI. - Upside: stronger external demand and FDI inflows could support activity. - External position: EBA-based current account gap for 2017 estimated at -0.5 percent of GDP; CA gap estimates suggest a small REER overvaluation of 3 percent, while an EBA-lite REER model suggests 14 percent. External debt sustainable but currency and rollover risks are high given low reserve coverage and structural rigidities. ### Fiscal Consolidation and Institutional Strengthening - Fiscal stance and recent outcomes: - Primary balance reached a small surplus in 2017 (from a deficit of 2.2 percent of GDP in 2015). - Improvement driven by lower current non-interest expenditure (1.7 percentage points) and higher revenues (0.5 percentage points). - Tax-to-GDP ratio improved by 0.2 percentage points in 2017 but fell short of the 2017 target. - Capital expenditure broadly unchanged; disaster-related spending of 0.4 percent of GDP accommodated via budget realignment. - Overall fiscal deficit of 5.5 percent of GDP in 2017. - Gross public debt was 84.6 percent of GDP in 2017. - Reclassification of the Hambantota Port loan increased central government debt (Annex IV, Box 3). - Structural fiscal reforms: - New Inland Revenue Act (IRA) enacted in October 2017 and implemented in April 2018; simplifies tax system and expected to boost income tax collections by ½ percent of GDP through rationalization of tax exemptions. - 2016 VAT amendments raised the VAT rate from 11 percent to 15 percent and broadened the VAT base by removing exemptions (e.g., telecommunications). - Implementation of risk-based VAT administration, roll-out of RAMIS, and introduction of spending commitment controls. - 2018 budget: - Targets a primary surplus of 1 percent of GDP. - IRA and additional measures expected to deliver 0.9 percent of GDP in revenue. - Reduction of import duties on gasoline and diesel in December 2017 expected to lower revenue by ¼ percent of GDP in 2018; shortfall to be met by rationalizing and prioritizing capital spending unless revenue outturn is stronger. - Debt outlook and risks: - Gross public debt projected at 83.7 percent of GDP in 2018. - Sizable gross financing needs of around 18.6 percent of GDP in 2018 and international bond redemptions in 2019-22. - Under sustained fiscal efforts to reach an overall deficit of 3.5 percent of GDP by 2020, debt ratio expected to fall to 80 percent of GDP by 2020 and to 73 percent by 2023 under unchanged policies. - Sensitivity analyses point to high debt sustainability risks, especially if contingent liabilities from SOEs (estimated at about 11 percent of GDP in 2017) materialize. - Near-term fiscal strategy: - Authorities committed to a primary surplus of 2 percent of GDP in 2019 (in line with the third EFF review). - Meeting the 2019 primary balance target requires additional measures of about 1 percent of GDP. - Staff recommendation: focus the package on domestic revenue mobilization because of limited room for further expenditure cuts and the need to protect or raise social spending. - Suggested tax options for the 2019 budget discussed by staff include removing remaining VAT exemptions, expanding labor income tax withholding, and raising excise rates for fuel. - Strengthening tax compliance (MEFP ¶12) recommended to create space for para-tariff rationalization. *Source: IMF staff report (Article IV consultation and EFF program documents).* ### 15. Improving efficiency of infrastructure spending can create space for social safety nets ### 15. Improving efficiency of infrastructure spending can create space for social safety nets ### Improving public investment efficiency and reprioritization - Based on the IMF/World Bank Public Investment Management Assessment (PIMA), scope remains to enhance public investment efficiency by: - upgrading the medium-term expenditure framework with binding multi-year spending ceilings; - introducing systematic project appraisal and selection; - strengthening commitment-based spending controls by fully rolling out the new public financial management IT system (ITMIS). - Potential uses of savings from improved efficiency: - expand coverage of social safety nets (¶47); - accommodate gender and contingency budgeting for natural disasters (¶48-49); - improve public healthcare to reduce out-of-pocket costs. ### Fiscal rule, consolidation, and debt sustainability - Authorities plan to upgrade the Fiscal Management (Responsibility) Act (FMA), which contains ceilings on central government debt, the budget deficit, and government guarantees, but currently lacks enforcement mechanisms and corrective actions. - Staff recommended a more ambitious consolidation path beyond the program period than the overall deficit of 3.5 percent of GDP envisaged under current policies. - Specific staff recommendation: - reduction of the deficit to 2 percent of GDP by 2025 would bring the debt ratio to 50 percent by 2029 (active scenario). - Alternative path: - If the fiscal deficit is maintained at 3.5 percent of GDP from 2020 onwards, the debt ratio would converge to 50 percent only in 2034. - Design elements for a revised fiscal rule: - contain mechanisms to raise the reputational cost of noncompliance, including transparent monitoring, correction mechanisms, and clearly defined escape clauses; - broaden coverage to include extrabudgetary and quasi-fiscal operations to reduce risks from quasi-fiscal operations. ### Debt management and fiscal reporting - Recent steps welcomed by staff: - cabinet approval of a strategy to cope with maturing international sovereign bonds; - parliament approval of the Liability Management Act. - Authorities are working on consolidating debt management functions into an independent public debt management agency to develop, implement, and periodically publish the Medium-Term Debt Management Strategy (MTDS), in line with global best practice. - To mitigate contingent risks from guaranteed debt: - tighten selection criteria and set an administrative limit on the stock of guarantees. - Fiscal reporting improvements: - plan to compile fiscal data in line with the 2014 Government Finance Statistics Manual to clarify the perimeter of fiscal activities including quasi-fiscal operations of SOEs (MEFP ¶9). *Authorities’ Views* - Authorities reiterated commitment to the 2020 fiscal target and highlighted progress via revenue mobilization and the new IRA, which will boost revenues and raise the share of direct taxes vis-à-vis indirect taxes. - Authorities agreed on making fiscal consolidation in 2018–19 as growth-friendly as possible and on reorienting expenditure toward priority areas, with quarterly reporting to parliament and parliamentary oversight over realignments. - Authorities expressed interest in IMF and World Bank Technical Assistance (TA) and emphasized balancing growth and debt reduction considerations when defining the fiscal path beyond 2020. ### Strengthening SOE governance and reducing fiscal risks - Background and risks: - SOEs’ financial obligations were estimated at 11 percent of GDP in 2017, consisting mainly of project loans, short-term bank loans linked to fuel subsidies, and aircraft lease commitments. - SOEs have engaged in quasi-fiscal operations (supplying energy below cost, funding infrastructure), with government absorbing debt when difficulties arise. - Lack of transparency and delays in publishing audited financial statements have raised concerns over undisclosed liabilities. - Financial losses by Sri Lankan Airlines averaged 0.1-0.4 percent of GDP per year in 2011-17. - Governance progress: - Authorities published Statements of Corporate Intent (SCIs) for 5 major SOEs in 2017 as a first step toward stronger governance and transparency. - Staff recommendations and actions: - use SCIs to monitor SOE performance and disseminate results periodically to the public; - Ministry of Finance (MOF) plans to prepare SCI compliance reports biannually on key performance indicators for each SOE; - accelerate publication of audited financial statements to assess contingent fiscal liabilities. - Contingent measures: - prepare SCI compliance reports; tighten selection criteria and administrative limits on guarantees (to mitigate contingent risks). ### Energy pricing reforms and social mitigation - Problem and magnitude: - Fuel and electricity prices had been set administratively and left unchanged since 2015, resulting in off-budget energy subsidies that disproportionately benefited the rich. - In 2017Q4, the cost of non-commercial obligations (NCOs) to supply energy at prices below cost-recovery levels reached 0.2 percent of GDP. - Recent reform steps: - Cabinet approved in May 2018 an automatic fuel pricing mechanism with immediate effect; one-off increases in gasoline, diesel, and kerosene were implemented to restore cost recovery, with formula-based quarterly adjustments going forward. - A targeted kerosene subsidy was planned by end-May to mitigate distributional impact. - Steps toward an automatic electricity pricing mechanism: a Bulk Supply Transaction Account (BSTA) was established in May 2018 to enhance transparency on electricity NCOs; cabinet approval for the automatic pricing mechanism envisaged by September. - Staff emphasis: - recognize quasi-fiscal cost of fuel and electricity NCOs as central government expenditure to prevent further buildup of contingent liabilities; - speed up social safety net reforms, starting with establishment of a social registry and means-testing criteria (¶47) to compensate the poor for higher energy prices as necessary. ### Restructuring SriLankan Airlines (SLA) - Actions taken: - a Restructuring Committee engaged an expert airline consulting firm to develop a detailed restructuring plan (updating 2015 resolution strategy) expected to include network and fleet optimization and debt resolution; - plan to be operationalized by a new board appointed in March. - Staff view: - welcomed progress and urged expeditious implementation of the restructuring plan. - Authorities: - prepared first SCI compliance report in May; intend to complete energy pricing reforms by 2018; expect restructuring implementation to advance rapidly and allow identification of a strategic partner; established a PPP unit in the MOF. ### Monetary policy, reserves, and exchange rate framework - Monetary management and inflation: - CBSL maintained a tightening bias in 2016–17, raising the policy rate corridor three times to 7.25–8.75 percent through March 2017 and keeping real lending rates above 5 percent since mid-2016. - Headline inflation fell to 3.8 percent in April 2018. - CBSL lowered the standing lending facility rate by 25 basis points in April 2018, narrowing the policy rate corridor. - Reserve accumulation and FX operations: - GIR declined to $6 billion by end-2016, with coverage dropping to about 3 months of next year’s imports or 55 percent of the Fund’s Assessing Reserve Adequacy (ARA) metrics. - As portfolio inflows recovered in March 2017, the CBSL resumed FX purchases and overperformed against the end-2017 NIR target, purchasing on average $200 million per month. - CBSL unwound FX swaps with commercial banks from $2.5 billion at end-2016 to $1.2 billion in March 2018. - Policy guidance: - monetary policy should remain vigilant and data-dependent; staff projects inflation to remain slightly below 5 percent by end-year; - sustain reserve buildup to bolster still low ARA metrics ahead of large external debt repayments; - exchange rate flexibility should be the first line of defense in the event of capital flow reversals; deepen FX market and increase two-way movements. - Legal and institutional reforms: - CBSL adopted a Roadmap for transitioning to inflation targeting and greater exchange rate flexibility by 2020 (supported by IMF TA). - Key milestone: revise the Monetary Law Act (MLA) to strengthen CBSL’s mandate, autonomy, governance, transparency, and accountability. - Cabinet approved a policy note with key MLA amendments to be submitted to parliament by March 2019, including: - setting price stability as the CBSL’s primary objective; - ensuring operational autonomy by removing MOF voting rights in monetary policy formulation; - restricting CBSL’s financing of the fiscal deficit. - Capital flow measures: - staff welcomed the new Foreign Exchange Act modernizing FX regulations; - the FX repatriation requirements introduced in April 2016 constitute a capital flow management measure; - staff recommended removal of the measure with timing linked to macroeconomic adjustment and reserve buildup by the end of the program. - Authorities’ stance: - CBSL remains committed to implementing inflation targeting by 2020, continue prudent monetary management, finalize RFQ system design and start RFQ operation for FX interventions by end-year, and gradually liberalize the capital account while timing removals with macroeconomic and market conditions. ### Financial sector resilience - Overview: - While banks’ balance sheets remain sound, continued efforts are needed to strengthen financial sector resilience. - Discussions focused on system-wide implications and policy response to rapid credit growth, Basel III implementation, non-bank supervision, and improving the AML/CFT regime. *Source: IMF staff report (cr18175).* ### 32. Financial soundness indicators are generally sound for the banking sector, although ### cr18175 - 32. Financial soundness indicators are generally sound for the banking sector, although ### Financial soundness indicators — key findings - Banks account for two thirds of total financial sector assets. - Banking sector metrics (2017): - Capital adequacy ratio (CAR) stabilized at 15.2 percent in 2017. - Gross NPL to total gross loans improved to 2.5 percent. - Provision coverage ratio improved to 70 percent. - Non-bank financial institutions (NBFIs), leasing and financing companies: - Account for about 9 percent of total financial sector assets. - Are generally well capitalized with CAR at 13.1 percent by end-2017. - Ten NBFIs (out of 52 in total and not systemic in size) are either in negative equity or show other financial strains. ### Policy discussions — macroprudential measures (MPMs) and credit risks - Observations: - Credit growth has decelerated gradually since mid-2016, likely reflecting a tightening bias in monetary policy and MPMs, including stricter LTV limits on vehicle loans. - Credit gap estimates remain large at about 6 percent of GDP with credit concentrated in the construction sector. - Staff’s stress test analysis indicates that a rapid credit unwinding is unlikely to pose systemic risks. - Policy options if credit pressures reemerge: - Consider further MPMs, including: - lower LTV limits; - higher risk weights on mortgages and construction sector loans; - debt-to-income limits on consumer credit. ### Basel III migration and bank capital preparedness - Migration timeframe imposes minimum CAR requirements by January 2019: - 14 percent for six systemic banks. - 12.5 percent for others. - Assessment: - The banking sector appears well prepared to meet the requirements. - Risks remain that an adverse shock could weaken asset quality and compel banks to raise additional capital. - Staff recommendation: - Prepare contingency plans, including through consolidation of banks that may not meet the requirement to raise additional capital. - Planned work: - A Financial System Stability Review is planned for FY2019. ### Strengthening NBFI supervision and resolution - Measures taken: - CBSL’s six-fold increase in the end-2020 minimum equity capital requirement for NBFIs is expected to strengthen capital positions and promote consolidation of small institutions. - With IMF TA, CBSL established a new Resolution and Enforcement Department to develop legal foundation and staff capacity for enforcement actions. - Staff recommendations: - Develop a comprehensive strategy to subject NBFIs to a level of oversight in line with their risks. - Promptly resolve weak NBFIs under CBSL supervision. ### AML/CFT regime improvements - Actions underway: - Financial Intelligence Unit is taking measures to address strategic deficiencies identified by FATF in 2017, with the goal of having Sri Lanka removed from FATF scrutiny. - Planned measures include: - amending laws relating to international cooperation and beneficial ownership; - ensuring implementation of customer due diligence rules and beneficial ownership requirements by financial institutions and DNFBPs; - enhancing risk-based supervision for financial institutions and DNFBPs; - establishing a targeted financial sanctions regime to implement relevant United Nations Security Council Resolutions. ### Authorities’ views - The authorities view the financial system as well-capitalized and stable. - They do not see systemic risks arising from credit to the construction sector but agree on the need to remain vigilant, especially in high segments of the real estate market. - Planned/legal actions: - Amend the MLA to introduce a broader legal framework that facilitates macroprudential surveillance. - Banks are on track to fulfill all Basel III requirements. - Financial sector weaknesses are concentrated in the NBFI sector; weak NBFIs are not systemically important. - Authorities are working to improve supervision and initiate resolution and enforcement actions with the new Resolution and Enforcement Department. - Authorities are committed to swiftly implement the FATF’s recommended action plan to address weaknesses in the AML/CFT regime. ### Accelerating structural reforms to promote inclusive growth — summary of priorities - Key areas to boost growth potential: - Trade liberalization. - Measures to promote the investment climate. - Gender equality in the labor market. - Well-targeted social safety nets. - Contingency planning for natural disaster risks. - Vision 2025 objectives: - Reach upper-middle income status by 2025. - Transform into an export-oriented Indian Ocean hub, shift away from inward-looking and protectionist policies, and promote exports, fiscal discipline, price stability, and inclusive growth. - Deliver over 2018–20 reforms on trade and investment regimes, female labor force participation, social safety nets, disaster risk management, and stronger governance. ### Trade, FDI, and investment climate issues - Trade and protection: - Para-tariffs have effectively doubled the rate of protection in Sri Lanka over the last decade. - Para-tariffs contributed 1.8 percent of GDP in 2017. - Trade and FDI regimes are more restrictive than in other EM peers (per new IMF cross-country database). - Export and FDI performance: - Export structure remains concentrated in garments, tea, and rubber products with little change since 1995. - FDI remained anemic at below 2 percent of GDP. - Policy recommendations: - Gradually rationalize para-tariffs and identify alternative domestic revenue sources. - Transition to a predictable, fair, and automated trade regime with a one-stop shop to streamline export and import processes. - New IRA expected to improve the investment climate by replacing rule-varying tax holidays with rule-oriented and investment-based incentives. ### Natural disaster risk and fiscal implications (Box 1) - Disaster profile and costs: - Combined average annual loss from natural disasters estimated at about 0.5 percent of GDP. - For high-risk events, disaster costs estimated at about 2.4 percent of GDP once every 100 years. - Fiscal impact: - In 2017, the central government spent 0.4 percent of GDP to cope with the floods and drought. - Government programs: - National Natural Disaster Insurance Scheme (NNDIS) covers all households and SMEs for property losses caused by disasters (excluding droughts); flooding in 2016 and 2017 resulted in net losses for the NNDIS. - World Bank providing TA to improve NNDIS risk management. - Vision 2025 pledges an assessment of disaster risk profile and development of a risk management framework. - Government spending on natural disasters (2017 Actual vs 2018 Budget), levels preserved as presented: - 2017 Actual Rs bn: Total 53.5; Mitigation 0.4; Rehabilitation 34.4; Cash support 5.2; Insurance 5.5; Other 8.0. - 2017 Actual % GDP: Total 0.4; Mitigation 0.00; Rehabilitation 0.26; Cash support 0.04; Insurance 0.04; Other 0.06. - 2018 Budget Rs bn: Total 21.0; Mitigation 15.2; Rehabilitation 0.6; Cash support 0.0; Insurance 3.5; Other 1.7. - 2018 Budget % GDP: Total 0.15; Mitigation 0.11; Rehabilitation 0.00; Cash support 0.00; Insurance 0.02; Other 0.01. ### Female labor force participation (Box 2) - FLFP trends and gaps: - FLFP rate fell from 41 percent in 2010 to 37 percent in 2017, compared to 75 percent for men in 2017. - Closing the gender gap in 50 years could raise incomes by about 21 percent by the year the gap is closed (model-based simulations). - Drivers of low FLFP: - Low proportion of high skilled female workers and persistent skill mismatches. - Outdated labor laws not addressing flexible work arrangements. - Absence of child care facilities. - Poor enforcement of laws for protection of females, especially in transportation. - Authorities’ measures: - Vision 2025 medium-term strategic plan to remove constraints. - Program to mainstream gender-budgeting in every ministry, developing key performance indicators starting with 20 ministries. ### Managing large-scale capital projects and BRI engagement (Box 3) - China-related infrastructure and financing: - Infrastructure-related FDI from China averaged about $200 million annually over 2013–17 (¼ percent of GDP). - Outstanding bilateral loans from China to Sri Lanka’s public sector, including SOEs, estimated at about US$4.6 billion at end-2016 (5.8 percent of GDP). - Major projects: - Hambantota Port: - 99-year concession agreement (December 2017): China Merchant Port Holdings (CMPH) acquired an 85 percent share and will pay Sri Lankan government a total of US$1.1 billion (1.3 percent of GDP) over December 2017-June 2018. - Colombo Port City: - Reclamation of 269 hectare adjacent to Colombo Harbor with FDI totaling US$1.3 billion (1.5 percent of GDP). - Government considering introduction of a special regulatory regime for the project. - Policy guidance: - Carefully select and manage large-scale capital projects given high public debt and social development needs. - Ensure sound and transparent project selection, consistency with fiscal targets, and mitigation of fiscal risks, including avoidance of special tax treatments or regulatory gaps. ### Anti-corruption and governance measures - Actions taken: - New Audit Bill submitted to parliament to strengthen the power of the Auditor General. - Special high court being established to investigate bribery cases. - Commission to Investigate Allegations of Bribery or Corruption taking steps to amend, draft, and implement new laws to comply with the United Nations Convention against Corruption. - Cabinet approved in March a proposal for new provisions in the Companies Act related to ownership disclosure as an anti-money laundering tool. - Complementary reforms: - IT-based tax administration and expenditure management, integrated debt management, and stringent SOE governance under the program to support transparent fiscal management. *Source: IMF staff report (cr18175).* ### 47. The authorities should step up efforts to strengthen social safety nets. There is scope to ### 47. The authorities should step up efforts to strengthen social safety nets. There is scope to ### Social safety nets: findings and recommendations - Improve targeting accuracy of social assistance programs and expand coverage. - Accelerate reforms, supported by the World Bank, to: - Develop a centralized registry of social safety net beneficiaries. - Establish means-testing criteria for all targeted social assistance programs. - Expected outcomes: - Properly target cash transfers to mitigate the impact of adverse shocks to the poor. - Expand coverage to eligible applicants. - Promote exit of non-eligible beneficiaries. ### Female labor force participation: potential gains and measures - Finding: Closing the gender gap in the workforce could raise GDP by as much as 20 percent over the long-term. - Key measures recommended: - Labor law reforms to support flexible work arrangements such as part-time work, telework, working from home, and night work. - Effective gender budgeting to actively target gender equality, with focus on vocational training, safe transportation, and child care support. - Greater financial inclusion through access to microfinance institutions and formal financial institutions to promote entrepreneurship among women. ### Disaster risk financing: recommendations and sequencing - Staff welcomed authorities’ efforts to introduce disaster insurance and increase mitigation spending; discussed options with World Bank support. - Recommended measures: - Starting in 2019, include contingency budgeting for emergency cash support and infrastructure rehabilitation in the budget. - Channel unused appropriations to build up reserves for future disasters, with stringent transparency requirements. - Introduce an automatic pricing mechanism for electricity, combined with well-targeted safety nets, to help contain fiscal risks from droughts (given reliance on hydro electricity generation). - Make disaster insurance schemes more cost-effective by minimizing reinsurance costs and targeting coverage for the poor. - Over the medium-term, develop a comprehensive disaster risk financing strategy in line with Sri Lanka’s debt sustainability and build capacity to implement innovative approaches such as parametric insurance. ### Authorities’ views - Concur with need to accelerate pro-growth structural reforms. - Emphasize trade liberalization and private sector investments; commit to phasing out inward-looking protectionist policies, while proceeding gradually to consider adjustment costs. - Expect Hambantota Port and Colombo Port City projects to enhance growth via greater trade and financial integration. - Strong commitment to anti-corruption agenda and continued cooperation with the World Bank on gender equality, social safety nets, and disaster risk financing framework. ### Program performance: summary - Overall: Program performance is broadly on track despite shocks and implementation delays. - End-December QPCs and end-March ITs on the primary balance and NIR, and the continuous QPC on no new external arrears, were met. - End-December and end-March IT on reserve money: met. - IT on tax revenues: missed. - Inflation exceeded the upper limit for the inner band under the Monetary Policy Consultation Clause (MPCC) for December, triggering a staff-level consultation; deviation reflected temporary increase in food inflation due to weather shocks; inflation fell back within the inner band for March. - All six structural benchmarks due by June 2018 were implemented, although four with a delay. ### Program quantitative and indicative target highlights (as presented) - Central government primary balance (floor, in billion rupees): -232 Met (End-December 2017); 15 Met (End-March 2018 IT). - Program net official international reserves (floor, in million US$): 2,212 2,933 Met (End-December 2017); -216 -59 Met (End-March 2018 IT). - Monetary policy consultation clause: CPI inflation (y/y, in percent) - Outer band (upper limit) 8.5...7.7... - Inner band (upper limit) 7.0... Outside6.2...Within - Actual / Center point 5.5 7.5inner 4.7 4.8inner - Inner band (lower limit) 4.0...band3.2...band - Outer band (lower limit) 2.5...1.7... - Indicative targets: - Central government tax revenue (floor, in billion rupees) 1,680 1,670 Not met (End-December 2017); 447 425 Not met (End-March 2018 IT). - Reserve money of the CBSL (ceiling, stock, in billion rupees) 967 941 Met (End-December 2017); 1,020 978 Met (End-March 2018 IT). - Cost of non-commercial obligations for fuel and electricity (ceiling, net of government transfers, in billion rupees) .........019 Not met. ### Structural benchmarks and implementation status (selected) - MOF to publish a detailed IRA tax manual: Jan-18 Not met (implemented with delay). Manual published in May 2018 after IRA entry into force in April. - MOF to implement an IT-based commitment control system for line ministries: Jan-18 Met. CIGAS IT system modified for quarterly commitment ceilings. - Cabinet to approve a debt management strategy for international sovereign bonds maturing over 2019-22: Jun-18 Met. - Cabinet to approve automatic fuel pricing mechanism to ensure retail prices above cost-recovery levels: Mar-18 Not met (implemented with delay). Cabinet approved cost-reflective fuel pricing mechanism in May. - CEB and PUC to establish Bulk Supply Transactions Account: Mar-18 Not met (implemented with delay). Account established in May 2018; PUC published monthly data for 2016-17. - Approval by cabinet of a policy note outlining key elements of MLA amendments: Mar-18 Not met (implemented with delay). Cabinet approved policy note in April. ### A. Fiscal policy: commitments and targets - Fiscal targets: - Authorities committed to targeting a primary surplus of Rs 141 billion (1 percent of GDP) in 2018. - Tax revenue IT for 2018 revised downward from Rs 1,954 billion (13.5 percent of GDP) to Rs 1,934 billion (13.3 percent of GDP). - Fiscal rules: - Intend to revise the FMA to include legally binding targets, well-defined escape clauses, and correction mechanisms, supported by Fund TA. - Cabinet approval of a policy note on planned amendments envisaged by March 2019 (proposed SB). - Debt management: - Plan to approve a MTDS for 2019–23 by October 2018 (proposed SB). - Eventually delegate responsibilities to an independent debt management agency; cabinet approval of time-bound plan for establishment by March 2019 (proposed SB). - New quantitative IT on government guarantees set for end-2018. ### B. SOE reforms: energy pricing and SLA - Energy pricing reforms: - Commit to introducing an automatic pricing mechanism for electricity, with cabinet approval by September 2018 (existing SB). - MOF plans to compensate CPC and/or CEB for NCO costs as automatic pricing is fully implemented to meet IT ceiling for fuel and electricity NCOs by end-year. - SLA restructuring: - Cabinet set to approve measures to cut operational and financial costs of SLA by July 2018 (proposed SB) following a comprehensive restructuring plan. ### C. Monetary and exchange rate policies - Plan to amend the MLA to lay a legal foundation for inflation targeting: - Cabinet approved policy note in April; cabinet set to approve MLA amendment bill by December 2018 (proposed SB) and submit bill to parliament by March 2019. - Reserve buildup and exchange rate flexibility: - Target to increase NIR (program definition) by US$1.771 billion in 2018. - Target end-2018 GIR of US$9.3 billion, equivalent to 74 percent of the ARA metric and 4 months of import. - Operationalize an RFQ system for FX trading by December 2018 (proposed SB). ### D. Structural reforms (social registry and trade) - Social Registry: - Develop a new Social Registry starting with four major cash transfer programs. - Cabinet set to approve means-testing criteria by August 2018 (proposed SB). - Trade liberalization: - Prepare a strategy to rationalize remaining para-tariffs over the medium term, with new revenue sources to offset revenue losses, for cabinet approval by March 2019 (proposed SB). ### Program financing and risks - Program remains fully financed for the next 12 months, but risks remain. - Financing context: - Net domestic fiscal financing for 2018-19 projected lower than expected at third review due to fiscal consolidation and higher cash buffers from Hambantota Port concession. - Market access prospects favorable given decline in rupee-denominated treasury bond yields and relatively stable sovereign spreads. - Financing assurances from World Bank, Asian Development Bank, and bilateral donors in place. - Key risks: - Revenue slippage. - Weaker than expected net capital inflows and reserves shortfall. - Lower than expected growth and/or new pressures on trade account. - Slow progress in SOE reforms with larger than expected losses. - Reacceleration of credit growth adding to macro-financial vulnerabilities. - Political uncertainty in run-up to national elections could slow reform momentum. ### Fund exposure and repayment capacity - Outstanding Fund credit will peak at SDR 1,071 million in 2019 (1.6 percent of GDP and 7 percent of goods and services exports). - Total debt service to the Fund will peak at SDR 195 million in 2024 (1 percent of goods and services exports) and taper off through 2030. - Sri Lanka has an unblemished repayment history with the Fund and a strong external repayment history in general. ### Staff appraisal: growth outlook and policy priorities - Growth outlook: Real GDP growth projected to recover in 2018 and over the medium term, supported by recovery in agriculture and industry and robust services growth. - Risks: Balance of risks significantly tilted to the downside from possible delays in fiscal reforms, political uncertainty, new weather calamities, and reversal of portfolio inflows. - Recent performance: Program remains broadly on track; progress in fiscal consolidation and energy pricing reforms; CBSL effective in curbing credit growth, stabilizing inflation, and building reserves. - External position: Broadly consistent with fundamentals in 2017 but vulnerable due to sizable public debt and low external buffers. - Key priorities to secure gains and support competitiveness and inclusive growth: - Accelerate reform momentum and strengthen policy frameworks and institutions. ### Policy recommendations and priorities (final counsel) - Strengthen institutions to promote inclusive growth and macroeconomic stability; Vision 2025 priorities include: - (i) Advance fiscal consolidation through revenue mobilization, a more robust fiscal rule, and stronger SOE governance. - (ii) Modernize monetary, financial and exchange rate policy frameworks. - (iii) Accelerate growth-enhancing structural reforms. - Revenue-based fiscal consolidation is critical to preserve space for public investment and social spending and bring down public debt: - Further revenue mobilization needed to meet primary surplus target for 2018–19 and reduce overall deficit to 3.5 percent of GDP by 2020. - Smooth implementation of the new IRA is critical. - Scope remains to strengthen efficiency of public investment and social safety nets. - Beyond 2020, amend FMA to include mechanisms ensuring greater compliance, improvements in debt management, and greater fiscal transparency. - Completing energy pricing reforms is a priority to contain fiscal risks from SOEs: - Cabinet decision to introduce automatic fuel pricing mechanism and planned automatic electricity pricing formula welcomed. - Use targeted social transfer programs to mitigate distributional impact of price adjustments. - Strengthen SOE governance and transparency and expand coverage of fiscal accounts. - Implement Sri Lankan Airlines restructuring plan quickly. - Monetary policy: - Focus on price stability as primary objective and adjust nimbly with macroeconomic conditions. - Continue reserve buildup; use exchange rate flexibility as first line of defense against volatile global capital flows. - Planned MLA changes are key to strengthen CBSL’s mandate, governance, and autonomy. - Financial sector vigilance: - Remain vigilant against systemic risk buildup. - Use macroprudential tools to curb excessive credit growth in certain sectors. - Banking sector to meet Basel III requirements and prepare contingency plans. - Subject NBFIs to same oversight as banks and promptly resolve problem institutions. *IMF staff assessment as presented in the source document.* ### 71. The reforms under the authorities’ Vision 2025 are important in promoting strong and ### cr18175 - 71. The reforms under the authorities’ Vision 2025 are important in promoting strong and ### Reforms under Vision 2025: promoting strong and sustainable growth - Gradually liberalize Sri Lanka’s protectionist trade regime through fiscally-neutral reforms of tariffs and para-tariffs and simplification of export and import processes. - Robust implementation of the new IRA and the one-stop shop for FDI to improve the investment climate. - Sustain efforts to combat corruption, including through greater transparency in fiscal and SOE management and a stronger AML/CFT regime. ### Fostering inclusive growth - Improve social safety nets, reduce the large gender gap, and cope with natural disaster risks. - Authorities are taking steps to improve targeting accuracy and coverage of social assistance programs. - Boost female labor force participation through: - labor market reforms and effective gender budgeting, - vocational training, - flexible work arrangements, - safe transportation, and - child care support. - Establish a well-designed natural disaster risk financing framework to help Sri Lanka address costs associated with climate change. *Source: cr18175 - 71. The reforms under the authorities’ Vision 2025 are important in promoting strong and* ### 73. Staff recommends that the next Article IV Consultation takes place in accordance with ### 73. Staff recommends that the next Article IV Consultation takes place in accordance with ### Recommendation and IMF program status - Staff recommends that the next Article IV Consultation takes place in accordance with the Executive Board decision on consultation cycles for members with Fund arrangements, and supports the authorities’ request for the completion of the fourth review under the EFF arrangement. - Table of Reviews and Purchases under the three-year Extended Arrangement (Table 8) shows availability dates and amounts with a Total of 1,070.780 SDR million and Percent of Quota 185.000. ### Real sector — key indicators (as presented) - Real GDP growth (row as presented): 5.0 4.5 4.2 3.1 4.6 4.0 4.5 4.7 4.8 4.9 5.0 - Inflation (average) (row as presented): 2.2 4.0 6.0 6.6 4.8 4.8 4.8 4.9 4.9 4.9 4.9 - Inflation (end-of-period) (row as presented): 4.6 4.5 5.1 7.1 5.0 4.7 4.8 4.9 4.9 4.9 4.9 - Core inflation (end-of-period) (row as presented): 6.7 5.8 4.6 4.3 4.6 4.6 4.6 4.6 4.5 4.5 4.5 - Real GDP Growth by Sector (charts): sectoral contributions shown for Agriculture, Industry, Services, and Taxes less Subsidies (figures presented graphically in Figure 1). ### Fiscal sector — key aggregates and projections (from Table 1 and Table 2) - National savings and investment (rows as presented): National savings28.8 32.8 28.7 33.9 29.1 34.4 35.0 35.1 35.2 35.4 35.6 - Central government balance (in percent of GDP) (row as presented): -7.0 -5.4 -5.7 -5.5 -5.0 -4.6 -3.6 -3.5 -3.5 -3.5 -3.5 - Revenue and grants (in percent of GDP) (row as presented): 13.3 14.2 14.2 13.8 15.0 14.6 15.9 16.0 16.1 16.2 16.2 - Expenditure (in percent of GDP) (row as presented): 20.4 19.6 19.9 19.4 20.0 19.2 19.5 19.5 19.6 19.7 19.6 - Primary balance (in percent of GDP) (row as presented): -2.2 -0.2 -0.2 0.0 1.0 1.0 2.0 2.1 2.1 2.1 2.0 - Central government net domestic financing (in percent of GDP) (row as presented): 4.3 2.1 3.4 2.2 2.9 2.1 2.9 2.9 2.7 2.7 2.7 - Central government debt (in percent of GDP) (row as presented): 78.5 79.6 81.6 79.3 80.3 77.3 75.2 73.0 70.9 68.8 66.7 - Selected central government nominal debt levels and flows (Table 2a, in billions of rupees): Total revenue and grants1,461 1,694 1,854 1,840 2,146 2,124 2,531 2,795 3,088 3,413 3,739; Total expenditure and net lending2,229 2,334 2,597 2,573 2,854 2,791 3,102 3,404 3,753 4,145 4,543. - Central government interest payments (Table 2a, in billions of rupees): Interest payments527 611 720 736 849 807 885 972 1,069 1,176 1,260. ### Monetary and financial sector — selected indicators - Reserve money (percent change, end of period) (Table 1 row as presented): 16.5 27.1 13.0 9.8 13.3 13.8 12.6 12.4 12.3 12.3 12.3 - Broad money (percent change, end of period) (Table 1 row as presented): 17.8 18.4 18.9 16.7 15.0 14.0 13.7 13.3 13.0 12.6 12.6 - Credit to private sector (percent change, end of period) (Table 1 row as presented): 25.1 21.9 16.3 14.7 14.8 13.7 12.6 12.4 12.3 12.2 12.1 - Banking sector soundness (Figure 5 / Table 7 highlights): - Regulatory capital to risk weighted assets series (quarterly): values in the mid-teens (e.g., 16.3 16.0 15.2 15.4 ... 15.2). - Gross nonperforming loans to total gross loans (quarterly series): values around 4.3 4.3 4.0 3.2 ... 2.5. - Return on equity (after tax) (quarterly series): values around 16.4 16.0 16.2 16.2 ... 17.6. ### External sector — reserves, current account, debt, and financing - Current account balance (in millions of U.S. dollars and percent of GDP) (Table 5a / Table 1 rows as presented): - Current account (in millions of U.S. dollars): -1,882 -1,743 -2,461 -2,309 -2,180 -2,308 -2,514 -2,567 -2,667 -2,692 -2,844 - Current account balance (in percent of GDP): -2.4 -2.2 -3.0 -2.6 -2.5 -2.5 -2.5 -2.4 -2.3 -2.2 -2.2 - Balance on goods and services (Table 5a): Balance on goods (examples) -8,388 -8,873 -9,796 -9,618 -10,072 -10,372 -11,345 -11,932 -12,426 -12,894 -13,402; Balance on services (examples) 2,324 2,879 3,081 3,337 3,542 3,932 4,384 5,015 5,464 5,970 6,399. - Gross official reserves (end of period, in millions of U.S. dollars) (Table 1 / Table 5a rows as presented): 7,304 6,019 7,505 7,959 8,014 9,268 9,710 10,179 10,949 11,602 12,240 - In months of prospective imports of goods & services (row as presented): 3.7 2.8 3.4 3.6 3.4 3.9 3.9 3.9 4.0 4.1 4.3 - In percent of ARA composite metric (row as presented): 68.9 54.7 66.9 68.9 66.5 74.2 74.5 75.1 76.8 77.4 79.7 - External debt (public and private) (Table 1 rows as presented): In billions of U.S. dollars 44.8 46.5 48.3 51.9 49.5 55.0 58.3 60.2 62.7 65.8 69.2; As a percent of GDP 56.4 57.4 58.2 59.3 57.4 58.9 58.5 56.7 55.3 54.2 53.2 - Gross external financing needs and sources (Table 6 rows as presented): - Gross external financing needs (in millions of U.S. dollars): -2,391 -4,063 -4,473 -4,862 -6,298 -5,771 -5,462 -5,895 -6,010 - Sources of financing include Borrowing (2,746 3,072 6,637 5,429 6,254 6,240 6,232 6,549 6,648), Other capital inflows, net, and Change in reserve assets (e.g., Change in reserve assets -355 472 -2,762 -1,310 -441 -470 -770 -654 -638). - Financial account (Table 5a) shows negative net lending/borrowing for multiple years (e.g., -3,172 -1,660 -3,478 -4,544 -1,968 -2,856 -2,455 -3,035 -3,484 -3,488 -3,713). ### IMF financing, repayments, and projected payments - Fund credit outstanding (Table 9 projected series, as of May 3, 2018): - Fund credit outstanding (In millions of SDR, row as presented): 893.0 1,070.8 1,060.8 1,020.8 916.4 752.8 574.3 395.9 227.4 88.9 14.8 0.0 0.0 0.0 0.0 - Fund repurchases and charges (In millions of SDR, row as presented): 10.0 22.8 33.7 63.3 126.7 183.8 195.4 192.0 178.6 145.6 78.9 18.4 3.5 3.5 3.5 - Fund repurchases and charges (In millions of U.S. dollars, row as presented): 14.6 33.4 49.5 93.5 187.0 271.3 288.4 283.4 263.7 214.9 116.4 27.2 5.1 5.1 5.1 - Table 8 (Reviews and Purchases Under the Three-year Extended Arrangement) documents completion dates and tranche amounts for each review through April 20, 2019. ### Policy implications and near-term focus (drawn from presented analysis and program metrics) - Continue implementation of fiscal consolidation to bring central government balance from -7.0 percent of GDP toward the projected path of around -3.5 percent of GDP in the medium term (Table 1 / Table 2b). - Sustain measures to rebuild gross official reserves and strengthen the external position — reserves already rising from 7,959 million U.S. dollars (2018) toward projected 12,240 million U.S. dollars by 2023 (Table 1 / Table 5a). - Complete program conditionality and performance criteria to secure reviews and disbursements under the EFF arrangement — staff supports authorities’ request for completion of the fourth review under the EFF arrangement. *Source: Data provided by the Sri Lankan authorities; and IMF staff estimates (as presented in the supplied content).* ### Annex I. Response to Past Fund Policy Advice ### Annex I. Response to Past Fund Policy Advice ### Fiscal policy and public financial management - Fund advice: Increase revenue mobilization and conduct fiscal consolidation through tax policy and tax administration reform. - Authorities' response: - Introduced VAT amendments in 2016 and legislated the new IRA. - Efforts have yet to raise tax revenues as planned, due to the need to offset one-off tax measures in 2015 and lower than projected collections for excise taxes. - Fund advice: Improve public financial management through expenditure commitment control. - Authorities' response: - Started to implement quarterly expenditure commitment ceilings. - Commitment control through the new PFM system (ITMIS) is being rolled out. ### State-owned enterprises and energy - Fund advice: Undertake decisive reforms of state owned enterprises (SOEs) through completing a resolution strategy for the Sri Lankan Airlines, reforming energy pricing mechanisms, and publish statement of corporate intent (SCIs) for major SOEs. - Authorities' response: - Reforms of SOEs have progressed. - SCIs for 5 major SOEs have been published. - Cabinet approved an automatic fuel pricing mechanism and further energy reforms are planned in 2018. - Cabinet is scheduled to approve a resolution strategy for Sri Lankan Airlines. ### Monetary policy and inflation targeting - Fund advice: Monetary policy should aim to keep inflation in mid-single digits and preempt inflationary pressures. - Authorities' response: - The CBSL has managed monetary policy prudently, following a data-dependent approach. - Inflation temporarily exceeded the inner band under the MPCC in December 2017 due to food price increases. - Fund advice: Transition towards a flexible inflation targeting regime. - Authorities' response: - Authorities developed a Roadmap for flexible inflation targeting with timebound measures. - Cabinet approved a policy note with the key elements of the revision to the Monetary Law Act, planned by March 2019. ### Exchange rate, reserves, and external buffers - Fund advice: Demonstrate stronger exchange rate flexibility. Accumulate reserves to strengthen external buffers. - Authorities' response: - Since March 2017, CBSL has intervened in the FX market to accumulate reserves, helping to increase transactions in the spot market and two-way exchange rate movements. - Nevertheless, there is still scope for greater exchange rate flexibility. ### Financial sector stability and macroprudential policy - Fund advice: Monitor rapid credit growth against potential buildup of systemic risks, and use macroprudential measures to stabilize growth as necessary. Strengthen financial sector supervision, including smooth migration to Basel III and supervision on non-banks. - Authorities' response: - Lowered the LTV ratio for motor vehicle loans. - New surveys are underway in credit growth. - Exposure to the real estate sector is closely monitored to detect vulnerabilities. - Migration to Basel III has started. - A new Resolution and Enforcement Department has been established within CBSL. ### Trade, investment, and structural reforms - Fund advice: Reform trade and investment regimes toward more outward-oriented ones. Strengthen competitiveness through structural reforms. - Authorities' response: - In 2017, the authorities announced a strategy to enhance Sri Lanka’s competitiveness through structural reforms (Vision 2025). - Cabinet approved a New Trade Policy in 2017 to promote exports. - The 2018 budget proposed to rationalize para-tariffs. --- ### Annex II. Risk Assessment Matrix — Key risks, likelihoods, impacts, and policy responses - Slippages in revenue-based fiscal consolidation - Relative Likelihood / Time Horizon: Medium / Short-term - Expected Impact: H: Erodes confidence in macroeconomic policies, challenging Sri Lanka to address large gross financing needs. - Policy response: Continue to implement revenue-based fiscal consolidation and structural fiscal reforms as planned. - Weather calamities (e.g., floods and droughts) - Relative Likelihood / Time Horizon: Medium / Short-term - Expected Impact: H: Disrupts agriculture production and increase food inflation. Higher imports of food and fuel will worsen current account balance. Disaster-related spending will challenge fiscal consolidation. - Policy response: Develop a comprehensive disaster financing framework, including contingency budgeting and disaster-linked social protections. Implement structural reforms to improve growth potential. - Continued rapid credit growth - Relative Likelihood / Time Horizon: Medium / Medium term - Expected Impact: M: Systemic vulnerability can build up in the financial sector. Worsens the capital position of weak institutions. - Policy response: Adjust monetary policy and use macroprudential measures as warranted. - Tighter global financial conditions - Relative Likelihood / Time Horizon: High / Short- and Medium-term - Expected Impact: H: Raises government borrowing costs. Portfolio capital outflows can disrupt reserves buildup. - Policy response: Continue fiscal consolidation and adjust monetary policy as warranted. Use greater exchange rate flexibility as the first line of defense against capital outflows. - Structurally weak growth in key advanced economies - Relative Likelihood / Time Horizon: High / Medium-term - Expected Impact: M: Can cause a protracted slowdown in exports and tourism from AEs, weakening current account balance and growth. - Policy response: Diversify export and tourism markets. Strengthen competitiveness through structural reforms. Continue to integrate with regional EMs through FTA. - Significant China slowdown and its spillovers - Relative Likelihood / Time Horizon: Low-Medium / Short- and Medium-term - Expected Impact: L: Can lead to a decrease in FDI inflows to Sri Lanka. - Policy response: Diversify economic integration with other EMs. Improve investment climate to attract FDI. --- ### Annex III. External Sector Assessment — Findings and implications ### Main findings - External position in 2017: - The External Sector Assessment finds that Sri Lanka’s external position was broadly consistent with fundamentals in 2017, but remains vulnerable to shocks amid rising market volatility. - Reserve buffers have improved but remain inadequate. - Export competitiveness has been constrained by past REER appreciation and structural factors. - 2017 current account and trade: - The current account deficit widened to 2.6 percent of GDP in 2017 from 2.2 percent in 2016 due to weather-related increases in food and fuel imports. - Trade deficit in goods was 11 percent of GDP at end-2017. - Capital flows and reserves: - Capital inflows resumed in Q2 2017 with broad-based increases in FDI, portfolio flows, and other investment, despite recent volatility in Q1 2018. - After a decline of US$2.2 billion in 2015-16, gross international reserves (GIR) increased by US$1.9 billion in 2017, reaching US$8 billion at year end. - Going forward, the current account deficit is expected to gradually decline to around 2 percent of GDP by 2023 as the public sector’s negative saving-investment balance declines. - Capital inflows are expected to continue but at somewhat lower level of around 3 percent of GDP over the next five years. - Net external liabilities: - Sri Lanka remains a net debtor country with large external liabilities and small external assets. - Net external liabilities increased slightly from 53 percent of GDP in 2012 to 55 percent of GDP in 2017. - Roughly 20 percent of external liabilities are in the form of FDI and about 70 percent as debt portfolios or bank loans. - Liabilities are mostly long-term (roughly 85 percent of total liabilities), although lumpy repayments starting in 2019 point to the need to speedily build up buffers. - The government is the biggest debtor followed by commercial banks. ### External position metrics and competitiveness - External Balance Assessment (EBA) and REER: - Based on the EBA, the cyclically adjusted current account balance is estimated at -2.5 percent of GDP, after adjusting for temporary factors, against the 2017 outturn of -2.6 percent of GDP. - The EBA-based current account gap for 2017 is estimated at -0.5 percent of GDP. - A residual of -0.9 percent of GDP suggests uncertainty and may point to the need for further structural reforms to improve competitiveness. - The CA gap estimates suggest a small REER overvaluation (3 percent), although alternative estimates based on the EBA-lite REER model suggest a somewhat higher one (14 percent). - Reserve adequacy: - The Assessing Reserve Adequacy (ARA) metric of GIR recovered from 55 percent at end-2016 to 69 percent at end-2017, but remains lower than the recommended range of 100-150 percent. - Net international reserves (NIR) at end-2017 barely covered foreign exchange claims falling due in 2018, leaving Sri Lanka reliant on rolling over its external liabilities every year to meet its foreign claims. - CBSL wound down liabilities from outstanding FX swaps with commercial banks from $2.5 billion (42 percent of GIR) at end-2016 to $1.2 billion (17 percent of GIR) at end-March 2018, improving the quality of reserves. - The ARA metric of GIR is projected to increase to about 75 percent by 2019. ### Export competitiveness and structural constraints - REER and exports: - Past REER appreciation constrained export competitiveness; REER depreciated by 3.5 percent in 2017 as depreciation of the nominal effective exchange rate (8 percent) was partially offset by Sri Lanka’s inflation differential with its trading partners. - Structural factors: - Sri Lanka is described as one of the most protectionist countries in the world, with a multitude of high tariffs and para-tariffs. - Trade structure has shown little change over the decade: the share of agricultural products, textiles and garments of total goods exports remained around 65–70 percent. - The World Bank’s Doing Business indicators marked Sri Lanka’s distance to frontier at 59, indicating weaknesses in registering property, enforcing contracts, and paying taxes. ### Exchange rate policy and capital flow management - FX intervention and market development: - The recent shift in FX intervention policy helped deepen the FX market and enhanced price discovery. - CBSL succeeded in purchasing $200 million per month during April-December 2017 on a net basis. - Combined with sustained capital inflows in 2017, this raised transaction volumes in the spot FX market and two-way exchange rate movements. - Despite increased market volatility in 2018, CBSL continued to intervene to accumulate reserves, although with some FX sales in the most recent volatility episode. - Authorities plan to operationalize a RFQ system, under transparent rules and competitive bidding. - Policy recommendations: - The CBSL should rely on a flexible exchange rate as a buffer against external shocks. - Greater exchange rate flexibility should be the first line of defense against portfolio capital outflows and would help preserve international reserves and maintain competitiveness. - Capital flow liberalization and CFMs: - Sri Lanka’s capital account is less open than in peer emerging and developing countries both in terms of de jure and de facto indices. - Capital flow liberalization can have benefits and costs; the integrated approach of capital account liberalization suggests an appropriate sequence to ensure benefits outweigh costs. - In April 2016 Sri Lanka imposed a repatriation requirement for export proceeds, constituting a capital flow management measure (CFM). - The repatriated export proceeds do not need to be converted into rupees and can be freely taken out from the country with no restrictions on their overseas use. - The measure has somewhat helped to encourage exporters to keep FX within the domestic financial system and reduce the imbalance in the FX market. - The role of this measure has diminished with continued macroeconomic adjustments and improved financial market confidence. - Given their distortive nature, CFMs should be temporary and lifted when macroeconomic stability is restored in line with the Institutional View on capital flows. --- *Annexes I–III, IMF staff assessment as presented in the source document.* ### 1. Public debt stabilized at 84.6 percent of GDP at end-2017. Public debt in this DSA covers ### 1. Public debt stabilized at 84.6 percent of GDP at end-2017. Public debt in this DSA covers ### Public debt stock and composition (end-2017) - Public debt: 84.6 percent of GDP. - Components of public debt under this DSA: - Central government debt: 79.3 percent of GDP. - Outstanding amount of loans guaranteed by the central government: 4.4 percent of GDP. - Outstanding Fund credit: 0.9 percent of GDP. - Domestic debt (mostly treasury bills and bonds) accounted for about 54 percent of the central government debt. - External composition of central government debt: - Multilateral and bilateral loans: 27 percent of central government debt. - International sovereign bonds: 14 percent of central government debt. - Nonresidents’ holdings of treasury bills and bonds: 3 percent of central government debt. - Foreign-currency denominated debt: 50 percent of total public debt. - Debt owed to official and multilateral creditors: about a quarter of total public debt. - Comparative metrics: - Sri Lanka’s debt to GDP ratio compared with emerging economies (excluding major oil exporters) median: 84.6 percent versus 53 percent. - Gross funding needs: described as the third largest among emerging economies (no numeric rank provided beyond "third largest"). ### Public debt detailed table highlights (2015–2017, selected figures) - Public debt (Rs. Bn and % GDP): - 2015: 8,996 (82.1 % GDP) - 2016: 9,113 (83.2 % GDP) - CR/17/253 estimate 2017: 9,968 (84.2 % GDP) - Updated 2017: 10,086 (84.7 % GDP) - Updated/Est. 2017 final: 11,241 (84.6 % GDP) - Central government debt (Rs. Bn and % GDP): - 2015: 8,503 (77.6 % GDP) - 2016: 8,595 (78.5 % GDP) - CR/17/253 2017: 9,387 (79.3 % GDP) - Updated 2017: 9,479 (79.6 % GDP) - Updated/Est. 2017 final: 10,534 (79.3 % GDP) - Central government domestic vs external (2017 updated/est.): - Domestic: 5,664 (42.6 % GDP) - Treasury Bills: 697 (5.2 % GDP) - Treasury Bonds: 3,892 (29.3 % GDP) - Other domestic: 1,075 (8.1 % GDP) - External: 4,870 (36.6 % GDP) - Multilateral and bilateral: 2,842 (21.4 % GDP) - International sovereign bonds: 1,475 (11.1 % GDP) - Nonresident holdings of T‑Bills and T‑Bonds: (value shown in table with formatting issues) 2.2 % reported in prior columns; updated/est. shows 2.4 % in one cell. - Publicly guaranteed debt (2017 updated/est.): 590 (4.4 % GDP). - Fund credit outstanding (2017 updated/est.): 117 (0.9 % GDP). - Financial obligations of SOEs (end-2017 estimate): 1,432 (10.8 % GDP). - Nominal GDP (2017 updated/est.): 13,289 (value shown in table; % GDP columns marked “...” for nominal GDP). ### Notes from table and data treatment (as reported) - Central government domestic debt includes treasury bonds issued to settle dues to CPC (Rs. 78,447 million) and to capitalize SriLankan Airlines (Rs. 13,125 million). - Central government external debt includes outstanding project loan for the Hambantota port development, following reclassification from the Sri Lanka Ports Authority. - Publicly guaranteed debt includes the Eurobond US$175 million issued by SriLankan Airlines. - Financial obligations of SOEs include short‑term debt, project loans, and SriLankan Airlines' liabilities related to aircraft lease; data for SriLankan Airlines are as of end‑March. - Financial obligations of SriLankan Airlines include lease commitment on aircrafts on order. - Debt owed by Road Development Agency is added to financial obligations of SOEs. ### Nonfinancial SOEs: financial obligations and performance (end-2017) - Estimated financial obligations of nonfinancial SOEs: 10.8 percent of GDP (based on latest available data as of end-2017). - Coverage and reporting: - Sri Lanka has more than 200 state-owned enterprises. - The Ministry of Finance publishes financial performance of 41 nonfinancial SOEs (nota bene: 41 SOEs comprise the dataset referenced). - Major SOEs’ 2017 aggregate result: - Three major SOEs (Ceylon Petroleum Corporation (CPC), Ceylon Electricity Board (CEB), Sri Lankan Airlines (SLA)) recorded a combined loss of 0.5 percent of GDP in 2017. - CPC: small profit (offset by others). - CEB losses: 0.4 percent of GDP. - SLA losses: 0.1 percent of GDP. - Year-to-year changes and drivers in 2017: - Nonfinancial SOEs’ financial obligations estimated to have decreased by 1.1 percentage points of GDP in 2017, reflecting absorption by the central government of the Hambantota Port loan from the Sri Lanka Port Authority. - Debt of CEB increased by 0.4 percent of GDP due to financial losses and an increase in project loans. - Data quality and transparency recommendations: - Scope to improve the quality of public debt data by adopting the 2014 Government Financial Statistics Manual. - Publish audited SOE financial data promptly. - Treatment in the DSA: - Nonfinancial SOEs’ financial obligations are not included in the public debt outstanding under this DSA. - Impact from possible realization of contingent liabilities from SOEs is assessed under a shock scenario. ### SOE balances (selected presentation) - Charted SOE balances show annual percentage-of-GDP balances for: - Ceylon Petroleum Corp., Ceylon Electricity Board, Sri Lankan Airlines, Other SOE balance, and Nonfinancial SOE balance for 2011–2017 (specific chart values not tabulated in text beyond aggregated statistics above). - Source for SOE balances: Ministry of Finance; and IMF staff estimates. ### External debt profile (end-2017) - External debt: 59 percent of GDP. - Sectoral holders: - General government: 36 percent of GDP. - Central bank: 2 percent of GDP. - Private external debt: around 21 percent of GDP (steady since 2014). - Debt-to-exports ratio: 272 percent in 2017. - Maturity and rollover: - 85 percent of private and public external debt is medium or long term, implying rollover risks described as "remain contained". - Sovereign bond repayments fall due in 2019–22, requiring preparation. - Currency composition: - More than half of the central government’s external debt stock is denominated in U.S. dollars. ### Baseline DSA projections and assumptions (program scenario under EFF-supported program) - Macroeconomic projections and targets: - Real GDP growth: from 3.1 percent in 2017 to 5.0 percent by 2023. - Inflation: projected to stay around 5 percent over the medium term. - Fiscal deficits: programmed to decrease from 5.5 percent of GDP in 2017 to the authorities’ target of 3.5 percent of GDP in 2020. - Primary balance: - 2017: balanced position. - 2018: surplus of 1 percent of GDP. - 2020: surplus of 2.1 percent of GDP. - Interest payment assumptions: - Projected on the basis of interest payments for existing debt and interest rates in primary and secondary government security markets prevailing in 2018 for newly issued debt. - Interest rates for newly issued debt are assumed to decrease gradually over the medium term. - Specific program-related items: - Projection incorporates expected proceeds in 2018 from the concession agreement on the Hambantota Port. - Publicly guaranteed debt projected at 4.9 percent of GDP at end-2018, in line with the indicative target under the program, and kept constant as a percent of GDP through 2023. - External debt projections reflect a projected reduction in the current account deficit from 2.6 percent of GDP in 2017 to around 2 percent of GDP over the medium term, and incorporate planned purchases under the Fund’s Extended Arrangement and disbursements of program loans by multilateral and bilateral creditors. ### Public debt projections (program scenario) - Public debt to GDP projection: from 84.6 percent in 2017 to 72.5 percent in 2023. - Drivers of debt reduction beyond 2018: - Favorable debt dynamics with a negative interest-rate-and-growth differential. - Primary surpluses. - Gross financing needs: - Projected to rise to 18.6 percent of GDP in 2018. - Projected to decrease to around 10 percent of GDP by 2023 as fiscal consolidation reduces overall deficit and debt amortization. ### Downside risks and shock scenarios - Stalled consolidation scenario: - If primary balance returns to historical level (-1.4 percent of GDP), debt-to-GDP ratio would remain about 83 percent until 2023. - Individual shock scenarios (effects summarized qualitatively on debt reductions being less significant): - Primary balance shock: lower primary surplus by 0.5 percentage points of GDP for 2019–20. - GDP growth shock: 2 percentage points lower than in the program scenario for 2019–20. - Exchange rate shock: 15 percent real depreciation in 2019 vis‑à‑vis the program scenario. - Interest rate shock: increase by 300 basis points for new borrowings during 2018–21 vis‑à‑vis the program scenario. - Combined shocks: - When shocks above are combined, debt to GDP ratio would reach 91 percent in 2023. - In the combined shock scenario, gross financing needs would remain elevated at 12−14 percent of GDP in 2023. - Contingent liability shock scenario: - Conservative scenario where central government becomes liable for additional debt of 10 percent of GDP in 2018: - Debt to GDP ratio would jump to 93 percent of GDP initially and gradually decline to 86 percent of GDP in 2023. - Gross financing needs in this scenario would remain elevated at 12−14 percent of GDP in 2023. - Likelihood of contingent liabilities materializing depends on completing energy pricing reforms (to ensure profitability of oil and electricity SOEs) and reducing losses from other SOEs. ### Fiscal consolidation challenge - The envisaged improvement in the cyclically-adjusted primary balance of around 3 percentage points of GDP over 2016−18 is noted to be higher than in 80 percent of international experiences, indicating the challenge of the fiscal consolidation plan. ### Debt sustainability risk assessment - Heat map analysis indicates a high risk to debt sustainability. - Benchmarks and exceedances: - Debt burden benchmark: 70 percent of GDP — exceeded in program and shock scenarios during the projection period. - Gross financing need benchmark: 15 percent of GDP — exceeded in program and shock scenarios during the projection period. - Initial conditions: under the program scenario, debt/GDP and gross financing needs in 2017 were 84.6 percent and 18.1 percent of GDP, respectively. - Debt profile analysis indicates a moderate degree of vulnerabilities related to: - Market perception. - External financing requirement. - Debt held by non-residents. - Debt denominated in foreign currency. ### External debt sustainability projections - External debt to GDP projection under program scenario: - From 59 percent of GDP in 2017 to around 53 percent of GDP in 2023. - Drivers of the external debt decline: - Robust GDP growth. - A steady pace of fiscal consolidation. - Gradual current account adjustments. *Source: IMF staff summary based on the DSA and related tables in the provided content.* ### 9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate ### 9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate ### Key vulnerabilities and risks - Currency risk, notably related to the dollar, is high. - Large rupee depreciation could pose a significant risk: stress tests show that a 30 percent real depreciation could raise the external debt to GDP ratio to about 78 percent by 2023. - In the short run, tighter global liquidity and shifts in investor confidence could raise rollover vulnerabilities and costs. - Despite the high share of medium- to long-term debt, lumpy repayments starting in 2019 and external financing at non-concessional terms, gradually substituting concessional financing, point to the need to speedily build up buffers. - Lower than expected GDP or export growth would also deteriorate debt dynamics. ### Public DSA — Baseline scenario: key projections and indicators (selected) - Nominal gross public debt (in percent of GDP): 76.4 (2016), 84.7 (2017), 84.6 (2018), 83.7 (2019), 81.8 (2020), 79.5 (2021), 77.2 (2022), 74.9 (2023), 72.5 (projection label present in table). - o/w: guarantees & Fund credit (in percent of GDP): 3.6 (2016), 5.1 (2017), 5.3 (2018), 6.4 (2019), 6.5 (2020), 6.4 (2021), 6.3 (2022), 6.1 (2023), 5.8 (projection label present). - EMBIG (bp): 368 (as presented). - Public gross financing needs (in percent of GDP): 22.4 (2016), 17.5 (2017), 18.1 (2018), 18.6 (2019), 15.9 (2020), 15.2 (2021), 12.6 (2022), 13.6 (2023), 10.2 (projection label present). - Real GDP growth (in percent): 6.1 (2016), 4.5 (2017), 3.1 (2018), 4.0 (2019), 4.5 (2020), 4.7 (2021), 4.8 (2022), 4.9 (2023), 5.0 (projection label present). - Inflation (GDP deflator, in percent): 7.6 (2016), 4.1 (2017), 8.2 (2018), 5.0 (2019), 4.7 (2020), 4.8 (2021), 4.7 (2022), 4.8 (2023), 4.7 (projection label present). - Nominal GDP growth (in percent): 14.2 (2016), 8.7 (2017), 11.6 (2018), 9.3 (2019), 9.5 (2020), 9.7 (2021), 9.8 (2022), 9.9 (2023), 10.0 (projection label present). - Effective interest rate (in percent): 7.5 (2016), 7.1 (2017), 7.8 (2018), 7.7 (2019), 7.9 (2020), 8.1 (2021), 8.4 (2022), 8.7 (2023), 8.7 (projection label present). - Change in gross public sector debt (in percent of GDP): 0.7 (2016), 1.5 (2017), -0.1 (2018), -0.9 (2019), -1.9 (2020), -2.3 (2021), -2.3 (2022), -2.3 (2023), cumulative -12.1. - Identified debt-creating flows (cumulative shown): -1.4 (2016), 0.5 (2017), -2.4 (2018), -3.0 (2019), -3.2 (2020), -3.2 (2021), -3.1 (2022), -3.0 (2023), cumulative -18.3. - Primary deficit (in percent of GDP): 1.7 (2016), 0.2 (2017), 0.0 (2018), -1.0 (2019), -2.0 (2020), -2.1 (2021), -2.1 (2022), -2.1 (2023), cumulative -11.2. - Primary (noninterest) revenue and grants (in percent of GDP): 13.0 (2016), 14.2 (2017), 13.8 (2018), 14.6 (2019), 15.9 (2020), 16.0 (2021), 16.1 (2022), 16.2 (2023), cumulative 95.1. - Primary (noninterest) expenditure (in percent of GDP): 14.7 (2016), 14.5 (2017), 13.8 (2018), 13.7 (2019), 13.9 (2020), 13.9 (2021), 14.0 (2022), 14.1 (2023), cumulative 83.9. - Automatic debt dynamics (in percent of GDP): -3.0 (2016), 0.3 (2017), -2.1 (2018), -1.3 (2019), -1.2 (2020), -1.2 (2021), -1.0 (2022), -0.9 (2023), cumulative -6.3. - Residual, including asset changes (in percent of GDP): 2.1 (2016), 1.0 (2017), 2.3 (2018), 2.1 (2019), 1.3 (2020), 0.9 (2021), 0.8 (2022), 0.7 (2023), cumulative 6.2. ### External debt sustainability / stress-test highlights - Baseline external debt (in percent of GDP): 53 (presented as baseline value). - Interest rate shock, CA shock, combined shock and real depreciation scenarios are presented; notable outcome: - Real depreciation shock: one-time real depreciation of 30 percent (occurs in 2017 per note) leads to external debt rising to about 78 percent by 2023 (stress test result). - External debt-to-exports ratio (in percent): 264.6 (2013), 257.2 (2014), 264.7 (2015), 266.6 (2016), 271.5 (2017), with projected series showing 269.0 (2018), 268.4 (2019), 261.3 (2020), 257.9 (2021), 255.9 (2022), 255.4 (2023) in the external DSA table. - Gross external financing need (in billions of US dollars): 11.9 (2013), 11.1 (2014), 12.2 (2015), 12.6 (2016), 12.9 (2017), 11.9 (2018), 13.6 (2019), 13.6 (2020), 13.6 (2021), 14.2 (2022), 14.3 (2023). - Gross external financing need (in percent of GDP): 16.0 (2013), 14.0 (2014), 15.3 (2015), 15.5 (2016), 14.7 (2017), 12.7 (2018), 13.6 (2019), 12.8 (2020), 12.0 (2021), 11.7 (2022), 11.0 (2023) (as tabulated). ### Stress tests and scenarios (selected underlying assumptions) - Baseline real GDP growth assumptions: 4.0 (2018), 4.5 (2019), 4.7 (2020), 4.8 (2021), 4.9 (2022), 5.0 (2023). - Alternative scenarios shown include Historical Scenario (real GDP growth 4.0 in 2018 then 5.5 from 2019 onward), and Constant Primary Balance Scenario (primary balance held at 1.0 percent of GDP from 2019 onward). - Stress test types shown: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Shock; Contingent Liability Shock; Combined Macro-Fiscal Shock. Charts report impacts on Gross Nominal Public Debt and Public Gross Financing Needs across 2018–2023. ### Debt dynamics drivers (external DSA decomposition highlights) - Identified external debt-creating flows (annual): -2.5 (2013), -2.1 (2014), 1.3 (2015), 0.2 (2016), -3.2 (2017), -1.6 (2018), -1.2 (2019), -1.6 (2020), -1.5 (2021), -1.6 (2022), -1.7 (2023). - Current account deficit, excluding interest payments (in percent of GDP): 2.0 (2013), 1.0 (2014), 0.9 (2015), 0.7 (2016), 1.0 (2017), 0.3 (2018), 0.2 (2019), -0.4 (2020), -0.9 (2021), -1.3 (2022), -1.0 (2023). - Net non-debt creating capital inflows (negative) (in percent of GDP): -1.5 (2013), -1.3 (2014), -0.7 (2015), -0.8 (2016), -1.5 (2017), -1.8 (2018), -1.3 (2019), -1.4 (2020), -1.3 (2021), -1.3 (2022), -1.3 (2023). - Automatic debt dynamics decomposition (contributions): contribution from nominal interest rate rises over projections (e.g., 1.4 to 3.2 across 2013–2023 range in table); contribution from real GDP growth negative and large in earlier years (e.g., -1.7 to -2.5), and contribution from price and exchange rate changes shows large negative in 2013 (-2.7) and varied thereafter. ### Policy implications highlighted in text - Need to speedily build up buffers given rollover risks, lumpy repayments starting in 2019, and substitution of concessional by non-concessional external financing. - Risks from currency depreciation and deleveraging warrant caution and greater reserve coverage to mitigate debt-servicing vulnerabilities. - Lower-than-expected GDP or export growth would worsen debt dynamics, implying the importance of policies that support growth and export performance. _Italic: Source: IMF staff; content as presented in the provided PDF extract._ ### 1. Growth has been subdued in 2017 due to the lingering effects of the drought since ### 1. Growth has been subdued in 2017 due to the lingering effects of the drought since ### Overview: growth, inflation, and external balance - Real GDP grew by 3.1 percent in 2017, the lowest in a decade, due to weather-related shocks and contraction in agriculture that only started to normalize in the last quarter of 2017. - Credit growth reached 14.7 percent in December 2017. - The current account deficit widened to about 2.6 percent of GDP due to higher imports of food and fuel from weather-related shocks. - Headline inflation is stabilizing to mid-single digit and is expected to remain within the inner consultation band under the program for the remainder of the year, as weather-related supply disruptions dissipate. ### II. Program performance (fourth review) - End-December quantitative performance criterion: met. - End-March indicative target for the primary balance: met. - Indicative targets missed: end-December and end-March on tax revenues; end-March on cost of non-commercial obligations for fuel and electricity (net of government transfers). - End-December NIR target: met by a margin of $721 million. - Reserve money target: below the IT target by about Rs 26 billion. - Monetary Policy Consultation Clause (MPCC): inner consultation band breached in December 2017 due to food inflation, but inflation stayed within the band in March 2018. - Structural and policy actions taken: - Cabinet approval of an automatic fuel pricing mechanism. - Establishment of the Bulk Supply Transaction Account for the electricity sector in early May. - Implementation progress on an IT-based commitment control system with commitment ceilings for line ministries for the 2018 budget. - Cabinet approved a debt management strategy for international sovereign bonds maturing over 2019-22 in January 2018. - Cabinet approved in April 2018 a policy note outlining key elements of amendments to the Monetary Law Act (MLA). - A detailed IRA tax manual was published in May 2018 (with delays). - Commitment: take corrective actions to ensure future structural benchmarks are met in a timely manner. ### III. Fiscal policy — Fiscal stance and targets - Overall fiscal deficit reduced to 5.5 percent of GDP in 2017. - Medium-term objective: bring overall central government deficit down to at least 3.5 percent of GDP by 2020 and beyond. - Program targets: - Primary surplus of 1 and 2 percent of GDP in 2018 and 2019, respectively. - Annual increase in the tax-to-GDP ratio by about 1 percentage point of GDP in 2019. - 2017 outcomes: - Ratio of tax revenue to GDP increased by 0.3 percentage point to 12.6 percent in 2017, but fell short of the program’s indicative target by 0.1 percentage point. - Spending to address drought and floods reached about Rs 50 billion (0.4 percent of GDP), including in-kind assistance to 840,000 needy families and reconstruction of damaged infrastructure. - Quasi-fiscal losses for Ceylon Electricity Board (CEB) in 2017: Rs 47 billion (0.4 percent of GDP), of which the government transferred Rs 6 billion to CEB. - Capital expenditure and net lending increased to 4.9 percent of GDP, from 4.8 percent in 2016. - Central government recorded a small primary surplus of Rs 2.1 billion in 2017, meeting the program target (floor) of a deficit of Rs 23 billion (0.2 percent of GDP). - Ceylon Petroleum Corporation (CPC) recorded a profit of Rs 3.5 billion (0.02 percent of GDP). ### 2018 budget and fiscal measures - 2018 budget target: primary surplus of about Rs 145 billion (1 percent of GDP). - Revenue measures expected to yield Rs 110 billion (0.8 percent of GDP), including: - VAT base-broadening measures. - Excise tax reforms for vehicle and beverage. - New levies on telecom and financial institutions. - Rate revision of fees and charges. - Compensation for revenue loss from fuel import duties cut in late 2017 (estimated at ¼ percent of GDP for 2018) to be phased out as fuel pricing mechanism comes into effect and through prudent expenditure management. - Appropriations within the total budget envelope for mitigation programs amounting to Rs 21 billion (0.15 percent of GDP) for river bank protection, crop insurance, urban flood mitigation and resettlement in landslide risk areas. - Commitment: earmark resources within the budget to compensate by end-year CPC and/or CEB for the cost of NCOs if necessary. - Published budget speech included: a tax expenditure statement, plan to rationalize tax expenditures, estimated fiscal cost of NCOs for CPC and CEB, and a report outlining the cost of fuel and electricity NCOs (structural benchmarks). - Diagnostic review of the VAT system completed in November (structural benchmark). ### Strengthening fiscal rules and transparency - Intention to revise the Fiscal Management (Responsibility) Act with IMF technical assistance to: - Design fiscal rule consistent with medium-term debt-reduction objectives. - Include effective enforcement mechanisms and correction mechanisms with clearly defined escape clauses for unforeseen events such as natural disasters. - Proposed structural benchmark: obtain cabinet approval of a policy note outlining key elements of amendments to the Fiscal Management (Responsibility) Act of 2003 by March 2019. - Operational commitment: achieve overall deficit of 3.5 percent of GDP by 2020. - Transparency improvements: - Quarterly fiscal performance reports to Parliament since 2017Q1. - Commitment to compile GFSM-compatible tables on cash operations and debt stock by December 2018 (with IMF TA). - Cabinet approval by end-September 2018 of a strategy with timetable to transition to accrual-based accounting for general government by end-2022 (with IMF TA). ### Debt management and contingent liabilities - Cabinet approved a strategy to manage international sovereign bond maturities between 2019 and 2022 in January 2018 (structural benchmark). - Active Liability Management Act approved by Parliament in March. - Proceeds from commercializing public assets to be used to smooth bunching of debt service and support liability management; earmarked for future debt service payments, particularly for international sovereign bonds maturing from 2019. - Proposed structural benchmark: approve Medium-Term Debt Strategy (MTDS) for 2019–23 by October 2018, supported by IMF and World Bank TA, to: - Quantify main risks of public debt portfolio. - Specify appropriate currency and maturity composition and strategy. - Present debt issuance options based on cost-risk tradeoffs. - Be consistent with monetary and fiscal policy objectives. - Cover both debt and guarantees. - Proposed structural benchmark: submit by March 2019 for cabinet approval a plan with timetable to establish an independent debt management agency (with IMF and World Bank TA). Agency to: - Be endowed with financial and administrative autonomy. - Conduct all operations related to issuance of debt and secondary market activities in line with MTDS. - Participate in evaluation and approval of all debt, derivatives, and guarantees. - Proposed indicative target for end-December 2018: keep ratio of outstanding guarantees to GDP at 4.9 percent of GDP (higher than end-2017 ratio of 4.4 percent of GDP) to accommodate additional guarantees for water and transportation development projects. ### Revenue mobilization: policy and implementation - Key tax policy measures implemented: - Cabinet suspended the Board of Investment Act in May 2016 to concentrate exemption-granting powers in the Ministry of Finance. - VAT amendment in November 2016 raised VAT rate from 11 percent to 15 percent and broadened VAT base by eliminating exemptions for telecommunication and private healthcare (excluding diagnostic tests, dialysis and OPD services); VAT continues to apply to wholesale and retail trade. - Diagnostic review of the VAT system (structural benchmark) completed in November concluded that VAT expenditure is 1.3 percent of GDP. - Budget 2018 VAT base broadening (items such as yarn, fabrics, industrial racks, electronic goods, and airplanes and parts) expected to yield about 0.2 percent of GDP in revenues. - Inland Revenue Act (IRA) came into force on April 1st, 2018, introducing: removal of tax exemptions to broaden the base; capital gains tax on immovable property; increased taxes on dividends and interest income; and a transparent set of investment-based tax incentives. - Budget 2019 focus: broaden base of income tax and VAT and rationalize excise taxes to secure about 1 percent of GDP in additional revenue. - IRA implementation actions: - Regulations: Draft regulations relating to transitional provisions published in early April 2018; delegation of powers for administrative authority to relevant IRD staff carried out. - Staff training: IRD head office staff trained and expanding training to regional IRD staff. - Comprehensive tax manual: published in May 2018 (originally expected in January 2018). - Communication and taxpayer awareness: comprehensive media campaign and awareness programs in Colombo and key regional centers. - IT systems: funding secured for changes to the RAMIS system. - Business process redesign: modifications for new taxes (capital gains, modified withholding taxes such as Pay-As-You-Earn) introduced in March 2018. - Administrative improvements expected to boost revenues: - RAMIS IT system rolled out; VAT compliance strategy with risk-based audits for large businesses (construction sector) and planned expansion to SMEs. - Under IRA, IRD can charge interest and penalties on late filings and require tax payment before filing an objection. - Organizational reforms at IRD: restructuring along functional lines, creating a design and monitoring unit, streamlining management, strengthening Large Taxpayer Unit, introducing mandatory e-filing, and enhancing use of taxpayer identification numbers. - Customs IT (ASYCUDA) improvements: case selection for risk-based cargo audit now automated. ### Expenditure reforms and social protection - Fiscal strategy: keep overall spending envelope under control while reallocating spending to health, education, and infrastructure. - Climate change and disasters: mitigation and adaptation measures to include contingent budgeting and enhanced insurance schemes for natural disasters. - Gender budgeting: Cabinet approved plan in November 2016 to establish a gender-budgeting mainstreaming program in every ministry; started developing key performance indicators for 20 ministries. - Social safety nets: - Welfare Benefits Board (WBB) established under MOF to rationalize and broaden coverage of social assistance through a consolidated national database. - With World Bank support, WBB to develop and manage a new Social Registry for welfare program beneficiaries starting with four major cash transfer programs: Samurdhi, Elderly Benefit, Disabled Benefit, and Chronic Kidney Disease Benefit. - Proposed structural benchmark: obtain cabinet approval of eligibility criteria for the four programs by August 2018. - Operational plan: make the Social Registry operational, establish and test data capture processes, and start collecting eligible beneficiaries’ information by January 2019. *IMF country report content (cr18175).* ### 15. Reforms to improve public financial management (PFM) are underway, despite ### 15. Reforms to improve public financial management (PFM) are underway, despite delays in rolling out the new Integrated Treasury Management Information System (ITMIS) ### Public Financial Management (PFM) systems and ITMIS - MOF modified the existing PFM IT system (CIGAS) and it is now capable of imposing quarterly spending ceilings for all ministries (January 2018 structural benchmark). - Expected benefits: - Prevent spending units from contracting with vendors beyond the commitment ceiling. - Allow the government to adjust and reallocate spending during the year. - ITMIS capabilities: - Commitment control, budget preparation, treasury operations, and accounting. - Implementation status and timeline: - Adoption delayed due to difficulties in upgrading IT equipment for spending units, especially in the regions, and delays in customizing the ITMIS software. - A detailed rollout plan has been developed; during the transition, CIGAS will remain operational. - ITMIS roll-out will be implemented on a staggered basis, with full roll-out expected by September 2019. ### IV. State enterprises — financial exposure and governance - Scale and risks: - Sri Lanka currently has about 200 public enterprises. - Outstanding financial obligations of SOEs identified totaling Rs 1.4 trillion by end-2016, including Rs 1.2 trillion for CPC, CEB, SriLankan Airlines, and the Sri Lanka Ports Authority. - These obligations represent a risk to public finances (either directly or through the state banks which fund the largest SOEs). - Transparency and monitoring measures: - Statements of Corporate Intent (SCIs) were signed and published in April 2017 for the five largest SOEs: CPC, CEB, National Water Supply and Drainage Board, Airport and Aviation Services Limited, and Sri Lanka Ports Authority. - SCIs include mission, high level objectives, multiyear corporate plan; capital expenditure and financing plans; and explicit financial and non-financial KPIs. - A compliance report outlining performance against KPIs was submitted to cabinet in May 2018 and will be updated by September 2018. - Plan to expand coverage of SCIs to an additional 10 SOEs. - Accelerate publication of audited financial statements for SOEs with SCIs, starting with 2016 and 2017 reports by end-2018. ### SriLankan Airlines restructuring - Policy decision: - Approve a restructuring plan to ensure commercial viability and increase attractiveness to investors. - A comprehensive restructuring considered least risky and most cost-effective. - Governance and timeline: - Restructuring Committee created and an expert airline consulting firm engaged to develop a detailed plan. - Plan involves network and fleet optimization and debt resolution. - New board appointed in March (2018) to implement measures to reduce operational and financial costs and eliminate future losses. - Obtain cabinet approval of such measures by July 2018 (proposed structural benchmark). ### Energy pricing and recognition of quasi-fiscal costs - Background and past deadline: - Original structural benchmark to establish automatic fuel and electricity pricing mechanisms by end-2016 was not met. - Actions taken: - Completed a report outlining the cost of non-commercial obligations (NCOs) for fuel and electricity in November 2017 with a delay (structural benchmark), supported by IMF TA. - CEB and the Public Utilities Commission (PUC) established a Bulk Supply Transactions Account and are using it to settle transactions per the November 2015 tariff methodology, with monthly submissions by CEB to PUC of related bank statements and other transactions, as of May 2018 (end-March structural benchmark). - Fiscal treatment and monitoring: - Recognize the quasi-fiscal cost of fuel and electricity NCOs as central government expenditure by explicitly accounting for them in the EFF program targets. - A quarterly indicative target has been set on the cost of NCOs for fuel and electricity (net of government transfers) for 2018Q1-Q4 (see the Technical Memorandum of Understanding for detail). - Cabinet approved the automatic pricing mechanism for fuel in May 2018 (end-March structural benchmark), based on a cost reflective pricing formula developed by a governmental technical committee in 2015. - Obtain cabinet approval of the automatic pricing mechanism for electricity by September 2018 (structural benchmark). - Continue to report the financial performance of CPC and CEB on a quarterly basis (see the Technical Memorandum of Understanding). - Intend to introduce cost-reflective water tariff settings when the PUC starts regulating the water sector. ### V. Monetary and exchange rate policy — objectives and legal framework - Monetary policy focus: - Keep inflation in the mid-single digits. - CBSL raised policy rates by 25 bps in March 2017 to rein in inflationary pressure and control credit growth. - Upper limit of the inner band of the MPCC was breached in December 2017, mainly due to food inflation from weather-related supply disruptions. - Inflation started to abate and March (2018) inflation remained within the inner MPCC band. - CBSL reduced the Standing Lending Facility Rate (SLFR) by 25 basis points in April 2018. - Monetary policy monitored through the MPCC, supported by monitoring of reserve money developments. - Strengthening CBSL legal framework: - Commit to modifying the Monetary Law Act (MLA) to remedy monetary financing, non-core activities, and inadequate autonomy identified as impediments to flexible inflation targeting (FIT) and to address 2016 safeguards assessment shortcomings. - A policy note outlining key elements of amending the MLA was submitted to cabinet in March 2018 and the cabinet approved the note (end-March structural benchmark) in early April 2018. - Next steps and timeline: - Draft amendments to the MLA in consultation with IMF staff and obtain cabinet approval of the amended MLA by December 2018 (proposed structural benchmark). - Submit a bill to amend the MLA to parliament by March 2019. - Planned amendment elements (among other issues): - (i) establish price stability as the primary objective of monetary policy; - (ii) address Central Bank lending to the government related to purchases of treasury bills in the primary market and advances to the government; - (iii) eliminate quasi-fiscal activities of the CBSL, if any; - (iv) strengthen the CBSL’s institutional, personal (e.g., the government’s voting representation in monetary policy) and financial (e.g. on recapitalization and profit distribution) autonomy, accountability, and transparency; - (v) streamline decision-making and monetary policy formulation process. ### Roadmap to flexible inflation targeting and exchange rate flexibility - Roadmap objectives and status: - Roadmap formulated in October 2017 to establish inflation as the nominal anchor allowing for greater exchange rate flexibility; identifies time-bound reform measures consistent with IMF staff recommendations (TA in May 2017) and has been approved by the Monetary Board. - Time-bound measures are being incorporated into program reviews. - Expected outcomes and reforms: - Ensure clear separation between fiscal and monetary policies. - Retain a role for CBSL in smoothing excessive exchange rate volatility while guarding against conflicts of objectives. - Adopt FX intervention policies consistent with a flexible exchange rate regime. - Improve FX market functionality by liberalizing financial account transactions, deepening the FX market, and introducing a transparent FX intervention mechanism. - Ensure financial sector stability by assessing risks associated with greater FX flexibility. - Develop technical infrastructure through improved forecasting and modeling with IMF TA. - Establish policy decision-making guidelines on target choice and handling unanticipated shocks. - Strengthen public-awareness outreach as the cornerstone of CBSL’s communication strategy during the IT transition. ### Exchange rate intervention strategy and RFQ system - Strategy and recent practice: - CBSL intends to durably transition to a more flexible exchange rate regime. - Since late May (2018), CBSL has intervened in the FX market only to build up reserves or respond to disorderly FX market conditions. - Plan to intervene via a Request-for-Quotes (RFQ) system that operates under transparent rules and permits competitive bidding by all banks that participate in FX trading. - Timeline and consultation: - Share RFQ system design plans with the IMF and discuss possible implications on obligations under Article VIII. - Finalize the RFQ system design and start using the system by December 2018 (proposed structural benchmark). ### Reserve coverage and FX operations - Reserve buildup: - Increased pace of FX purchases brought program NIR (per the TMU definition) from $4.2 billion at end-June to $5.1 billion at end-December 2017. - Exchange rate change between end-May 2017 and end-February 2018: -1.5 percent against the US$. - Commit to continue FX purchases to enable steady buildup of reserves while allowing greater exchange rate flexibility. - Commit to monthly consultations with the IMF for corrective actions in foreign exchange intervention if significant deviations from an agreed benchmark occur; will consult with Fund staff in event of highly disruptive exchange rate movements. - FX swaps: - Gradually wound down FX swaps with domestic commercial banks from $2.5 billion at end-2016 to $1.4 billion at end-February 2018. - Plan to further reduce swap liabilities gradually during 2018. ### FX liberalization and repatriation requirement - Policy pledges during the program: - Will not impose or intensify restrictions on payments and transfers for current international transactions; introduce or modify multiple currency practices; conclude bilateral payments agreements inconsistent with Article VIII; or impose or intensify import restrictions for balance of payments reasons. - Enacted the Foreign Exchange Act which repealed the previous exchange control law to further liberalize FX transactions. - CBSL and the government will abstain from providing subsidized exchange guarantees for foreign currency borrowing. - Repatriation requirement: - Introduced a repatriation requirement of export proceeds to encourage keeping FX within the domestic financial system amid balance of payments pressures. - Will assess removing the FX repatriation requirement, with timing linked to progress with macroeconomic adjustments (especially net international reserves) envisaged under the program. ### VI. Financial sector policies — supervision, resolution, and legal reforms - Recent measures implemented: - Implemented the first phase of the Basel III capital standards in July 2017 and will continue to ensure banks comply with the current schedule by January 2019. - Established in January 2018 a new Resolution and Enforcement Department within CBSL to oversee resolution actions transferred from respective regulators for financial institutions in need of resolution. - Planned measures to ensure stability: - (i) Continue to monitor credit growth and report to the Monetary Board. - (ii) Develop macro- and micro-prudential tools to address rapid credit expansion or imprudent lending. - (iii) Encourage the Condominium Management Authority to introduce a regulatory framework for mandatory certification and pre-sale actions. - (iv) Improve management of exchange rate risk in the financial sector during greater exchange rate flexibility. - (v) Use a Financial System Stability Review provided by IMF assistance to assess FX and credit risks in banks and NBFIs. - (vi) Review and update Banking Act, Finance Business Act, and the Microfinance Act to modernize the financial sector. - (vii) Ensure banks abide by CBSL’s schedule for increases in capital adequacy ratios under Basel III, and that all banks and NBFIs meet new core capital requirements stipulated by CBSL. - (viii) Strengthen NBFI supervision so cases with significant capital shortfalls or severe business practice shortcomings are referred to the resolution and enforcement department. - (ix) Properly authorize CBSL’s resolution and enforcement department to take resolution and enforcement actions and take steps to amend the legal framework in 2019 to enable effective enforcement and resolution functions. ### AML/CFT, anti-corruption, and beneficial ownership reforms - Legislative and regulatory measures and timelines: - By end-December 2018, submit to Parliament a draft law to criminalize all outstanding United Nations Convention Against Corruption (UNCAC) offences and an amendment to the Asset Disclosure Law covering a comprehensive range of public officials, including assets legally owned and beneficially owned, subject to dissuasive sanctions for non-compliance or false declarations, verifiable and publicly available online. - FIU measures underway to address key issues with relevant ministries and stakeholders to ensure all AML/CFT measures are implemented during 2018. - Draft amendments to the Mutual Assistance in Criminal Matters Act (MACMA) finalized and will be submitted to Parliament in due course; expected to be passed before end of June 2018. - Amendments to Trust Ordinance passed by Parliament in March 2018. - Cabinet approval in March 2018 to amend the Companies Act No 7 of 2007 to include a new provision on beneficial ownership disclosures; drafting process has started. - Customer due diligence (CDD) rules for designated non-financial businesses and professions (DNFBPs) issued in January 2018. - Guidelines for casino, real estate and gem and jewelry sectors issued in April 2018. - Guidelines on identification of beneficial ownership for financial institutions issued in April 2018. - Regulation promulgating UNSCR 1718 on DPRK issued in October 2017 and implementation completed. - Regulation promulgating UNSCR 2231 drafted and expected to be issued before June 2018. - Commit to enhance risk-based supervisory activities in the financial sector, impose enforcement actions where appropriate, and introduce risk-based supervision of high-risk DNFBPs such as real estate dealers, casinos and the gem and jewelry sector. - Ensure adequate resources for the FIU. ### VII. Structural reforms to boost trade, investment, and inclusive growth - Policy priorities: - Greater integration into regional and global supply chains, higher levels of FDI, and enhanced prospects for private sector investment as critical to achieving medium-term macroeconomic objectives. - Need for better infrastructure and improvements in the trade regime and investment climate. - Recent trade developments: - Entered into a Free Trade Agreement with Singapore in January 2018. - Started negotiations on new Free Trade Agreements with China, India, Japan, Malaysia and Thailand. - GSP plus trade status with EU—reinstated in May 2017—has already started to have a positive impact on exports. *IMF / Sri Lanka program document (excerpt).* ### 31. To boost trade and private sector development, we will seek to reduce costs and ### 31. To boost trade and private sector development, we will seek to reduce costs and ### Trade and competitiveness — measures and objectives - Removed around 1,200 para-tariffs in 2017. - Conduct a stock-taking review of Sri Lanka’s trade regime, including an evaluation of tariffs and para-tariffs and other nontariff barriers that have led to a high level of effective protection and hampered trade by October 2018. - Prepare and obtain cabinet approval of a strategy to rationalize remaining para-tariffs over the medium term, together with new revenue sources to offset revenue losses by March 2019 (proposed structural benchmark). - Formulated a new Trade Policy and a National Export Strategy with objectives to: - increase the efficiency of trade facilitation; - remove barriers to foreign investment entry and establishment (including access to land); - enhance access to finance; and - strengthen financial market infrastructure. - Operationalize a one stop shop for foreign direct investment under the Board of Investment by October 2018. - Expected outcomes: create a predictable, consistent, and transparent trade regime that will improve competitiveness, attract FDI, and unlock new sources of growth. ### Port City project and regulatory approach - Progress being made on development of the Port City project. - Considering the introduction of a special regulatory regime for the project to reach the full growth and social impact potential of this mega-project while ensuring transparency and even-handedness in the investment development process. - Authorities will share plans with the IMF and discuss any implications under the program. ### Labor force participation and gender measures - Undertaken several measures to remove barriers that constrain female labor force participation. - Plan to launch gender budgeting in 20 ministries as pilots during the year with assistance from USAID and eventually expand it to all line ministries. - Training provided to 450 childcare providers and established 35 new childcare facilities. - Seek Cabinet approval on a policy guideline by October 2018 that will require employers to provide childcare services in housing complexes and industrial zones. - Additional initiatives: facilitate part-time and flexible work arrangements by taking legislative measures as needed, and improve access to tertiary education and vocational training. - Expected effect: facilitating female labor force participation is expected to boost growth in the long run. ### Risks and contingencies - Main domestic risks identified: - (i) weaker than projected revenues due to implementation delays in fiscal reforms; - (ii) a slower-than-expected recovery in agriculture which keeps food inflation high; - (iii) weaker than expected performance of state owned enterprises; and - (iv) a reacceleration of credit growth, particularly in construction which would add to macro-financial vulnerabilities. - External risks mainly stem from reversal of portfolio inflows which raises government borrowing costs and slows the buildup of foreign reserves. - If risks materialize, the government stands ready to adjust policies promptly, in close consultation with the IMF staff, to ensure achievement of a stronger and resilient economy at the end of the program. ### Program monitoring: review schedule and key implementation dates - Program subject to semiannual reviews with performance criteria and indicative targets set out in Table 1 attached to this MEFP and the TMU. - Completion of the fifth and sixth reviews will require observance of the quantitative performance criteria for end-June 2018 and end-December 2018, respectively, as well as continuous performance criteria, as specified in Table 1 attached to this MEFP. - The fifth and sixth reviews of the program are scheduled to take place on or after November 20, 2018, and April 20, 2019 respectively. ### Structural benchmarks (selected) and target completion dates - Fiscal policy: - Senior management at the Ministry of Finance and CBSL to approve a Medium-Term Debt Strategy (MTDS) for 2019-23 — Oct-18. - Cabinet to approve a policy note outlining key elements of amendments to the Fiscal Management (Responsibility) Act of 2003 — Mar-19. - Cabinet to approve a plan with a clear timetable for establishment of an independent debt management agency — Mar-19. - SOE reforms: - Cabinet to approve measures to reduce operational and financial costs of SriLankan Airlines and eliminate future losses — July-18. - Monetary and exchange rate policies: - Cabinet to approve the amended Monetary Law Act (MLA), for submission to Parliament by March 2019 — Dec-18 (target completion date indicated in the table). - CBSL to operationalize a “Request for Quotes” (RFQ) system for FX trading — Dec-18. - Structural reforms: - Cabinet to approve eligibility criteria for four major targeted cash transfer programs (Samurdhi, Elderly Benefit, Disabled Benefit, and Chronic Kidney Disease Benefit) — Aug-18. - Cabinet to approve a strategy to rationalize para-tariffs over the medium term, together with new revenue sources to offset revenue losses — Mar-19. ### Status notes on selected existing structural benchmarks (as reported) - Approval by cabinet of a policy note outlining the key elements of amendments (or replacement) to the Monetary Law Act (MLA), in consultation with the IMF — March 2018 — Not met (implemented with delay). The cabinet approved a policy note to amend the MLA in April 2018. - MOF to publish a detailed IRA tax manual with practical tax and administrative examples — January 2018 — Not met (implemented with delay). The manual was published in May 2018 after the entry into force of the IRA in April 2018. - MOF to implement an IT-based commitment control system with commitment ceilings for line ministries for the 2018 budget — January 2018 — Met (modified CIGAS system used to make quarterly commitment ceilings operational for the 2018 budget). - Cabinet to approve a debt management strategy for international sovereign bonds maturing over 2019-22 — June 2018 — Met (January 2018 cabinet approval of tender offers and parallel new issues to refinance maturing sovereign bonds from 2019 onwards). - Automatic fuel pricing mechanism — March 2018 — Not met (implemented with delay). Cabinet approved adoption of a cost-reflective fuel pricing mechanism in May 2018; target date had been reset to March 2018 at the second review. - CEB and the Public Utilities Commission to establish a Bulk Supply Transactions Account — March 2018 — Not met (implemented with delay). The Bulk Supply Transactions Account was established in May 2018 and monthly data for 2016-17 published by the PUC. *Source: Excerpt from IMF staff report and MEFP materials (as provided).* ### 2017. Publication of the non-comme ### 2017. Publication of the non-comme ### Reform actions and state-owned enterprises (SOEs) - Cabinet-approved strategy for Sri Lankan Airlines: Substantial reforms undertaken under a strategy approved by the Cabinet in June 2015. Restructuring measures included route and fleet optimization and reduced operational losses under the oversight of the Ministry of Public Enterprise Development and a Cabinet Committee. The authorities will report the airline’s financial performance to IMF staff on a quarterly basis. (December 2016) — Met. - MOF, line ministries, and SOEs to sign and publish Statements of Corporate Intent for the six largest SOEs: Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Airlines, National Water Supply and Drainage Board, Airport and Aviation Services Limited, and Sri Lanka Ports Authorities. (December 2016) — Met with delay. - Draft SCIs were finalized in December 2016 for each of the 6 SOEs except for Sri Lankan Airlines. Following Cabinet approval, the SCIs were signed in March 2017 and published in April 2017. - MOF to complete a report outlining the cost of non-commercial obligations for fuel and electricity. (September 2017) — Not met (implemented with delay). - The report was published as an annex to the 2018 budget speech in November. ### Monetary and exchange rate policy roadmap - Develop a roadmap for flexible inflation targeting and flexible exchange rate regime that identifies timebound reform measures to be taken during the program period. (October 2017) — Met. - An IMF TA mission for designing the roadmap took place in May 2017. The Monetary Board approved this roadmap. ### Technical Memorandum of Understanding (TMU): overview - Purpose: Framework for monitoring performance of Sri Lanka under the Extended Arrangement under the Extended Fund Facility (EFF); specifies performance criteria and indicative targets (including adjustors) assessed through semiannual reviews; sets monitoring procedures and reporting requirements. - Quantitative performance criteria and indicative targets listed in Table 1 attached to the MEFP: - a) quantitative performance criterion on central government primary balance (floor); - b) quantitative performance criterion on net official international reserves (floor); - c) continuous quantitative performance criterion on new external payment arrears by the nonfinancial public sector and the CBSL (ceiling); - d) a monetary policy consultation clause; - e) indicative target on central government tax revenue (floor); - f) indicative target on reserve money of the CBSL (ceiling); - g) indicative target on cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling); - h) indicative target on treasury guarantees (ceiling). - Definitions: Central government includes line ministries, departments, and other public institutions. CBSL, state-owned enterprises, parastatals and other agencies that do not receive subventions from the central government are excluded. Debt is defined in accordance with paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements attached to Executive Board Decision No. 15688-(14/107), adopted December 5, 2014. ### Performance criterion on central government primary balance - Definition: Primary balance of the central government on cash basis = central government revenues and grants minus expenditures and net lending, plus interest payments. Proceeds from privatization or commercialization of public assets are not recorded as part of central government revenues. Spending recorded when cash disbursements are made. - For program monitoring, primary balance measured as overall balance of the central government plus interest payment of the central government. Overall balance measured from financing side as negative of sum of listed financing items; net borrowings = gross disbursements minus principal repayments. - 2015 illustrative amounts: - Primary balance of the central government on cash basis: Rs –241 billion (overall balance Rs –768 billion; interest payment Rs 527 billion). - a) Net borrowings from Treasury Bills, Treasury Bonds, and Rupee Loans: Rs 257.6 billion. - b) Net borrowings from Sri Lankan Development Bonds (SLDBs) and commercial borrowings including international sovereign bonds and syndicated loans: Rs 455.7 billion. - c) Net borrowings from project and program loans: Rs 69.7 billion (after adjustment for program loans contracted and disbursed during 2014 but recorded in 2015 fiscal account Rs 61.6 billion). - d) Net increases in non-market borrowings, CBSL advances, government import bills, government overdraft from the banking system, cash items in process of collection, and borrowings from offshore banking units of domestic commercial banks: Rs –10.1 billion. - e) Net decreases in the deposit of the central government in the banking system: Rs –4.4 billion (an increase in deposit). - f) Net borrowings from all other bonds, loans, and advances contracted by the central government: Rs –0.5 billion (net repayment). - g) Proceeds from privatization or commercialization of public asset to residents and non-residents: Rs 0 billion. - Adjustment: If actual gross cash disbursement of project loans in 2018 > Rs 230 billion, the floor on the primary balance for end-December 2018 will be adjusted downward by the difference between the actual amount and Rs 230 billion. The downward adjustment is capped at Rs 20 billion. If actual gross cash disbursement of project loans in 2018 < Rs 230 billion, the floor will not be adjusted. ### Performance criterion on Net Official International Reserves (NIR) - Measurement: Program NIR = difference between (a) CBSL’s conventional definition of NIR and (b) CBSL’s outstanding liabilities (net short positions) in foreign exchange swaps with domestic commercial banks. Program NIR evaluated at market exchange rates and specified program exchange rates and gold price for program measurement. - Program NIR levels: - At end-2015: Program NIR (market exchange rates) = US$ 2,893.1 million. - At end-2016: Program NIR (market exchange rates) = US$ 2,032.1 million. - At end-2017: Program NIR (market exchange rates) = US$5,104.0 million. - CBSL conventional NIR (components and exclusions noted). CBSL conventional NIR levels: - At end-December 2015: NIR per CBSL conventional definition = US$ 5,028.8 million. - At end-December 2016: US$4,529.0 million. - At end-December 2017: US$6,597.4 million. - CBSL outstanding liabilities (net short positions) in FX swaps with domestic banks: - End-December 2015: US$ 2,135.7 million. - End-December 2016: $2,496.9 million. - End-December 2017: US$1,495.2 million. - Framework to wind down FX swap liabilities: Include discontinuing provision of FX swaps on concessional terms and gradually reducing outstanding net short positions as described in the MEFP. - Valuation for program measurement: - All foreign-currency related assets and liabilities converted into U.S. dollar terms at exchange rates prevailed on January 2, 2018. - Monetary gold valued at US$1,306.34 per troy ounce (price prevailed on January 2, 2018). - Exchange rates (Sri Lankan Rupee per currency unit, rates as of January 2, 2018): - U.S. dollar 153.4697 - British pound 207.4066 - Japanese yen 1.3613 - Canadian dollar 122.3354 - Euro 184.3478 - Chinese yuan 23.6055 - SDR 219.1740 - NIR adjustors (paragraph 10): If (i) foreign program financing by the central government, (ii) net borrowings from SLDBs and FCBUs by the central government, (iii) external commercial loans (including international sovereign bonds and syndicated loans) by the central government, and (iv) proceeds from commercialization of public assets to non-residents—as set out in Table 2—are higher/lower in U.S. dollar terms than assumed under the program, the floor on the program NIR will be adjusted upward/downward by the cumulative differences on the test date (applies to end-December 2017 and thereafter). - Amortization adjustor (paragraph 11): If amortization of official external debt by the central government in U.S. dollar terms—as set out in Table 2—is higher/lower than assumed, the floor on the program NIR will be adjusted downward/upward by the cumulative differences on the test date. Official external debt refers to external debt owed to multilateral and official bilateral creditors as defined in the 2013 External Debt Statistics: Guide for Compilers and Users. ### Continuous performance criterion on new external payment arrears - A continuous performance criterion applies to non-accumulation of new external payments arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL. - Definition: Nonfinancial public sector follows the 2001 Government Finance Statistics Manual and the 1993 System of National Accounts and includes the central government and nonfinancial public enterprises. External payments arrears = debt-service obligations (principal and interest) to nonresidents not paid when due as specified in contractual agreements, subject to any applicable grace period. Overdue debt and debt service obligations in dispute are not considered external payments arrears for program monitoring. ### Program assumptions (Table 2 excerpts; cumulative from beginning of the year, in million US$) - Foreign program financing by the central government: - Dec. 2017: 2250 - Mar. 2018: 0125 - Jun. 2018: 225 - Sep. 2018: (table formatting in source indicates sequence) 225 - Dec. 2018: 225 - Net borrowings from SLDBs and FCBUs by the central government: - Dec. 2017: 6270 - Mar. 2018: -150 - Jun. 2018: -1,118 - Sep. 2018: -1,118 - Dec. 2018: (same as Sep.) -1,118 - External commercial loans (including Eurobonds and syndicated loans) by the central government: - Dec. 2017: 2,200 - Mar. 2018: 1,500 - Jun. 2018: 1,500 - Sep. 2018: 3,500 - Dec. 2018: 3,500 - Proceeds from commercialization of public assets to non-residents: - Dec. 2017: 2000 - Mar. 2018: 400 - Jun. 2018: 680 - Sep. 2018: 682 - Dec. 2018: (table shows sequence) 682 - Amortization of official external debt by the central government: - Dec. 2017: 1,065 - Mar. 2018: 365 - Jun. 2018: 572 - Sep. 2018: 1,055 - Dec. 2018: 1,276 ### Monetary policy consultation clause - Inflation target bands around projected 12-month inflation rate measured by the headline Colombo Consumers Price Index (CCPI) (2013=100) published by the Department of Census and Statistics of Sri Lanka are specified in Table 1 attached to the MEFP. - Measurement of year-on-year inflation for each test date uses 3-month averages: - CCPI*(t) = { CCPI(t-2) + CCPI(t-1) + CCPI(t) } / 3 - CCPI*(t-12) = { CCPI(t-14) + CCPI(t-13) + CCPI(t-12) } / 3 - Year-on-year inflation = { CCPI*(t) – CCPI*(t-12) } / CCPI*(t-12) - Consultation triggers: - If observed year-on-year inflation for end-June 2018 or end-December 2018 falls outside the outer bands in Table 1, the authorities will complete a consultation with the IMF Executive Board focusing on: (i) the stance of monetary policy and whether the Fund-supported program remains on track; (ii) reasons for the deviation; and (iii) proposed policy response. When this consultation is triggered, access to Fund resources would be interrupted until the consultation takes place and the relevant program review is completed. - If observed year-on-year inflation falls outside the inner bands in Table 1 for end-June 2018, end-September 2018, or end-December 2018, the authorities will complete a consultation with IMF staff on reasons for the deviation and proposed policy response. ### Indicative targets - Indicative target on central government tax revenue: - Definition: Revenues from taxes collected by the central government; excludes asset sales, grants, and non-tax revenues. Calculated as cumulative flow from beginning of the year. - 2015 central government tax revenue (defined this manner): Rs. 1,356 billion. - Indicative target on reserve money of the CBSL: - Definition: Reserve money consists of currency in circulation (with banks and with the rest of the public), financial institutions’ domestic currency deposits at the CBSL, and deposits of specified government agencies: National Defense Fund (General Ledger Acc. No. 4278), Buddha Sasana Fund A/C (General Ledger Acc. No. 4279), and Road Maintenance Trust Fund (General Ledger Acc. No. 4281). - At end-December 2015, reserve money stood at Rs. 673.4 billion. - From December 2017 onwards, reserve money for each test date is measured as the average reserve money from 16th to end of the month. - Adjustment: If any bank fails to meet its legal reserve requirement, the ceiling on reserve money will be adjusted downward by the shortfall in compliance. Changes in required reserve regulations will modify the reserve money ceiling according to the formula provided in the TMU (formula and variable definitions preserved exactly in source). - Indicative target on cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers): - Definition: NCOs for fuel and electricity refer to obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery levels. The target is the cost of fuel and electricity NCOs net of government transfers (i.e., NCO cost not compensated by central government budget). - Measurement of cost of NCOs for fuel each quarter: cost of sales (including fuel cost, terminal charges, transport charges, personnel cost, other operational expenses, exchange rate variation, and finance cost; excluding sales taxes) minus revenues (net of sales taxes) for CPC supplies to transport, power generation, aviation, industries, kerosene and LPG, and agrochemicals. If revenues (net of taxes) exceed cost of sales, cost of NCOs for fuel is zero. - Government transfers to cover fuel NCOs measured as central government current transfers disbursed to CPC. *International Monetary Fund — Technical Memorandum of Understanding excerpts from the program documentation.* ### 20. The cost of NCOs for electricity during each quarter is measured as total ### 20. The cost of NCOs for electricity during each quarter is measured as total ### Measurement of electricity NCOs - The cost of NCOs for electricity during each quarter is measured as total expenditures (including energy purchases and allowed revenue for transmission) minus total sales revenues from 5 distribution licensees under CEB, as shown in the statement of the Bulk Supply Transaction Account managed by CEB. - If the total sales revenues exceed the total expenditures, the cost of NCOs for electricity is zero. - The government transfers to cover the cost of electricity NCOs are measured as central government current transfers disbursed to CEB. ### Calculation for program monitoring (cost of fuel and electricity NCOs net of government transfers) - The cost of fuel and electricity NCOs net of government transfers is calculated taking account of a time lag in estimating the cost of fuel and electricity NCOs. - For the test date of end-March 2018: - NCO(2017Q4) – G(2018Q1) - For the test date of end-June 2018: - { NCO(2017Q4) + NCO(2018Q1) } – { G(2018Q1) + G(2018Q2) } - For the test date of end-September 2018: - { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) } - For the test date of end-December 2018: - { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) + NCO(2018Q3) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) + G(2018Q4) } - Definitions used in the calculations: - NCO(q) = cost of NCOs for fuel and electricity during quarter “q” - NCO_fuel(q) = cost of NCOs for fuel during quarter “q” - NCO_electricity(q) = cost of NCOs for electricity during quarter “q” - NCO(q) = NCO_fuel(q) + NCO_electricity(q) - G(q) = central government current transfers to CPC and CEB disbursed during quarter “q” - G_fuel(q) = central government current transfers to CPC disbursed during quarter “q” - G_electricity(q) = central government current transfers to CEB disbursed during quarter “q” - G(q) = G_fuel(q) + G_electricity(q) ### Indicative target on treasury guarantees - Treasury guarantees are defined as outstanding debt guarantees issued by the central government; a guarantee of a debt refers to any explicit legal obligation of the central government to service such a debt in the event of nonpayment by the recipient. - Treasury guarantees exclude letters of credit. - Outstanding guarantees are defined as the drawn amounts of guaranteed debts; they differ from issued guarantees, which are the total amount of guaranteed debts (including for debts that are not disbursed yet). - Treasury guarantees include outstanding treasury guarantees published in the Statement of Contingent Liabilities contained in the Annual Report of the Ministry of Finance and the guarantee issued for the SriLankan Airlines’ $175 million Eurobond. - Rupee values for guarantees issued in other currencies will be calculated using the exchange rate for the last day of the calendar year as it appears in the Statement of Contingent Liabilities in the Annual Report of the Ministry of Finance. - As of end-2017, the outstanding treasury guarantees were valued at Rs 591 billion (including the guarantee issued for the SriLankan Airlines’ Eurobond amounting to Rs. 27 billion). ### Data reporting requirements and frequencies - Sri Lanka shall provide the Fund, through reports at intervals or dates requested by the Fund, with such information as the Fund requests in connection with the progress of Sri Lanka in achieving the objectives and policies set forth in the Memorandum of Economic and Financial Policies and Letters of Intent. - All the program monitoring data will be provided by the Ministry of Finance and the CBSL. - Specific reporting formats and frequencies: - Fiscal performance (Tables 3 and 4): data will be provided in the format shown in Tables 3 and 4. - Monetary targets (Table 5): data will be provided in the format shown in Table 5. - External sector performance (Tables 6 and 7): data will be provided in the format shown in Tables 6 and 7. - Financial performance of CEB, CPC, and SriLankan Airlines (Tables 8, 9, 10): data will be provided on a quarterly basis. - Indicative target on the cost of fuel and electricity NCOs (net of government transfers) (Tables 11 and 12): data will be provided on a quarterly basis in the format shown in Tables 11 and 12. - Indicative target on treasury guarantees (Table 13): data will be provided on a quarterly basis in the format shown in Table 13. - Reporting timetables: - Fiscal targets (Table 3 and Table 4): furnished within no more than five weeks after the end of each month, except for salaries and wages, goods and services, subsidies and transfers (and its subcomponents) furnished within no more than seven weeks after the end of each month; total recurrent expenditure and interest payments furnished within no more than five weeks after the end of each month. - External and monetary targets (Tables 5, 6, and 7): furnished within no more than three weeks after the end of each month. - Three state-owned enterprises (Tables 8–10): furnished within no more than 2 months after the end of each quarter. - Indicative target on the cost of fuel and electricity NCOs (net of government transfers) (Tables 11 and 12): furnished within no more than 5 weeks after the end of each quarter. - Indicative target on treasury guarantees (Table 13): furnished within no more than two months after the end of each quarter. *Excerpt from STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION AND FOURTH REVIEW UNDER THE EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY—INFORMATIONAL ANNEX (May 17, 2018).* ### 1. The Systematic Country Diagnostic (SCD) prepared in 2015 identified critical ### 1. The Systematic Country Diagnostic (SCD) prepared in 2015 identified critical ### SCD findings: constraints and cross-cutting challenges - Identified priority challenges: (i) fiscal sustainability; (ii) enhancing competitiveness and promoting more and better jobs for the bottom 40 percent; (iii) providing for social inclusion for disadvantaged segments of the population; and (iv) longer term sustainability (especially of the environment, political stability, and an aging population). - Governance was identified as a cross-cutting challenge. ### Country Partnership Framework (CPF) (2017-2020): pillars and cross-cutting objectives - Anchored in the SCD analysis; consists of three major pillars: - Pillar one: improve macroeconomic stability and competitiveness. - Pillar two: promote inclusion and opportunities. - Pillar three: enhance resilience and management of natural assets. - Cross-cutting objectives: strengthening governance and improving gender equality. - CPF emphasis: policy reform orientation aligned with government priorities on improving macro-fiscal stability, enabling private sector development, export competitiveness, and global integration. - Social inclusion actions: support for improving living standards in lagging regions, including conflict-affected Northern and Eastern regions, and strengthening education and training systems. - Environmental and resilience focus: balancing development with environmental conservation and enhancing resilience to climate change. - Bank support modalities: policy advice, analytical support and technical assistance funded through trust funds and Bank budget on fiscal reform, governance, capital markets, pension reform, trade and competitiveness, and sustainable urban development. ### World Bank support in macro-critical areas - Financial sector development - Project: Financial Sector Modernization Project (FSMP). - Component 1 (results-based financing): addresses several mid-level Financial Sector Assessment Program (FSAP) policy recommendations to facilitate downstream progress on high-level reforms; targets developing more competitive markets by requiring a holistic supervisory approach; switching to a forward-looking supervisory perspective; and leveling of the playing field within and across financial subsectors; aims to improve the investment performance of the pension provident funds to secure adequate replacement income for retirees. - Component 2: aims to improve the financial market infrastructure (FMI), legal and regulatory framework for the financial system, and the institutional capacity of financial sector regulators, Central Bank of Sri Lanka (CBSL), Securities and Exchange Commission of Sri Lanka (SEC) and Insurance Regulatory Commission of Sri Lanka (IRCSL). - Complementary trust funds: close to around USD 2 million in trust funds (capital market development, legal reforms TA, insurance TA, financial inclusion strategy, agriculture insurance, financial literacy and secured transactions reform). - Additional engagement: a joint Bank-Fund mission took place in December 2016 to review the primary market for government securities. - Trade policy and trade facilitation - Major reform of trade policy with WBG support. - Outcomes: Cabinet’s approval of the New Trade Policy in 2017; start of the tariff reform program in the November 2017 budget. - Tariff reform expected to continue as part of unilateral reforms and new free trade agreements. - Ongoing and planned support: technical assistance, a new trade report in FY19, and a report and dialogue on trade adjustment to address winners and losers in trade reform. - Trade facilitation support: strengthening compliance with TFA commitments under the WTO, institutional framework (National Trade Facilitation Committee), targeted advice for selected reforms (reform of the Customs Ordinance, risk management), implementation of transparency initiatives (Trade Information Portal), and paving way for border clearance reforms (National Single Window Blueprint). - Regulatory simplification and promoting investment including FDI - Coordinated effort on regulatory simplification yielding improved user experience for foreign and domestic investors. - Support via Investment Climate Roadmap (launched in July 2017) to improve Ease of Doing Business. - Expected positive results in 2018-19 in business registration, construction permits, property registration, minority shareholder rights, local e-government, e-documents and pre-processing procedure amendments of the customs ordinance. - Enhancing Investment Promotion capacity: support to BOI to identify, attract, and retain efficiency-seeking FDI. - One-Stop Shop (OSS) for FDI: assistance in design and implementation to reduce time and transaction costs for foreign investors. - Cooperation on investment incentives: strengthen effectiveness while minimizing fiscal costs. - Sectoral support: National Tourism Strategy (Cabinet approval 2016) supported via a WBG lending operation to implement the National Tourism Strategic Plan for 2017-2020. - Other strategies drafted: National Quality Infrastructure Strategy and an Innovation and Entrepreneurship Strategy (being finalized for submission to Cabinet), supported by a national quality infrastructure gap analysis and an Exporter Marketplace Pilot Program. - Public financial management and transparency - Project: Public Sector Efficiency Program (PSEP). - Objectives: modernize core public financial management functions and services affecting the private sector to strengthen public sector efficiency and support government fiscal and economic policy objectives; support implementation of transparency and accountability reforms. - Three components (primarily focused on the Ministry of Finance): - (i) Strengthening allocative efficiency of public investments, programs and debt management, with a greater focus on performance. Bank and Fund collaboration examples: joint training on the Debt Sustainability Analysis for Market-Access Countries (MAC-DSA) in 2016; a joint Public Investment Management Assessment (PIMA) in December 2017; prospective joint technical support on the Medium-Term Debt Management Strategy (MTDS) and a unified Debt Management Office (proposed structural benchmarks). - (ii) Improving operational efficiency of budget execution and procurement. - (iii) Strengthening governance, transparency and efficiency of public services. - Implementation timeframe: expected to be implemented between the second half of 2018 and 2022. - Social protection sector development - Project: Social Safety Nets project (SSNP). - Focus: improving the equity, efficiency and transparency of Sri Lanka’s social safety net programs for the benefit of the poor and vulnerable. - Financing modality: first two components follow a results-based financing modality with disbursements made upon achievement of specific results measured by Disbursement Linked Indicators (DLIs). - Component details: - Component 1: supports establishment of the Welfare Benefits Board (WBB), development of the unified social registry for identification and collection of information on beneficiaries. - Component 2: supports collection of data on current beneficiaries and new applicants of programs under the Welfare Benefit Schemes, and development of an integrated Management Information System for harmonized management of programs. - Component 3: includes technical assistance to support implementation of the Welfare Benefits Act, developing a National Social Protection Strategy and use of the new system for monitoring and longer-term strategic planning. - Complementary trust funds: smaller amounts to support targeting, development of exit and graduation strategy and integrate adaptive safety nets assistance to safety nets delivery system. *Source: cr18175 - 1. The Systematic Country Diagnostic (SCD) prepared in 2015 identified critical* ### 4. The World Bank has been supporting Sri Lanka’s development for close to six decades, ### 4. The World Bank has been supporting Sri Lanka’s development for close to six decades, ### World Bank portfolio and sectoral composition - Current active IDA-IBRD portfolio consists of 15 projects with a total net commitment of nearly USD 1.9 billion (13 IDA, 1 IBRD and 1 Blend). - Sectoral shares of the overall portfolio: - Urban operations: 21 percent - Water: 16.5 percent - Resilience to climate and disaster risk: 13 percent - Education: 13 percent - Health: 10 percent - The World Bank has provided a mix of financing – investment project, development policy, and program-for-results – to support reforms. ### Active projects (project-level details) - Dam Safety & Water Resources Planning Project - Board Approval: 03/27/2008 - Closing Date: 05/15/2018 - Net Commitment Amount ($ million): 148.33 - Transforming School Education Project - Board Approval: 11/29/2011 - Closing Date: 06/30/2018 - Net Commitment Amount ($ million): 100.00 - Second Health Sector Development Project - Board Approval: 03/27/2013 - Closing Date: 09/30/2018 - Net Commitment Amount ($ million): 200.00 - Metro Colombo Urban Development Project - Board Approval: 03/15/2012 - Closing Date: 06/30/2020 - Net Commitment Amount ($ million): 213.00 - Sri Lanka Strategic Cities Dev Project - Board Approval: 05/05/2014 - Closing Date: 12/31/2021 - Net Commitment Amount ($ million): 202.00 - Skills Development Project - Board Approval: 06/20/2014 - Closing Date: 12/31/2019 - Net Commitment Amount ($ million): 101.50 - Transport Sector Project - Board Approval: 05/09/2016 - Closing Date: 06/30/2026 - Net Commitment Amount ($ million): 125.00 - Improving Climate Resilience Project - Board Approval: 04/22/2014 - Closing Date: 05/30/2019 - Net Commitment Amount ($ million): 152.00 - Water and Sanitation Improvement Project - Board Approval: 06/24/2015 - Closing Date: 12/31/2020 - Net Commitment Amount ($ million): 165.00 - Early Childhood Development Project - Board Approval: 06/24/2015 - Closing Date: 06/30/2021 - Net Commitment Amount ($ million): 50.00 - Agriculture Sector Modernization Project - Board Approval: 06/28/2016 - Closing Date: 12/31/2021 - Net Commitment Amount ($ million): 125.00 - Ecosystem Conservation and Management Project - Board Approval: 04/25/2016 - Closing Date: 06/30/2021 - Net Commitment Amount ($ million): 45.00 - LK-Social Safety Nets Project - Board Approval: 12/02/2016 - Closing Date: 06/30/2022 - Net Commitment Amount ($ million): 75.00 - Sri Lanka Financial Sector Modernization Project - Board Approval: 04/05/2017 - Closing Date: 12/31/2022 - Net Commitment Amount ($ million): 75.00 - Accelerate Higher Education Development Project - Board Approval: 05/12/2017 - Closing Date: 06/30/2023 - Net Commitment Amount ($ million): 100.00 _Source: World Bank._ ### Policy relevance - Continued World Bank support spans core sectors (education, health) and infrastructure, complementing reform efforts through mixed instruments to support Sri Lanka’s middle-income transition. ### Relations with the Asian Development Bank (ADB) — strategic priorities - Country Partnership Strategy (CPS, 2018-2022) approved in 2017 supports transition to upper-middle income status with two pillars: - (i) Strengthening drivers of growth: expanding growth-oriented infrastructure and logistics; developing economic corridors; upgrading human capital. - (ii) Improving quality of growth: promoting inclusiveness via agriculture infrastructure and commercialization; improving rural connectivity; improving public service delivery; expanding SME access to finance. - Indicative Resources: - Sri Lanka will graduate from ADB’s concessional resources, effective 1 January 2019. - Allocation for 2019-2021: $1,895 million from regular ordinary capital resources (OCR). - Co-financing and private sector operation opportunities will be actively explored. - Indicative Pipeline for 2018-20 focuses on advanced infrastructure (expressway, railways, ports), wind and solar power generation, integrated urban development, higher education; thematic priorities include private sector development, public-private partnership, gender, climate change, disaster risk management, and environment strengthening. ### ADB sector-specific planned operations (highlights) - Transport: - Proposed Port Access Elevated Highway Project (2018) — elevated toll highway in Colombo between New Kelani Bridge and city center of Galle Face; support trade logistics facilitation. - Proposed Colombo Suburban Railway Efficiency Improvement Project — improve telecom system, computerized ticketing, equipment for railway training center, operation and train control center, workshop and equipment. - Transport Project Facility preparing detailed design for priority investment in Kelani Valley Line; physical investments under proposed Sri Lanka Railway Investment Program in 2020. - Urban and water supply: - Continued support for secondary cities including Colombo–Trincomalee economic corridor and the Western Megapolis. - Proposed Urban Project Preparatory Facility (TA loan, approval in 2018) to complete advanced feasibility studies, detailed designs, procurement actions, and build implementing agency capacity. - Energy: - Focus on expanding wind and solar renewable energy and introducing innovation/advanced technology. - Proposed Power System Reliability Strengthening Project (approval in 2019) — focus on system reliability and optimization of existing fault clearance system of the Ceylon Electricity Board network. - Proposed TA loan for Preparing the Power Development and Interconnection Project — support connectivity and power trade between Sri Lanka and India. - Education: - Continued support for secondary education and skills development; exploration of higher education opportunities. - Skills Sector Enhancement Program (additional financing) supporting Skills Sector Development Program for 2017–2020. - Proposed Science and Technology Human Resource Development Project (approval in 2018) — establish new technology degree programs and engineering degree programs with industry linkages and entrepreneurships in selected universities. - Higher education interventions to reorient research and development in universities and research institutions to strengthen innovation capacity. - Health: - Proposed Health System Enhancement Project (2018) — enhance primary health care, improve equity and underserved communities’ access to essential health services, and address gaps in core public health capacities in line with international health regulations. - Finance: - Additional financing of $75 million approved in January 2018 to support SMEs outside Colombo District, led by women, or first-time bank borrowers. - Agriculture and natural resources: - Proposed Northern Province Sustainable Fisheries Development Project (approval in 2018) — investments to revive fisheries in Jaffna, Mannar, Mullaitivu, and Killinochchi: development of two fishery harbors, 8 anchorages, 27 fisheries landing sites, sustainable aquaculture, and livelihood improvements. ### ADB Private Sector Operations - Provide loans, equity investments, or guarantees for banks or nonbank institutions to expand activities in housing, SME finance, leasing, renewable energy, and infrastructure lending. - Pursue opportunities for local currency lending to alleviate constraints to nonsovereign domestic borrowing. ### ADB ongoing projects and portfolio statistics (as of 31 March 2018) - Projects approved in 2017: 7 new sovereign projects totaling $881 million and 1 new non-sovereign loan facility of $4 million: - Wind Power Generation Project ($200 million from OCR) - Solar Rooftop Power Generation Project ($50 million from OCR) - Mahaweli Water Security Investment Program (tranche 2) ($179 million from OCR and $31 million from concessional OCR) - Second Integrated Road Investment Program (tranche 1) ($90 million from OCR and $60 million from concessional OCR) - Integrated Road Investment Program (tranche 4) ($150 million from OCR) - Jaffna Kilinochchi Water Supply Project Additional Financing ($95 million from OCR and $25 million from concessional OCR) - Project Design Advance for Northern Province Sustainable Fisheries Project ($1.3 million from concessional OCR) - Walkers Colombo Shipyard (private limited) for shipyard rehabilitation and infrastructure ($4 million from OCR) - Portfolio cumulative totals and ongoing portfolio: - As of 31 March 2018, ADB has approved a total of 197 loans, with cumulative lending of $8.6 billion to Sri Lanka. - ADB provided $366 million grant assistance (including ADB-administered co-financed grants) and $146 million through 300 technical assistance grants. - Current portfolio includes 55 ongoing loans and grants for 33 projects with a net loan amount of $ 3.8 billion. - Cumulative contract awards: $1.9 billion. - Disbursements: $1.4 billion. - About 69% of the ongoing portfolio are in transport, urban and water, and energy sectors. - Sector composition of the ongoing loan portfolio (In percent of total, Figure 1): - Energy, 24 - Transport, 23 - Water and other urban infrastructure and services, 22 - Finance/ Public sector management, 12 - Education, 10 - Agriculture, natural resources and rural development, 9 ### Statistical issues — assessment and data adequacy (As of May 7, 2018) - General: Macroeconomic statistics are broadly adequate for surveillance, but weaknesses remain in the timeliness and coverage of certain statistical series. - National Accounts: - 2015 DCS comprehensive revision: change of base year from 2002 to 2010; expanded service sector coverage; improvements in compilation methods. - DCS developing supply and use tables for 2013 to benchmark revised estimates. - Quarterly national accounts methodology updated and published in 2015 based on quarterly indicators for most economic activities; data presented relative to the same quarter of the previous year. - GDP data by expenditure available only annually and rely mostly on commodity flow methods. - Price Statistics: - New national Consumer Price Index (CPI) and Producer Price Index (PPI) released in 2015. National CPI based on weights from the 2012/13 Household Income and Expenditure Survey. - DCS compiles Colombo Consumer Price Index (CCPI) and national CPI (NCPI). TA mission in 2017 recommended discontinuing publishing CCPI. - Current PPI covers only agriculture, manufacturing, and utilities. Need to expand PPI coverage to include services and construction. PPI weights (2010) are outdated and should be updated using data from a 2015 annual survey of industrial activity. - Government Finance Statistics: - Authorities report budgetary central government operations data in GFSM 2014 format on an annual basis and debt data to the World Bank’s Public-Sector Debt Statistics database on a quarterly basis. - June 2016 STA mission supported implementing GFSM 2001 and GFSM 2014; Chart of Accounts aligned with GFSM2014 incorporated into new IFMIS system. - Additional steps to integrate extra-budgetary central government, local government and social security funds into annual general government GFS reporting. - Monetary and Financial Statistics: - CBSL compiles monetary and financial statistics broadly in line with MFSM 2000. - Since June 2011, data based on a standardized report form (SRF) for the central bank and depository corporations. - Recommendation to expand monetary data to include financial accounts of other financial corporations that account for about 34 percent of total financial sector assets. - Financial sector surveillance: - CBSL regularly reports quarterly FSIs to the IMF for publication; currently reports 11 core and 8 encouraged FSIs. - External Sector Statistics (ESS): - Since 2014, CBSL reports IIP and BOP on a quarterly basis following BPM6. - May 2015 TA mission observed improved coverage of BOP, IIP, CDIS and external debt. - CBSL aligned ESS framework and subscribed to IMF’s Special Data Dissemination Standards (SDDS) in November 2015. - Data Standards and Quality: - Sri Lanka subscribed to the Special Data Dissemination Standards (SDDS) in November 2015. - A data ROSC mission visited Sri Lanka in 2001 and prepared a comprehensive report on the quality of its statistics. - Reporting to STA: - Authorities report key data to the Fund on a timely basis. - Annual cash government finance data reported for publication in the GFS Yearbook cover only central government budgetary accounts; no data on extrabudgetary funds or provincial and local governments are reported. - No sub-annual government finance data reported for publication in IFS. - Authorities encouraged to reduce time lag for data reporting and to report data for the general government. ### Table of Common Indicators Required for Surveillance (As of May 7, 2018) — selected timing and frequency notes - Exchange rates: Date of Latest Observation: Today; Date Received: Today; Frequency of Data/Reporting/Publication: D - International reserve assets and reserve liabilities of the Monetary Authorities: Date of Latest Observation: 03/2018; Date Received: 03/2018; Frequency: D - Reserve/base money: Date of Latest Observation: 03/2018; Date Received: 04/2018; Frequency: M - Broad money: Date of Latest Observation: 03/2018; Date Received: 04/2018; Frequency: M - Consolidated balance sheet of the banking system: Date of Latest Observation: 03/2018; Date Received: 04/2018; Frequency: M - Consumer price index (New Colombo CPI): Date of Latest Observation: 03/2018; Date Received: 04/2018; Frequency: M - Revenue, expenditure, balance and composition of financing—central government: Date of Latest Observation: Q4/2017; Date Received: 03/2018; Frequency of Data: A; Frequency of Reporting: A; Frequency of Publication: M - External current account balance: Date of Latest Observation: 2017 Q4; Date Received: 04/2018; Frequency: Q - GDP/GNP: Date of Latest Observation: 2017 Q4; Date Received: 04/2018; Frequency: Q - Gross external debt: Date of Latest Observation: 2017 Q4; Date Received: 03/2018; Frequency: A - International Investment Position: Date of Latest Observation: 2017 Q4; Date Received: 04/2018; Frequency: Q ### Statement by Mr. Subir Vithal Gokarn and Mr. Mahinda K.M. Siriwardana (June 1, 2018) — government view and program status - Authorities’ appraisal: - Thank IMF staff for comprehensive 2018 Article IV Consultation and Fourth Review under the Extended Arrangement under the Extended Fund Facility (EFF) and Selected Issues papers. - Value constructive and candid policy dialogue in Colombo (February/March 2018) and Washington DC (2018 Spring Meetings). - Achievements and strategy: - Notable improvements during last two years from stabilization policies supported by EFF despite natural calamities and complex political environment. - Measures strengthened macroeconomic fundamentals, accessed foreign markets, and facilitated long-term growth toward transforming Sri Lanka into a hub of the Indian Ocean. - Authorities committed to institutionalizing frameworks: monetary policy aligned with flexible inflation targeting framework; fiscal policy to continue and strengthen fiscal consolidation beyond the EFF program. - Strengthening financial sector oversight and upgrading public debt management; reforms to address SOE deficiencies; easing bottlenecks to increase competitiveness; enhance economic diversification; improve financial inclusion; address corruption; increase female labor force participation. - Authorities broadly concur with staff’s assessment on risks. - Program performance: - Sri Lanka’s EFF program progressing well amidst recent temporary shocks. - All end-December 2017 Quantitative Performance Criteria (QPC) and end-March 2018 Indicative Targets (IT) on the primary balance and NIR were met. - End-December and end-March IT on reserve money were met; IT on tax revenues was missed. - Inflation exceeded the upper limit for the inner band under the Monetary Policy Consultation Clause (MPCC) for December (temporary deviation due to increase in food prices following weather-related supply disruptions). Authorities agreed to be vigilant on upside risks to inflation. - In March 2018, inflation decelerated reaching the inner band. - In April 2018, inflation further decelerated to 24 month lowest since April 201 (text truncated in source). *Source: IMF staff summary of World Bank and ADB relations, statistical assessments, and authorities’ statement, as provided in the chapter.* ### 6. The ### 6. The ### Progress under the program and request - Continuous QPC of accruing no new external arrears was met. - All six structural benchmarks (SBs) to be completed by June 2018 were implemented. - Authorities request approval of the Fourth EFF Review based on the progress achieved. ### Economic growth and outlook - 2017 growth: 3.1 per cent, mainly reflecting contraction in agriculture due to severe drought and large-scale floods. - Industry and Services contributed positively to growth despite agricultural spillovers. - 2018 projection: growth expected to rebound to around 5.0 per cent, supported by: - recovery in agricultural production; - global upswing and positive spillovers from improved growth in Sri Lanka’s trading partners; - improving domestic conditions enhancing private sector investment. - Risks/offsets: - Ongoing fiscal consolidation may dampen growth prospects. - Supportive factors: improved fiscal discipline, implementation of structural reforms, realization of higher FDI inflows, a conducive low inflation environment and a competitive exchange rate expected to help reach potential. ### Monetary and exchange rate policy - Inflation developments: - Consumer price inflation peaked in October 2017, then moderated towards mid-single digit levels with improvements in domestic supply conditions. - Core inflation moderated subsequently. - Monetary policy stance: - CBSL maintained tight monetary policy from end 2015 to contain inflation and expectations. - CBSL eased policy in April 2018 by reducing the upper bound of its policy interest rate corridor by 25 basis points. - Easing considered appropriate given favorable inflation developments, inflation outlook, and lower than expected real GDP growth widening the output gap. - Monetary policy will remain prudent and data dependent; authorities stand ready to act if inflationary pressures emerge. - Institutional framework: - Time bound action plan to move towards a flexible inflation targeting (FIT) framework by 2020. - Amendments to the Monetary Law Act (MLA) aligned with the Road Map for Implementing FIT; approved by Cabinet of Ministers on 03 April 2018. - Finalized bill expected to be submitted to Parliament by March 2019. - Exchange rate management: - Authorities committed to a flexible exchange rate regime aligned with macro fundamentals, with intervention confined to avoid wide fluctuations and build official reserves. - Since March 2017, reserve accumulation has been a legitimate policy objective of CBSL intervention, leading to buildup of quality reserves; this policy will continue. - Proposed Request for Quotes (RFQ) system for CBSL intervention expected to deepen operations and transparency. - Flexible exchange rate management has depreciated the exchange rate in real terms, indicating improved external competitiveness. - Since second half of April 2018, higher exchange rate volatility and some capital outflows observed; CBSL intervened to smooth excess volatility while allowing depreciation. ### Financial sector - Overall soundness: - Prudential indicators reflect adequate capital and liquidity buffers, healthy profit levels and low NPLs. - Regulatory and supervisory measures: - Prudential measures introduced to strengthen the regulatory framework. - Proposed MLA amendments expected to facilitate macroprudential supervision by strengthening CBSL’s powers. - Transition to IFRS 9 and Basel III regulatory requirements underway. - Financial Sector Stability Review (FSSR) planned in 2019. - Resolution and macroprudential action: - CBSL prioritized addressing regulatory forbearance in non-bank financial institutions and primary dealers. - Firm action taken to resolve issues with some non-bank financial institutions. - New Resolution and Enforcement Department established at CBSL in early 2018 to expedite resolution of weak financial institutions. - Macroprudential tools implemented, e.g., LTVs on motor vehicles. - Financial inclusion and AML/CFT: - CBSL and government continue strategies to promote financial inclusion. - Authorities implementing FATF time bound action plan to strengthen AML/CFT regime, including amendments on international cooperation, beneficial ownership, UN Security Council Resolutions implementation, and strengthening AML/CFT supervision. - Concerted effort to strengthen fight against corruption by improving good governance, judicial independence and rule of law. ### Fiscal policy and SOE reforms - Fiscal performance: - Budget deficit increased marginally in 2017 due to weather-related expenditures. - A primary surplus was recorded in the budget after several decades, mainly due to gradual adjustments in non-interest recurrent spending. - Government target: reduce budget deficit to 3.5 per cent of GDP by 2020. - Fiscal framework and revenue measures: - Authorities committed to deepen institutionalization of fiscal framework by revising the Fiscal Management (Responsibility) Act with binding fiscal rules, escape clauses and correction mechanisms. - Recent revenue measures: revision of VAT Act in 2016; introduction of the new Inland Revenue Act in 2017; RAMIS IT-based tax administration improvement project expected to improve tax collection efficiency and taxpayer services. - VAT reforms are yielding improved buoyancy of VAT revenue. - Expenditure and debt management: - Introduction of a commitment control system, improvements in Public Financial Management (PFM) and IT-based treasury management system, ITMIS, have strengthened expenditure management. - Four major cash transfer programs to be streamlined to improve coverage and targeting while protecting needy and vulnerable. - Active Liability Management Act, enacted in March 2018, provides mechanism to manage financing needs and payment obligations over medium to long-term. - Receipts from concession agreement for Hambantota Port PPP have strengthened cash buffers. - Medium Term Debt Strategy (MTDS) for 2019-2023 being developed; eventual delegation to an independent debt management agency planned. - SOE contingent liabilities and reforms: - Strong measures underway to mitigate fiscal risks from SOE contingent liabilities while improving governance and accountability. - Energy sector measures: - Introduction of an automatic pricing formula and increase in domestic retail petroleum prices with effect from 11 May 2018. - Establishment of a bulk supply transaction account (BSTA) as key step towards revising electricity prices to reflect costs. - Authorities expect to complete energy price reforms by end 2018. - Staff Report recognized these two measures as “a clean break from the past”. - Statements of Corporate Intent (SCIs) signed with key SOEs in 2017 to monitor SOE performance under specific KPIs; expected to expand to other SOEs. - SriLankan Airlines (SLA) restructuring and PPP process being implemented under Officials Committee guidance to put airline on viable commercial footing. - PPP unit in the Ministry of Finance supporting PPPs and leveraging private sector for public investment. ### External sector - 2017 external developments: - Marginal increase in current account deficit due to wider trade deficit from weather-related imports, widened primary income deficit, moderate tourism earnings and lower workers’ remittances. - Higher inflows of foreign direct investment observed. - Rupee-denominated government securities market and Colombo stock market recorded net inflows. - Outlook and buffers: - Authorities expect current account deficit to taper over the medium-term with expected improvements in trade account, services account inflows and workers’ remittances. - Foreign reserves: US$ 9.9 billion by end April 2018, equivalent to about 5.4 months of imports. - Exchange rate: Sri Lankan rupee depreciated by 3.3 per cent against the US dollar up to May 28, this year. - Domestic swaps: outstanding amount declined to US$ 0.9 billion by end May 2018 from US$ 2.5 billion at end December 2016; gradual winding down of swaps with commercial banks continued. ### Trade and investment policy - Commitments to improve exports and investment through greater global integration, bilateral trade negotiations to widen market access and diversify products and markets. - Notable developments: - Free Trade Agreement (FTA) with Singapore signed in January 2018. - Negotiations ongoing for Economic and Technology Cooperation Agreement (ETCA) with India and proposed China - Sri Lanka Free Trade Agreement (CSFTA). - Considering FTAs with Bangladesh, Malaysia, South Korea and Thailand. - Safeguard measures introduced to address import surges. - Anti-Dumping and Countervailing Duties Act passed in Parliament in March 2018. - Competitiveness and adjustment support: - Gradual phasing out of para-tariffs being undertaken in fiscally-neutral manner to promote foreign investment. - Trade Adjustment Package being worked out with assistance from the World Bank, EU and International Trade Centre (ITC) to support local enterprises. ### Natural calamities and resilience - Authorities note frequent natural calamities (drought and floods) becoming the “new normal”, adversely affecting economic performance. - Policy responses emphasized: - Diversification of growth drivers. - Mainstreaming sustainability into planning and budgeting. - Improving disaster preparedness, mitigation and adaptation. - Developing an appropriate natural disaster risk financing framework. ### Conclusion - Authorities appreciate Fund policy advice and support and note Fund technical assistance (TA) and EFF-supported reforms have fortified macroeconomic and financial stability. - Authorities committed to continuing structural reforms, building buffers to improve resilience, and continuing policy dialogue with the Fund, complemented by TA. *Source: cr18175 - 6. The* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18175.pdf_