## 1lkaea2019001 ## Source details **Canonical URL:** [1lkaea2019001](https://www.imf.org/-/media/files/publications/cr/2019/1lkaea2019001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1lkaea2019001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1lkaea2019001.pdf.json) --- ### EXECUTIVE SUMMARY — Recent developments and outlook - External and security shocks in 2018–2019: - Higher fuel prices and global financial volatility generated strong balance-of-payment pressures in 2018. - Political crisis late 2018 and multiple terrorist attacks on April 21, 2019 (over 250 casualties). - Macroeconomic performance and near-term projections: - Real GDP growth: slowed to 3.2 percent in 2018; projected to recover to 3.6 percent in 2019 and to 5 percent over the medium-term. - Headline inflation: 2.8 percent (y-o-y) by end-2018; January 2019: headline 3.7 percent, core 5.5 percent; March 2019: headline 4.3 percent, core 5.6 percent. - External balances and reserves: - Current account deficit: 3.2 percent of annual GDP in 2018 (from 2.6 percent of GDP in 2017). - Real effective exchange rate: depreciated by 13 percent in 2018. - Gross international reserves (GIR): US$6.9 billion by end-2018 (CBSL sold US$1.1 billion, on a net basis, in 2018); GIR recovered to US$7.6 billion as of end-March 2019 after CBSL resumed FX purchases and the government raised US$2.4 billion in March 2019 (at 5- and 10-year maturities with yields of 6.9 and 7.9 percent). - EMBI spread: widened to 445 basis points as of end-2018; narrowed to 405 basis points as of end-March 2019. ### PROGRAM PERFORMANCE, AUTHORITY ACTIONS, AND FUND ARRANGEMENT - Program performance and requests: - Program performance suffered setbacks in 2018; the fifth review was delayed. - Authorities requested a one-year extension of the EFF arrangement with rephasing of purchases to complete the reform agenda ahead of presidential and parliamentary elections in late 2019 and mid-2020. - Purchase available upon completion of this review: SDR 118.5 million; total purchases under the EFF to date: SDR 833.73 million. - Date of staff report: April 26, 2019. - Prior actions and corrective measures: - 2019 budget submitted to Parliament as a prior action. - CBSL resumed FX purchases as corrective action for the requested waiver on the reserve target. - Five structural benchmarks implemented for this review (despite delays). ### KEY CHALLENGES AND RISKS - Structural vulnerabilities: - High public debt, large refinancing needs, and low external buffers. - Balance of risks (tilted to the downside): - Tightening global financial conditions, capital flow reversals, trade tensions, weaker global growth, domestic political uncertainty ahead of elections could raise refinancing risks and weaken exports, FDI, and remittances. - Security concerns after April 21 attacks could negatively affect tourism and investor sentiment. - Upside risks: - Stronger external demand, FDI, easing global financial conditions, and lower energy prices. ### FISCAL STRATEGY AND MEASURES — Advancing fiscal consolidation and institutions - 2018 fiscal outturn: - Primary surplus: 0.6 percent of GDP in 2018 (short of the 1 percent target at the time of the fourth review). - Shortfall driver: 1.4 percentage-point-of-GDP shortfall in tax revenues due to weaker growth, a waiver on fuel import duties, and delayed implementation of some 2018 budget measures. - 2019 budget (submitted as prior action): - Targets a primary surplus of 1.5 percent of GDP in 2019. - Revenue measures: new measures equivalent to 0.7 percent of GDP; base effects from IRA and 2018 budget measures expected to add +1.7 (percent of GDP) in revenue relative to the 2018 outturn. - IRA amendments: annual cost of up to 0.1 percent of GDP to support private sector investment and mitigate distributional impacts. - Social protection and capital spending: - Samurdhi cash transfer allocation to be increased by 25 percent, expanding coverage to an estimated 600,000 additional beneficiaries. - Part of 2018 unexecuted capital budget accommodated; full implementation contingent on revenue performance and attainment of the primary surplus target. - New Disaster Management Contingency Fund envisaged for natural disasters. - Revenue administration reforms: - Plan to modernize the IRD and Customs with enhanced risk assessment and organizational improvements; expected cabinet approval by June 2019 with IMF TA support. - VAT compliance strategy with risk-based audits piloted; roll‑out by end-December to maximize collections under expanded VAT base. - IRD to expedite IT system compatibility with the new IRA. ### MONETARY, EXCHANGE RATE, AND EXTERNAL POLICY - Monetary policy: - CBSL maintained a tight stance to contain inflation and stabilize markets; policy rate corridor raised to 8-9 percent in November 2018 and maintained. - SRR reduced from 7½ to 5 percent since November to address liquidity shortage. - Exchange rate and reserves: - CBSL intervened to smooth adjustment, sold US$1.1 billion (net) in 2018, allowed greater exchange rate flexibility; real effective depreciation 13 percent in 2018. - CBSL resumed FX purchases in early 2019 (nearly US$150 million purchased on a net basis as of April 26 in the source). - CBSL to consult monthly with IMF staff on FX market and reserve developments; introduced RFQ system for direct dealing since July 2018. - External sector measures: - Administrative exchange restrictions issued in September–October 2018 gave rise to nonobservance of Article VIII continuous PC; measures eliminated in March 2019 and staff supports waiver request. - CFMs sequencing: plan to remove repatriation requirement for export proceeds as adjustment progresses; foreign investor threshold in rupee government securities lowered from 10 to 5 percent in response to outflows, with possibility to loosen later. ### STRUCTURAL REFORMS, SOE GOVERNANCE, AND PUBLIC FINANCE INSTITUTIONS - Debt and fiscal institutions: - Public debt: rose to 90 percent of GDP in 2018. - Authorities committed to lower fiscal deficit to 3.5 percent of GDP in 2020; plan to reduce deficit to 2 percent of GDP by 2024 to bring public debt below 70 percent of GDP (specific measures yet to be identified). - Medium-Term Debt Strategy approved; plan to establish an independent debt management agency (proposal expected by end-September). - Public financial management and PPPs: - New PFM Act under development with WB support; new PPP guidelines to strengthen project selection and appraisal. - Dedicated MOF unit established to oversee fiscal risks and affordability of PPP projects. - SOE fiscal risks and reform steps: - Combined losses of three main SOEs (CPC, CEB, SriLankan Airlines): 1.3 percent of GDP in 2018 (compared to 0.5 percent of GDP in 2017). - Major SOE financials (in percent of GDP, preliminary 2018 data): - CEB balance: -0.2 (2018) from -0.4 (2017). - CPC balance: -0.7 (2018) from 0.0 (2017). - SLA balance: -0.4 (2018) from -0.1 (2017). - Energy pricing reforms: - Fuel pricing formula reinstated in late December; authorities committed to achieve full cost recovery by June 2019. - Electricity pricing mechanism approval delayed to second half of the year; cabinet discussion expected and implementation targeted. - SriLankan Airlines: - Committee appointed to prepare restructuring report; cabinet expected to discuss in May; Board to prepare strategic plan and operating business model with measures to reduce costs by end-September 2019. ### MONETARY LAW ACT (MLA) AMENDMENTS AND TRANSITION TO INFLATION TARGETING - Cabinet approved draft MLA amendments in March 2019 (prepared with IMF TA) to: - Establish price stability as CBSL’s primary objective and a flexible exchange rate regime. - Phase out CBSL participation in the primary market and provision of advances to the government; eliminate other quasi fiscal functions. - Strengthen CBSL autonomy, governance, transparency, and accountability; introduce explicit macroprudential policy mandate. - Submission to Parliament of final bill expected by end-July 2019 (proposed SB). - CBSL roadmap and operational steps to transition to flexible inflation targeting and a more market-based FX regime are in place. ### FINANCIAL SECTOR REFORMS, STABILITY, AND AML/CFT - Credit and soundness: - Credit to private sector: 16 percent in 2018; moderated to 13½ percent in February and projected 13 percent for 2019. - NPLs: 3.4 percent in banking sector and 7.7 percent in NBFIs as of end-2018; provision coverage declined to 57 percent in both sectors. - Regulatory upgrades: - Phased Basel III capital and liquidity requirements effective January 2019; IFRS 9 adoption ongoing. - NBFI sector accounts for 7.6 percent of financial system assets; consolidation expected. - New Banking Act draft with WB support; cabinet approval planned by end-December 2019; harmonization of bank and NBFI regulation targeted by end-March 2020. - Macroprudential and contingency framework: - Plan to enhance systemic risk monitoring, develop macroprudential tools, and align stress-testing with best practices with IMF TA and a resident advisor. - Resolution regime and deposit insurance chapter to be included in new Banking Act. - AML/CFT progress: - Considerable progress on APG and FATF recommendations; FATF on-site visit planned to verify implementation; could result in exit from FATF’s Improving Global AML/CFT Compliance list. ### SOCIAL SAFETY NETS, GENDER, AND LABOR MARKET PACKAGES - Samurdhi and social protection: - Samurdhi serves approximately 19 percent of the population; SSN spending totals about 0.8 percent of GDP. - 2019 budget appropriates a 25 percent increase in Samurdhi spending to enroll an estimated 600,000 additional eligible applicants starting in the second half of 2019. - New means-tested eligibility criteria approved by cabinet in March 2019. - Digital social registry to be populated in second half of 2019 after software finalization and testing. - Female and youth employment (Annex I): - FLFP rate: 34.3 percent (2018Q4); male LFPR: 73.2 percent (2018Q4). - Youth unemployment (age 15–24): 21.9 percent (2018Q4); youth unemployment for young women: 28.7 percent (2018Q4). - Staff estimates: fully closing gender gaps could generate overall income gains of about 21 percent over the long term. - Policy recommendations include gender-responsive budgeting (12 KPIs), expand childcare (open 2000 daycare centers; train 10,000 daycare operators), amend labor laws to facilitate part-time/flexible work, improve maternity/paternity leave, and expand Technical and Vocational Education and Training. ### PUBLIC DEBT, DSA HIGHLIGHTS, AND STRESS TESTS - Public debt and projections: - Public nominal gross debt: 77.1 (2017) rising to 82.7 (2018) and projected 90.0 (2019) (table series as presented); public gross debt rose to 90 percent of GDP in 2018 (narrative). - Public gross financing needs: 22.0 (2017); 18.3 (2018); 19.6 (2019) (table series as presented). - Baseline macro assumptions (selected): - Real GDP growth: 5.9 (2017), 3.4 (2018), 3.2 (2019), 3.6 (2020), 4.0 (2021), 4.3 (2022), 4.5 (2023), 4.6 (2024), 4.8 (later). - Inflation (GDP deflator): 6.5 (2017), 8.2 (2018), 4.3 (2019), 4.5 (2020–2024 ~4.5–5.0). - Primary balance (baseline): 1.5 (2019), 2.4 (2020–2024). - Effective interest rate: 7.5–8.4 (series as presented). - Stress test results: - Real depreciation shock: a one-time real depreciation of 30 percent occurring in 2017 could raise external debt-to-GDP ratio to about 83 percent by 2024 (stress test outcome shown as "83"). - Baseline external debt shown at "56" (percent of GDP) in Figure 6; stressed scenarios include values "63", "61", "60", and "30 % depreciation 83." - Identified debt-creating flows and scenario comparisons are detailed in the DSA tables and charts. ### EXTERNAL SECTOR, FINANCING NEEDS, AND FUND ENGAGEMENT - Balance of payments series (selected): - Net international reserves and gross international reserves series and months-of-imports metrics are presented (tables through Apr/Mar 2019). - Current account (millions of US$) series include values such as -1,742; -2,309; -2,814; -2,380; -2,378; -2,370; -2,410; -2,416; -2,552 across years as reported. - Gross external financing needs (Table 6, millions US$): -3,998; -4,351; -5,416; -5,893; -5,572; -5,242; -5,587; -5,253; -5,450 (series as reported). - Sources of financing (selected): sovereign bond issuances and bilateral/multilateral financing series reported in tables; government raised US$2.4 billion in March 2019. - IMF arrangement and disbursements (Table 8): - Availability dates/amounts (SDR millions): June 3, 2016 — 119.89; November 18, 2016 — 119.89; April 20, 2017 — 119.89; November 20, 2017 — 177.77; April 20, 2018 — 177.77; April 3, 2019 — 118.50; October 20, 2019 — 118.50; April 3, 2020 — 118.55. - Total: 1,070.78 SDR millions; 185.000 percent of quota (as reported). - Fund credit outstanding and projected repayments given in SDR and US$ series (Table 9). ### PROGRAM MODALITIES, TMU, AND PERFORMANCE CRITERIA - Reviews and monitoring: - Semiannual reviews; completion of sixth review requires observance of end‑June 2019 QPCs and continuous PCs; seventh review requires end‑December 2019 QPCs and continuous PCs. - Quantitative PC on central government primary balance (floor) and on Program NIR (floor); continuous PC on no new external payment arrears; monetary policy consultation clause on year‑on‑year CCPI inflation; indicative targets on tax revenue, reserve money, NCO costs, and treasury guarantees. - Selected quantitative targets and outcomes (as reported in Table 1 excerpt): - Central government primary balance (floor, in billion rupees): end‑Dec. Prog. 141; Act. 91 (Not Met). - Program NIR (floor, in million US$): end‑Dec. Prog. 1,771; Act. -320 (Not Met). - Central government tax revenue (floor, in billion rupees): end‑Dec. Prog. 1,934; Act. 1,712 (Not Met). - Reserve money of CBSL (ceiling, billion rupees): multiple dates with Act. 999; 1,015; 961 (Met). - Cost of NCOs for fuel and electricity (ceiling, billion rupees): series where Act. 54; 74; 116 noted as Not Met for earlier test dates. - TMU specifics: - Program NIR measured as CBSL conventional NIR minus CBSL outstanding FX swap liabilities with domestic banks. - NIR and primary balance floors include adjustors for project loans/grants, external commercial loans, proceeds from commercialization of public assets, foreign program financing, and official external debt amortization/interest. - Definitions and measurement rules for NCOs, reserve money, tax revenue, and other targets explicitly specified, with reporting timelines. ### STAFF VIEW AND RECOMMENDATIONS - Staff supports the authorities’ request for a one-year extension and rephasing of the EFF arrangement to allow more time to complete reforms. - Policy priorities and recommendations (selected): - Fiscal: sustained fiscal consolidation through domestic revenue mobilization and prudent spending; implement 2019 budget and new IRA; modernize tax administration; strengthen fiscal rules and MTDS. - Monetary and exchange rate: continue prudent, data-dependent monetary policy; sustain exchange rate flexibility; rebuild reserves; enact MLA amendments to support transition to flexible inflation targeting. - SOEs and governance: improve transparency, accountability, cost-efficiency of large SOEs; complete energy pricing reforms; restructure SriLankan Airlines. - Financial sector: harmonize regulation and supervision for banks and NBFIs; strengthen macroprudential policy and crisis-preparedness toolkit; continue AML/CFT progress. - Structural reforms: promote trade openness and investment, strengthen governance and anti-corruption, encourage female labor force participation, and enhance social protection. *Source: IMF staff report — EXECUTIVE SUMMARY and associated chapters and annexes (content unit: 1lkaea2019001), April 26, 2019.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Recent developments and outlook - Higher fuel prices and global financial volatility generated strong balance-of-payment pressures in 2018, exacerbated by a political crisis late in the year and multiple terrorist attacks on April 21, 2019 (over 250 casualties). - The Central Bank of Sri Lanka (CBSL) maintained a tight monetary policy stance, intervened in the FX market, and allowed for greater exchange rate flexibility in response to rising pressures. - Real GDP growth slowed to 3.2 percent in 2018; growth is expected to recover gradually to 5 percent over the medium-term. - Short-term projection: Real GDP growth is projected to recover to 3.6 percent in 2019. - Inflation developments: - Headline inflation: 2.8 percent (y-o-y) by end-2018. - Core inflation: 3.1 (y-o-y) percent by end-2018. - January 2019: headline 3.7 percent, core 5.5 percent. - March 2019: headline 4.3 percent, core 5.6 percent. - External balances and reserves: - Current account deficit: 3.2 percent of annual GDP in 2018 (from 2.6 percent of GDP in 2017). - Real effective exchange rate: depreciated by 13 percent in 2018. - Gross international reserves (GIR): US$6.9 billion by end-2018 (CBSL sold US$1.1 billion, on a net basis, in 2018). - GIR recovered to US$7.6 billion as of end-March 2019 after CBSL resumed FX purchases and the government raised US$2.4 billion in March 2019 (at 5- and 10-year maturities with yields of 6.9 and 7.9 percent). - EMBI spread: widened to 445 basis points as of end-2018; narrowed to 405 basis points as of end-March 2019. ### Program performance and authorities’ response - Program performance suffered setbacks in 2018 amid external shocks and a weak domestic environment; the fifth review was delayed. - Authorities remain committed to the program and requested a one-year extension of the EFF arrangement with rephasing of purchases to allow more time to complete the reform agenda and provide a policy anchor ahead of presidential and parliamentary elections in late 2019 and mid-2020. - Prior actions and corrective measures: - A well-targeted 2019 budget was submitted to Parliament as a prior action for this review. - CBSL resumed FX purchases to rebuild reserve buffers as a corrective action for the requested waiver on the reserve target. - Authorities implemented five structural benchmarks for this review, despite delays. - Fund financing under review: - The purchase available upon completion of this review will be equivalent to SDR 118.5 million, bringing total purchases under the Extended Fund Facility (EFF) to SDR 833.73 million. - Date of staff report: April 26, 2019. ### Key challenges and risks - Structural vulnerabilities: - High public debt, large refinancing needs, and low external buffers leave the economy vulnerable to shocks. - Balance of risks: - Tilted to the downside: tightening global financial conditions, capital flow reversals, trade tensions, weaker global growth, and domestic political uncertainty ahead of elections could raise refinancing risks and weaken exports, FDI, and remittances. - Security concerns after the April 21 attacks could negatively affect tourism and investor sentiment. - Upside risks include stronger external demand, FDI, easing global financial conditions, and lower energy prices supporting reforms. ### Fiscal strategy and measures (Advancing fiscal consolidation and strengthening institutions) - 2018 fiscal outturn: - Primary surplus: 0.6 percent of GDP in 2018 (short of the 1 percent target at the time of the fourth review). - Shortfall driver: 1.4 percentage-point-of-GDP shortfall in tax revenues due to weaker growth, a waiver on fuel import duties, and delayed implementation of some 2018 budget measures. - 2019 budget (submitted as a prior action): - Targets a primary surplus of 1.5 percent of GDP in 2019. - Structural adjustment: broadly in line with the fourth review. - Revenue measures: new measures equivalent to 0.7 percent of GDP, mainly through increases in excises and unwinding of customs duty waivers; base effects from IRA and 2018 budget measures expected to add +1.7 (percent of GDP) in revenue relative to the 2018 outturn (table/headline context). - IRA amendments: well-targeted amendments implemented in consultation with IMF staff, with an annual cost of up to 0.1 percent of GDP to support private sector investment and mitigate distributional impacts. - Expenditure policy: some space from revenue measures to strengthen social safety nets and development spending; Samurdhi cash transfer allocation to be increased by 25 percent, expanding coverage to an estimated 600,000 additional beneficiaries. - Capital spending: part of the 2018 unexecuted capital budget accommodated, but full implementation contingent on revenue performance and attainment of the primary surplus target. - New Disaster Management Contingency Fund envisaged for natural disasters. - Revenue administration and tax compliance: - Reform plan to modernize the Inland Revenue Department (IRD) and Customs administration, with enhanced risk assessment and organizational improvements, expected to be approved by cabinet by June 2019 with IMF TA support. - VAT compliance strategy with risk-based audits for large taxpayers piloted; roll-out by end-December to maximize collections under the expanded VAT base. - IRD to expedite IT system compatibility with the new IRA given delays. ### Monetary, exchange rate, and external policy stance - Monetary policy: CBSL maintained a tight stance to contain inflation and stabilize markets. - Exchange rate: CBSL intervened to smooth adjustment and allowed greater exchange rate flexibility in response to pressures. - Reserves rebuilding: CBSL resumed FX purchases in early 2019 to rebuild reserves; government issuance in March 2019 raised US$2.4 billion. ### Structural reforms and institutional strengthening - Authorities committed to advance structural reforms to secure program gains, support debt sustainability, and promote inclusive growth. - Areas emphasized: SOE governance and fiscal risk reduction; modernizing the monetary policy framework; rebuilding reserves; advancing financial sector reforms; accelerating reforms to promote sustainable growth. - Staff and mission engagement: - Discussions held in Colombo during September 13–27, 2018 and February 14–28, 2019 with senior officials and stakeholders. - Mission team included Manuela Goretti (head), Pablo Morra, Andrew Hodge, Sarwat Jahan, Masahiro Nozaki, Saji Thomas, Peter Lindner, Fei Liu, Tubagus Feridhanusetyawan, Eteri Kvintradze, Amitha Sundararaj; Mr. Siriwardana (OED) participated; contributions from Guli Gamwalla-Khadivi, Cormac Sullivan, Biying Zhu, and Nimarjit Singh. ### Staff view - Staff supports the authorities’ request for the one-year extension and rephasing of the EFF arrangement to allow more time to complete the reform agenda. - The baseline staff report was finalized on April 26, 2019; staff notes the baseline does not make assumptions about the potential impact of the April 21 terrorist attacks. *Source: IMF staff report — EXECUTIVE SUMMARY (1lkaea2019001), April 26, 2019.* ### 10. Fiscal institutions are being strengthened to anchor fiscal consolidation efforts and ### 10. Fiscal institutions are being strengthened to anchor fiscal consolidation efforts and ### Fiscal outlook, debt vulnerabilities, and consolidation plans - Despite the improvement in the primary balance, Sri Lanka’s public debt rose to 90 percent of GDP in 2018, due to weaker growth and rupee depreciation. - Debt profile vulnerabilities: - Exposure to currency and interest rate shocks. - Lumpy repayments pose rollover risks in coming years (Annex II). - Authorities’ fiscal targets: - Committed to lowering the fiscal deficit to 3.5 percent of GDP in the 2020 budget (proposed SB). - Announced plans in the 2019 budget speech to reduce the deficit further to 2 percent of GDP by 2024, bringing public debt below 70 percent of GDP (specific measures yet to be identified). - Debt management measures: - Approved in early April a Medium-Term Debt Strategy, with IMF and WB TA, to optimize debt management, mitigate FX exposure and support maturity transformation (end-October 2018 SB). - A plan to establish an independent debt management agency expected to be approved by end-September (proposed to reset the end-March 2019 SB). - Fiscal path scenarios (note on modeling): - Under current policy, the fiscal deficit declines to 3.5 percent of GDP by 2020. - Under the active scenario, the fiscal deficit declines to 2 percent of GDP by 2024. ### Public financial management, PPPs, and investment project governance - Reforms underway: - Authorities, with WB support, are working on a new Public Financial Management Act to improve the budget process and control risks from Public Private Partnerships (PPPs). - New PPP guidelines to strengthen project selection and appraisal are being finalized. - A dedicated unit was recently established within the MOF to oversee fiscal risks and affordability of PPP projects. - Transparency and tax policy: - Importance of ensuring transparency and evenhandedness across all investment development projects. - Allow investors to access the incentive regime under the IRA while avoiding ad hoc tax exemptions. - Rationale: - Efforts are critical to manage large-scale capital projects, including ongoing development initiatives under China’s Belt and Road Initiative. ### Strengthening SOE governance and reducing fiscal risks - SOE fiscal risk overview: - Three main SOEs—Ceylon Petroleum Corporation (CPC), Ceylon Electricity Board (CEB), and SriLankan Airlines—recorded a combined loss of 1.3 percent of GDP in 2018, compared to 0.5 percent of GDP in 2017. - Deterioration driven primarily by CPC’s increased financing costs associated with higher oil prices and FX depreciation; losses partly mitigated by the fuel pricing formula implemented during May-October 2018. - Financial performance of major SOEs (in percent of GDP, data note: 2018 based on preliminary information supplied by the Sri Lankan Ministry of Finance): - Ceylon Electricity Board (CEB) - Revenue: 1.7 (2017), 1.7 (2018) - Expenditure: 2.0 (2017), 1.9 (2018) - Balance: -0.4 (2017), -0.2 (2018) - Ceylon Petroleum Corp. (CPC) - Revenue: 3.4 (2017), 4.2 (2018) - Expenditure: 3.4 (2017), 4.9 (2018) - Balance: 0.0 (2017), -0.7 (2018) - SriLankan Airlines (SLA) - Revenue: 1.1 (2017), 1.2 (2018) - Expenditure: 1.3 (2017), 1.6 (2018) - Balance: -0.1 (2017), -0.4 (2018) ### Concrete SOE reform steps and governance measures - Energy pricing reforms: - Fuel pricing formula monthly implementation disrupted by the October political crisis, with unwarranted price reductions. - Formula reinstated in late December; authorities committed to achieve full cost recovery by June 2019. - Approval by cabinet of an electricity pricing mechanism delayed to the second half of the year to allow stakeholder consultation (end-September 2018 SB; proposed reset end-October 2019). - SriLankan Airlines restructuring: - President appointed a committee to prepare a new report to advance restructuring. - Cabinet expected to discuss a paper in May, including recommendations for a joint venture with a strategic partner and measures to strengthen governance and accountability. - Based on cabinet decision, the Board to prepare an effective strategic plan and operating business model with measures to reduce operational and financial costs and minimize future losses by end-September 2019 (proposed SB). - SOE corporate planning and transparency: - Biannual compliance reports against KPIs in Statements of Corporate Intent (SCIs) for the 5 major SOEs submitted to cabinet for 2017; 2018 SCIs being prepared. - Ten additional SOEs expected to sign and publish SCIs by mid-2019, outlining multiyear corporate plans and establishing KPIs. - Mission stressed need to expedite publication of audited financial statements for SOEs, starting with the major ones. ### Box 1 — Status of China’s Belt and Road Initiative Projects in Sri Lanka (key facts) - China’s lending and investment exposure: - China’s outstanding official loans to the Sri Lankan central government amount to approximately US$3 billion based on end-2018 data or 9 percent of external central government debt, compared to 13 percent by the Asian Development Bank, 10 percent by Japan, and 10 percent by the World Bank. - China’s loans to the Sri Lankan public sector, including SOEs, are around US$5 billion (15 percent of external debt). - Infrastructure-related FDI from China amounted to about US$2.3 billion over 2013-2018, of which US$1.5 billion took place in 2017–2018. - Major BRI projects: - Hambantota Port: - Originally financed with Chinese bilateral loans of US$1.1 billion (1.3 percent of GDP), maturities 15 to 20 years, interest rates 2 to 6.3 percent. - Restructured in 2017 into a 99-year concession with China Merchant Port Holdings (CMPH); CMPH paid US$1.1 billion and acquired an 85 percent share of the company developing and operating the port. - Planned economic zone development; announced projects in March 2019 include an oil refinery with an investment of US$3.85 billion supported by the Sultanate of Oman, and a cement manufacturing plant with an investment of US$100 million. - Colombo Port City: - Development on reclaimed land of 269 hectares adjacent to Colombo Harbor. - CHEC oversaw land reclamation with FDI totaling US$1.4 billion (1.5 percent of GDP) and is granted 116 hectares as a 99-year leasehold. - Government responsible for connecting utilities to the boundary of the reclaimed land; a special regulatory regime for the Port City under consideration. - Other Chinese financing: - Exim Bank of China provided loan assistance of US$1.6 billion for Southern Expressway extension. - Exim Bank agreed to provide concessional financing for US$989 million for section 1 of the Central Expressway (CEP). ### Modernizing monetary policy framework and rebuilding reserves - Central Bank law reform: - Cabinet approved in March 2019 draft amendments to the Monetary Law Act (MLA) (end-December 2018 SB). Amendments prepared with IMF TA will: - Establish price stability as the CBSL’s primary objective and a flexible exchange rate regime. - Phase out CBSL’s participation in the primary market and provision of advances to the government, and eliminate other quasi fiscal functions. - Strengthen CBSL’s autonomy, governance, transparency, and accountability frameworks, consistent with the 2016 safeguards recommendations. - Introduce an explicit macroprudential policy mandate for the CBSL. - Submission to Parliament of the final bill, in line with IMF staff recommendations, expected by end-July 2019 (proposed SB). - Policy stance and operations: - CBSL raised the policy rate corridor to 8-9 percent in November 2018 and has since maintained policy rates unchanged. - To address liquidity shortage, CBSL reduced the statutory reserve ratio from 7½ to 5 percent since November. - Inflation developments: - Inflation fell below the CBSL’s inner band in late 2018, triggering a monetary policy consultation. - Inflation was back within the target range in early 2019 and is expected to converge gradually towards the 5 percent target. - CBSL agreed to remain vigilant and stand ready to adjust policy rates as warranted by evolving macroeconomic conditions. - Reserve management and exchange rate flexibility: - CBSL intervened and sold US$1.1 billion on a net basis in 2018, resulting in a sizable breach of the NIR target. - As FX pressure intensified, CBSL allowed greater exchange rate flexibility; real effective terms depreciation of the rupee was 13 percent. - With improved market conditions after the political crisis, CBSL resumed FX purchases: - Nearly US$150 million purchased on a net basis as of April 26 (year not specified in source). - CBSL remains on track to meet the recalibrated NIR target for end-June. - CBSL will consult monthly with IMF staff on FX market and reserve developments, or on a higher frequency in case of significant deviations from the envisaged reserve path. - Since July 2018 CBSL introduced a market-based and transparent Request for Quotes system for direct dealing (end-December 2018 SB). ### External sector measures and capital flow management - Exchange restrictions and Article VIII: - During September-October 2018, authorities issued administrative measures that gave rise to exchange restrictions inconsistent with Sri Lanka’s Article VIII obligations, resulting in nonobservance of the continuous PC on non-introduction of exchange restrictions (MEFP ¶26). - Measures were eliminated in March 2019; staff supports authorities’ request for a waiver of nonobservance. - Sequencing removal of CFMs: - Staff welcomed plan to remove the repatriation requirement of export proceeds introduced in 2016 as macroeconomic adjustment progresses. - Following sizable capital outflows during the political crisis, CBSL lowered the threshold for foreign investment in rupee-denominated government securities from 10 to 5 percent of the total outstanding stock (tightening a residency-based CFM). - Staff advised loosening the measure back in the absence of a capital inflow surge to take advantage of portfolio inflows to build reserves and deepen the domestic bond market, in line with the Fund’s Institutional View on capital flows. - Authorities expressed concerns about capital flow volatility and agreed to review the foreign investment threshold as reserves reach more comfortable levels. - Additional measures: - The measures in September-October 2018 aimed at restricting payments for imports of some items by imposing cash margins on letters of credit and imports under documents-against-acceptance terms, and by restricting FX conversion for advance payments. ### Advancing financial sector reforms and resilience - Credit and lending dynamics: - Credit to the private sector grew at 16 percent in 2018. - Credit growth uptick in 2018Q4 driven by currency depreciation impact on FX-denominated loans and strong demand for motor vehicles (duty-free import permits extension and anticipation of tax increases in 2019 budget). - Credit growth moderated to 13½ percent in February and is projected at 13 percent for 2019, given tighter financial conditions. - Financial system health and regulatory changes: - Non-performing loans (NPLs) increased to 3.4 percent in the banking sector and 7.7 percent in NBFIs as of end-2018 due to the economic slowdown; provision coverage declined to 57 percent in both sectors. - Phased introduction in January 2019 of new capital and liquidity requirements under Basel III and ongoing adoption of IFRS 9 with stricter asset classification and provisioning will require additional efforts to meet capital requirements. - NBFI sector accounts for 7.6 percent of financial system’s assets; further consolidation expected to meet capital needs. - Authorities viewed the financial system as sound and stable but agreed to remain vigilant given these challenges. *Source: IMF staff and Sri Lankan authorities (content unit: 10. Fiscal institutions are being strengthened to anchor fiscal consolidation efforts and reduce debt vulnerabilities over the medium term).* ### 21. The CBSL is committed to implement the recommendations of the recent Financial ### 21. The CBSL is committed to implement the recommendations of the recent Financial Sector Stability Review (FSSR). ### Financial sector stability — reform agenda and timelines - Enhancing the macroprudential policy framework: - Plans to strengthen the financial stability framework by enhancing monitoring of systemic financial risks, developing macroprudential tools to contain systemic risk, and aligning stress testing methodologies with best practices. - Implementation support from IMF TA and a resident advisor. - Strengthening regulation and supervision: - Authorities, with support from the WB, are working on a new Banking Act to strengthen banks’ regulation and supervision. - Cabinet approval of the draft legislation is planned by end-December 2019. - Steps to harmonize regulatory and supervisory requirements for banks and NBFIs, with relevant CBSL Directions to be issued by end-March 2020. - Upgrading the contingency framework: - Recognition that the existing framework for crisis preparedness and management is incomplete. - The new Banking Act will include a new resolution regime for banks and NBFIs and a separate chapter to provide a stronger legal foundation to the deposit insurance system. - Key FSSR focus areas (as presented): - Macroprudential Framework: Systemic risk monitoring; Develop macroprudential policy tools; Enhance macroprudential policy formulation and communication; Strengthen stress testing framework. - Regulation and Supervision: Implement Basel capital and liquidity standards; Upgrade other regulations; Strengthen supervision (risk-based, consolidated, cross-border); Harmonize regulation and supervision of banks and NBFIs. - Contingency Framework: Increase crisis preparedness; Strengthen resolution framework; Enhance deposit insurance system; Improve liquidity assistance framework. - IMF and WB Capacity Development noted as support. ### Social safety nets and inclusion - Ongoing reforms to support youth and women economic empowerment and strengthen social safety nets. - Samurdhi program and SSN context: - Samurdhi serves approximately 19 percent of the population. - SSN spending currently totals about 0.8 percent of GDP. - In 2015, Samurdhi transfers were significantly increased by more than doubling individual benefits. - Samurdhi leaves around 63 percent of the poorest quintile group out of the program. - Under Samurdhi, around two-thirds of the benefits accrue to the poorest 40 percent, while the rest goes to higher-income households. - Reforms under the World Bank’s Social Safety Net Project: - Better targeting: Cabinet approved new means-tested eligibility criteria in March 2019; means-testing based on household size, age, education, type of housing and assets. - More beneficiaries: The 2019 budget appropriates a 25 percent increase in Samurdhi spending to enroll an estimated 600,000 additional eligible applicants starting in the second half of 2019. - Electronic database: A digital social registry is being established; software development is being finalized and the government plans to start populating the registry in the second half of 2019 after thorough testing. ### Trade openness, investment climate, and export promotion - Reform priorities to spur exports and attract investment: - Elevated trade restrictions and anemic FDI have hindered export sector development. - Investment-based tax incentives under the IRA, enhanced under the 2019 budget, are expected to promote private investment and make income taxes more predictable and transparent. - WB-supported Investment Climate Roadmap: regulatory, institutional, and legal reforms including enhancing the contractual framework and strengthening debt enforcement. - National Export Strategy presented in July 2018 to facilitate trade, attract investment, and promote export diversification. - WB-supported initiatives: Trade Information Portal; blueprint for National Single Window; web portal to streamline investment approval process. - Tariff and levy adjustments: Authorities removed 1,200 para-tariffs since 2017; phasing out of CESS and PAL over a five-year period beginning in September 2019. - A strategy to gradually rationalize remaining para-tariffs is expected to be approved by cabinet by March 2020. ### Governance, anti-corruption, and AML/CFT - Actions to strengthen governance and combat corruption: - National Action Plan for Combating Bribery and Corruption approved by cabinet and launched last March with a roadmap for 2019–23 covering prevention, education, institutional strengthening, and law and policy reforms. - Bribery Act amended in July 2018 and new courts established to try bribery and corruption cases. - Plan to consolidate all laws related to bribery and corruption into a comprehensive piece of legislation to comply with the United Nations Convention against Corruption treaty. - AML/CFT progress: - Considerable progress in implementing recommendations by the Asia/Pacific Group on Money Laundering and the FATF action plan. - FATF Plenary planning an on-site visit to verify implementation; this could result in Sri Lanka exiting the FATF’s list on Improving Global AML/CFT Compliance. - Complementary measures: - Ongoing efforts to support transparent fiscal management and stringent SOE governance to prevent corruption. ### Program modalities, financing, and risks - Authorities requested an extension of the EFF arrangement by one year to complete reform agenda and to rephase undisbursed purchases evenly among the three remaining reviews; waivers requested for non-observance of missed fiscal and NIR QPCs and the continuous PC on non-introduction of exchange restrictions. - Conditionality adjustments: - New QPCs and ITs proposed for the sixth and seventh reviews, plus new adjustors on project loans and grants and interest payments by the central government. - Pending SBs proposed to be rescheduled and new SBs to be added for the sixth and seventh reviews. - Financing and exposure: - Fund’s exposure is relatively low, with outstanding Fund credit peaking at 6.6 percent of exports in 2020 under the proposed extension and rephasing of the arrangement. - Program remains fully financed on a forward-looking basis; however risks remain elevated. - Downside risks identified that could necessitate further macroeconomic adjustment or financing: - (i) renewed market and FX pressures; - (ii) lower growth; - (iii) implementation delays in fiscal or SOE reforms. - Political window for reforms might narrow in the run-up to the elections, exacerbating risks. ### Macroeconomic outlook and staff appraisal — key projections and policy recommendations - Growth and inflation: - Growth projected to recover to 3.6 percent in 2019, and gradually reach 5 percent over the medium-term. - Inflation expected to be in the mid-single digits. - Policy priorities and recommendations: - Fiscal: Sustained fiscal consolidation through domestic revenue mobilization and prudent spending to maintain public debt sustainability; implement the 2019 budget and the new IRA; modernize tax administration; strengthen fiscal rules and medium-term debt strategy. - Monetary and exchange rate: Continue prudent and data-dependent monetary policy by the CBSL, be ready to adjust policy rates if inflationary pressures re-emerge; sustain greater exchange rate flexibility and renew efforts to strengthen reserves; MLA amendments to support transition to flexible inflation targeting by strengthening CBSL’s mandate, autonomy, governance and accountability frameworks. - SOEs and governance: Renewed efforts to improve transparency, accountability, and cost-efficiency of large SOEs; progress noted from fuel pricing reform to mitigate fiscal risks from CPC; move forward with plans to bring SriLankan Airlines on a sound commercial and financial footing and complete energy pricing reforms. - Financial sector: Advance efforts to harmonize regulatory and supervisory regimes; strengthen macroprudential policy and crisis-preparedness toolkit; continue progress on AML/CFT. - Structural reforms: Continue reforms to promote trade openness and investment, strengthen governance and anti-corruption, encourage female labor force participation, enhance social protection, and improve crisis preparedness for natural disasters. - Staff recommendation: - Staff supports completion of the fifth review and the extension and rephasing of the arrangement, and supports the authorities’ request for waivers of nonobservance of performance criteria and modification of program conditionality, given progress and commitments. *Italic: Source — IMF staff report content provided in the supplied PDF excerpt.* ### 4. Foreign Exchange and Reserves ### 4. Foreign Exchange and Reserves ### Exchange rate and market indicators - Exchange rate indicators shown include onshore 3-month forward points (basis points) and spot exchange rate (LCU/USD) (charts present series through Mar-19). - Effective exchange rate indices presented: NEER and REER (Index, June 2009 = 100; series through Feb-19). - Exchange rate indices (USD/LCU, Index, Jan 2015 = 100) are shown for India, Indonesia, Malaysia, Philippines, Vietnam, and Sri Lanka (series through Apr-19). - Foreign holdings of government securities and share of foreign ownership are tracked (series through Mar-19). ### Central bank foreign exchange operations and reserves - Gross international reserves (end of period, in millions of U.S. dollars) shown in Tables/Annexes: - 6,019; 7,959; 9,268; 6,919; 9,710; 8,650; 9,580; 10,403; 11,003; 11,646; 11,996. - Gross international reserves (in months of prospective imports of goods & services): - 2.8; 3.6; 3.9; 3.0; 3.9; 3.5; 3.7; 3.9; 3.9; 4.0; 4.0. - Gross official reserves (Table 5a, projections and historical): - 6,019; 7,959; 9,268; 6,919; 9,710; 8,650; 9,580; 10,403; 11,003; 11,646; 11,996 (series as reported). - Gross official reserves—in percent of the ARA composite metric: - 54.8; 68.8; 74.2; 56.4; 74.5; 68.2; 72.6; 75.1; 75.9; 78.5; 79.0. - Net international reserves (end-period, in millions of U.S. dollars), selected values: - 4,529; 6,597; 7,475; 5,495; 7,656; 6,888; 7,847; 8,726; 9,474; 10,301; 10,893 (as reported). - Net international reserves—in percent of the ARA composite metric: - 41.2; 57.0; 59.8; 44.8; 58.7; 54.3; 59.5; 63.0; 65.3; 69.4; 71.7. ### Balance of payments, current account, and external financing - Current account (in millions of U.S. dollars; Table 5a and Table 6): - -1,742; -2,309; -2,814; -2,380; -2,378; -2,370; -2,410; -2,416; -2,552 (series as reported across years). - Balance on goods (credit and debit, selected years): - Exports: 10,310; 11,360; 11,922; 11,890; 12,504; 12,566; 13,251; 13,970; 14,721; 15,509; 16,344. - Imports: -19,183; -20,980; -22,294; -22,233; -23,848; -23,437; -24,681; -25,950; -27,245; -28,603; -30,033. - Balance on services (credit and debit, selected years): - Services credit (exports): 7,138; 7,724; 8,535; 8,375; 9,218; 8,668; 9,240; 9,822; 10,480; 11,141; 11,586. - Services debit (imports): -4,259; -4,421; -4,603; -4,609; -4,833; -4,655; -4,669; -4,762; -4,858; -4,955; -5,054. - Primary income, net (selected values): - -2,201; -2,319; -2,422; -2,399; -2,510; -2,360; -2,367; -2,343; -2,364; -2,376; -2,378. - Secondary income, net and workers' remittances (net), selected values: - Secondary income: 6,452; 6,327; 6,555; 6,163; 6,956; 6,838; 6,848; 6,893; 6,856; 6,868; 6,982. - Workers' remittances: 6,434; 6,316; 6,543; 6,156; 6,945; 6,832; 6,843; 6,888; 6,851; 6,864; 6,976. - Financial account (net lending / net borrowing, Table 5a): - -1,649; -4,542; -2,856; -1,912; -2,455; -3,536; -3,140; -3,237; -3,146; -3,231; -3,133. ### Gross external financing needs and financing sources - Gross external financing needs (Table 6, in millions of U.S. dollars): - -3,998; -4,351; -5,416; -5,893; -5,572; -5,242; -5,587; -5,253; -5,450. - Sources of financing (Table 6, selected components): - Borrowing totals: 3,007; 6,531; 4,000; 7,069; 6,336; 6,065; 6,187; 5,895; 5,800. - General government external borrowing: 3,123; 4,180; 2,904; 5,985; 3,900; 3,230; 3,880; 3,980; 3,980. - Sovereign bonds (selected issuance amounts reported): 1,500; 1,500; 2,500; 4,400; 2,000; 1,500; 2,000; 2,000; 2,000. - Bilateral and multilateral financing (based on existing and expected commitments): 1,420; 1,263; 420; 693; 600; 1,450; 1,600; 1,700; 1,700. - FDI inflows, net: 661; 1,301; 1,541; 1,956; 1,711; 1,490; 1,340; 1,340; 1,340. - Change in reserve assets (Table 6): 472; -2,778; 1,039; -1,731; -930; -823; -600; -643; -350. - External financing gap / financing (Table 6): - External financing gap: 518; 598; 377; 554; 166; 0; 0; 0; 0 (years as shown). - IMF contribution reported in the financing gap: 333; 413; 252; 329; 166; 0; 0; 0; 0. - Other IFIs: 185; 185; 125; 225; 0; 0; 0; 0; 0. ### Central government use of reserves, Fund engagement, and projected Fund payments - IMF-supported arrangement reviews and purchases (Table 8): - Availability dates and amounts (SDR millions): June 3, 2016 — 119.89; November 18, 2016 — 119.89; April 20, 2017 — 119.89; November 20, 2017 — 177.77; April 20, 2018 — 177.77; April 3, 2019 — 118.50; October 20, 2019 — 118.50; April 3, 2020 — 118.55. - Percent of Quota (%) corresponding to each purchase listed (e.g., 420.714; 430.714; 20.473; 20.485). - Total: 1,070.78 SDR millions; 185.000 percent of quota (as reported). - Note in table: The fifth, sixth, and seventh reviews are proposed to be rephased. - Fund credit outstanding and projected repayments (Table 9, as of March 31, 2019): - Fund repurchases and charges (in millions of SDR): 17.4; 37.1; 67.2; 130.4; 152.8; 189.3; 195.4; 181.6; 148.1; 81.1; 54.9; 14.5; 4.6; 4.6; 4.6 (series 2019–2033). - Fund credit outstanding (in millions of SDR, end-of-year series): 952.2; 1,060.8; 1,020.8; 916.4; 787.4; 618.8; 440.3; 271.8; 133.3; 59.3; 9.9; 0.0; 0.0; 0.0; 0.0 (2019–2033 series as reported). - Fund credit outstanding (in millions of U.S. dollars, selected): 1,329; 1,490; 1,443; 1,296; 1,113; 875; 623; 384; 189; 84; 14; 0.0; 0.0; 0.0; 0.0. ### Monetary and liquidity context relevant to reserves - Monetary accounts and international reserve memoranda (selected figures from Table 4a/4b): - Reserve money (end-period, billions of rupees): 856; 940; 1,069; 961; 1,070; 1,192 (series reported). - Broad money (end-period, billions of rupees): 5,406; 6,308; 7,190; 7,128; 8,043; 9,048 (series reported). - Net foreign assets of monetary authorities (in millions of U.S. dollars, selected): 3,725; 5,513; 6,215; 4,104; 5,410; 6,342. - Money multiplier values reported: 6.3; 6.7; 6.7; 7.4; 7.5; 7.6. - Broad money velocity (annualized, end-period quarterly GDP basis): 2.4; 2.3; 2.0; 2.1; 1.9; 1.9. *Source: Chapter 4, "Foreign Exchange and Reserves," IMF staff estimates and data provided by the Central Bank of Sri Lanka and Sri Lankan authorities (as presented in the source PDF).* ### Annex I. Supporting Sri Lanka’s Female and Youth Employment ### Annex I. Supporting Sri Lanka’s Female and Youth Employment ### Overview: participation and unemployment indicators - Female labor force participation (FLFP) rate: 34.3 percent (2018Q4). - Male labor force participation rate: 73.2 percent (2018Q4). - Youth unemployment rate (age 15–24): 21.9 percent (2018Q4). - Youth unemployment for young women: 28.7 percent (2018Q4). - Adult unemployment rate (age over 30 years): 1.5 percent (2018Q4). - FLFP has "remained broadly unchanged over the past decade." - Despite advances in education and health, Sri Lanka ranks below ASEAN countries and several low-income developing countries in economic opportunity for women (per World Economic Forum’s Global Gender Report). ### Key drivers of low FLFP and high youth unemployment - Skill mismatches between education/training and labor market needs. - Preference for public sector employment. - Inequality in access to quality education, especially among poorer households and regions. - Low proportion of technically-skilled female workers despite an overall high level of education. - Inadequate maternity and paternity leave benefits. - Insufficient good-quality and affordable childcare facilities. - Outdated clauses in labor laws that inhibit part-time and flexible work arrangements. - Lack of safe transport. ### Economic importance and staff estimates - Exclusion of women and youth from the labor market reduces economic efficiency and output. - Staff estimates indicate that "fully closing gender gaps could generate overall income gains of about 21 percent over the long term." - Boosting FLFP would help mitigate adverse effects from population aging and the rising dependency ratio. ### Measures already underway by the authorities - Gender-responsive budgeting launched in 2018, with the development of twelve key performance indicators (KPIs) to assess progress (support from USAID). - Authorities conducting awareness programs and establishing focal points in each ministry to monitor KPI compliance. - Cabinet approval (March 2019) of a national policy to support early childhood care and development, especially among the most vulnerable and disadvantaged (support from the WB Group). - Policy includes initiatives to expand access to childcare services and training of staff. - 2019 budget proposals to reduce the tax cost for employers related to maternity leave benefits to strengthen incentives for hiring female workers. - Ongoing measures to improve access to safe transportation, with dedicated training and awareness programs. - Ongoing efforts to support maternity leave and expand benefits; paternity leave benefits remain limited. ### Policy objectives and recommended actions (as presented) - Improve gender-responsive budgeting by assessing in a systematic way the performance of line ministries based on the identified twelve key performance indicators. - Expand childcare facilities and develop a childcare policy. - Proceed with existing plans to establish After-School and Vacation Care centers in public schools, open 2000 daycare centers and train 10,000 daycare center operators. - Amend relevant legislation to facilitate flexible work arrangements, including allowing women to work at night in specific sectors. - Improve maternity and paternity leave benefits. - Provide maternity benefits irrespective of number of children. - Improve access to safe transportation. - Encourage the participation of women in the boards of listed companies. - Improve quality and access to education to reduce the skills mismatch, including through Technical and Vocational Education and Training. - Improve opportunities for innovation and entrepreneurship, including through access to finance and incubation facilities in early-stages of development. - Implement the investment climate reform agenda to reduce obstacles for the creation of Small and Medium-sized Enterprises that can generate jobs. - Create a more level playing field between the public and private sectors to reduce bias towards public sector employment. - Implement structural reforms to increase competitiveness and remove bottlenecks for trade to create jobs in the export sector. ### Labor law reforms and flexible work - Authorities committed to review existing labor laws to address rigidities and facilitate part-time and flexible working arrangements. - Current disincentives to part-time work: employers are expected to provide the same compensation to part-time and full-time workers upon termination, which discourages offering part-time jobs. - Provisions regulating night shifts reduce FLFP in some sectors (e.g., IT sector). ### Youth employment initiatives - 2019 budget includes proposals to support youth. - Strategy focuses on improving access to education, particularly among poorer households and regions, including expanding technical and vocational education and training to reduce skills mismatches. - Expansion of vocational training can also support FLFP in non-traditional jobs. - Initiatives aim to increase access to finance for projects in early stages of development to support innovation and entrepreneurship and facilitate creation of Small and Medium-sized Enterprises. *Source: IMF staff based on information provided by the Sri Lankan authorities.* ### 9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate ### 1lkaea2019001 - 9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate ### Debt vulnerabilities and risk assessment - "Vulnerabilities linked to inadequate reserve coverage, exchange rate depreciation, and deleveraging could pose a risk for debt servicing." - "Currency risk, notably related to the U.S. dollar, is high." - "Large rupee depreciation could pose a significant risk, if sustained, as stress tests show that a 30 percent real depreciation could raise the external debt-to-GDP ratio to about 83 percent by 2024." - "In the short run, tighter global liquidity and shifts in investor confidence could raise rollover risks and costs." - Despite a "high share of medium- and long-term debt," the report highlights "lumpy repayments and external financing at non-concessional terms gradually substituting concessional financing point to the need to speedily build buffers." - "Lower-than-expected GDP or export growth would also deteriorate debt dynamics." ### Public DSA — baseline projections and key indicators - Nominal gross public debt (Prel. As of December 31, 2018): - "2017 2018 2019 2020 2021 2022 2023 2024" - "Nominal gross public debt77.182.7 90.088.9 86.8 84.0 81.2 78.4 75.4" - "o/w: guarantees & Fund credit3.75.3 6.86.8 6.8 6.7 6.5 6.2 5.9" - Public gross financing needs: - "Public gross financing needs22.018.3 19.617.9 15.4 12.2 11.5 11.2 10.7" - Real GDP growth (in percent): - "Real GDP growth (in percent)5.93.4 3.23.6 4.0 4.3 4.5 4.6 4.8" - Inflation (GDP deflator, in percent): - "Inflation (GDP deflator, in percent)6.58.2 4.34.5 4.5 4.7 4.8 5.0 5.0" - Nominal GDP growth (in percent): - "Nominal GDP growth (in percent)12.811.9 7.78.3 8.7 9.2 9.5 9.8 10.0" - Effective interest rate (in percent): - "Effective interest rate (in percent)4/ 7.57.8 8.27.8 7.9 7.9 8.2 8.3 8.4" - Sovereign spreads and market perception: - "EMBIG (bp) 3/445" - "338 bp" (present in market perception panel) - Change in gross public sector debt and identified flows (cumulative to 2024): - "Change in gross public sector debt1.1-1.4 7.4-1.1 -2.2 -2.7 -2.8 -2.8 -3.0 -14.6" - "Identified debt-creating flows-0.7 -2.6 5.7 -1.8-3.1-3.4-3.4-3.5-3.6 -18.8" - "Primary deficit1.50.0 -0.6-1.5 -2.4 -2.4 -2.4 -2.4 -2.4 -13.5" - "Primary (noninterest) revenue and grants 13.013.7 13.415.1 16.0 16.2 16.2 16.2 16.2 95.7" - "Primary (noninterest) expenditure14.513.7 12.713.6 13.6 13.7 13.7 13.7 13.7 82.2" - Automatic debt dynamics contributions (cumulative): - "Automatic debt dynamics-2.2-2.2 7.8-0.4 -0.7 -1.0 -1.0 -1.1 -1.2 -5.3" - "Interest rate/growth differential-3.4-3.1 0.4-0.4 -0.7 -1.0 -1.0 -1.1 -1.2 -5.3" - "Of which: real interest rate0.6-0.5 2.92.6 2.6 2.4 2.4 2.3 2.3 14.6" - "Of which: real GDP growth-3.9-2.6 -2.5-3.0 -3.3 -3.4 -3.4 -3.4 -3.4 -19.9" - Residual (including asset changes): - "Residual, including asset changes8/ 1.81.2 1.60.7 0.9 0.7 0.6 0.7 0.6 4.2" ### Composition of public debt and scenario comparisons - Underlying assumptions and selected baseline series: - "Baseline Scenario 2019 2020 2021 2022 2023 2024" - "Real GDP growth3.64.04.34.54.64.8" - "Inflation4.54.54.74.85.05.0" - "Primary Balance1.52.42.42.42.42.4" - "Effective interest rate7.87.97.98.28.38.4" - Alternative scenarios shown: - "Historical Scenario Real GDP growth3.65.45.45.45.45.4" - "Constant Primary Balance Scenario Primary Balance1.51.51.51.51.51.5" - Composition charts highlighted: - Gross Nominal Public Debt (in percent of GDP) projection across 2017–2024. - Public Gross Financing Needs (in percent of GDP) projection across 2017–2024. - By Maturity (Medium and long-term vs Short-term) projection across 2008–2024. - By Currency (Local currency-denominated vs Foreign currency-denominated) projection across 2008–2024. ### Stress tests and scenario results - Stress test types and inputs (underlying assumptions reported for each stress test): - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, Contingent Liability Shock, Combined Macro-Fiscal Shock. - Stress test highlights: - Under a "Real depreciation shock (One-time real depreciation of 30 percent occurs in 2017)", the external debt outcome is shown as "83" (presented as external debt-to-GDP under that shock in Figure 6). - Figure 6 box captions and panels indicate baseline external debt at "56" (percent of GDP) and historical or shocked scenarios with values such as "63", "61", "60", and the "30 % depreciation 83." - Public gross financing needs under stress: - Charts show public gross financing needs in percent of GDP and gross nominal public debt in percent of revenue under baseline and stress scenarios across 2019–2024; specific plotted scales include up to "700" (percent of revenue) in contingency panels. ### External debt sustainability and identified external flows (Table excerpts) - Baseline external debt path and debt-stabilizing non-interest current account: - "Baseline: External debt 54.3 55.7 56.3 57.5 58.8 66.2 63.4 61.4 59.7 57.7 55.9" - "Debt-stabilizing non-interest current account-2.2" - "Change in external debt0.5 1.4 0.7 1.2 1.3 7.4-2.8-2.0-1.7-2.1-1.8" - Identified external debt-creating flows (selected lines): - "Identified external debt-creating flows (4+8+9)-2.2 0.6 -0.2 -3.0 0 .7 -1.2 -1.7 -1.8 -1.8 -1.9 -1.8" - "Current account deficit, excluding interest payments1.0 0.9 0.6 1.0 1.0 0.1-0.6-1.1-1.5-1.3-1.1" - "Deficit in balance of goods and services8.1 7.5 7.3 7.2 7.4 8.1 7.6 ..." - "Exports21.1 21.0 21.2 21.7 22.8 25.0 24.8 24.5 24.2 23.8 23.3" - "Imports29.2 28.6 28.5 28.9 30.2 33.1 32.4 31.6 30.8 30.0 29.2" - Gross external financing need (in billions of US dollars) and percent of GDP: - "Gross external financing need (in billions of US dollars)4/ 11.7 11.5 12.4 12.8 13.8 12.2 13.0 12.7 12.8 13.4 13.5" - "in percent of GDP14.8 14.2 15.1 14.6 15.5 14.4 14.4 13.1 12.3 12.0 11.2" ### Capacity development and policy actions (excerpt) - Fiscal consolidation and institutional strengthening objective: - "Advance revenue-based fiscal consolidation to reduce the still sizable public debt, while safeguarding social and infrastructure spending, supported by stronger fiscal institutions and reform of state-owned enterprises." - Tax policy reforms and outcomes: - Engagements: "FAD: tax system diagnostics and reform options; LEG: assistance with new IRA draft, regulations, and manuals; training." - Achieved outcomes: "VAT collections boosted by 2016 and 2018 VAT amendments; New IRA implemented in April 2018; Tax expenditure statements published in 2017-2019 budgets." - Future program outcomes: "Submit 2020 budget with a plan to rationalize tax expenditures and related statement; Cabinet to approve medium term strategy to rationalize para-tariffs by March 2020." - Indirect tax administration reforms and outcomes: - Engagements: "FAD: indirect tax administration TA; SARTTAC: support to FAD in providing TA on selected topics; WB: TA on customs valuation of imports." - Achieved outcomes: "Dedicated unit to perform risk-based VAT audits established in 2018; New RAMIS IT system rolled out in 2016; Risk-based VAT compliance strategy with KPIs on audits adopted in 2016 and piloted for key sectors in 2018; Risk management unit for customs established." - Future program outcomes: "Establish a risk-management unit in IRD by June 2019; Rollout of risk-based audits to all sectors by end-2019; Expand VAT compliance strategy and risk-based audits to small and medium enterprises; Automate risk-based customs audits of cargo using the ASYCUDA system." *Source: IMF staff (content unit 1lkaea2019001).* ### Part I: Reform Progress under the EFF-Supported Program ### Part I: Reform Progress under the EFF-Supported Program ### Income Tax Administration - Objective: Mobilize revenue by consistently implementing the new IRA. - TA/Training engagement: - SARTTAC: coordination of hands-on TA on new IRA implementation; - FAD: support to SARTTAC in finding long-term and short-term experts; - LEG: legal support to implement the new IRA. - Achieved outcomes: - Manual accompanying new IRA published; - Media campaign rolled out on IRA, with call centers fielding taxpayer queries; - Business process redesign for withholding taxes; - Contract signed with software developer to upgrade RAMIS IT system to be fully IRA compatible. - Future program outcomes: - Continue to strengthen tax administration capacity of MOF’s Inland Revenue Department (IRD); - Develop a plan for audit of withholding obligations by employers by June 2019; - Cabinet to approve a plan to reform the IRD and Customs departments by June 2019. ### Fiscal Rules and Macro-Fiscal Policy Framework - Objective: Upgrade fiscal rules to anchor debt sustainability beyond 2020; Strengthen capacity for macro-fiscal policy making in MOF. - TA/Training engagement: - FAD: design of new fiscal rules and assistance with medium-term budgeting; - FAD/SARTTAC: set up of macro-fiscal unit in MOF; - SARTTAC/ICD: Capacity development of MOF macro-fiscal policy analysis and forecasting. - Achieved outcomes: - Plans to upgrade the fiscal rule discussed in the authorities’ Vision 2025 reform strategy and the 2019 budget speech; - Medium-term fiscal consolidation path for 2020-24 included in 2019 budget. - Future program outcomes: - Cabinet to approve key elements of new fiscal rules by May 2019 and approve related legal amendments by September 2019; - Credible MTFF to be regularly updated to guide the budget process. ### Public Debt Management - Objective: Strengthen capacity for public debt management with Medium-Term Debt Strategy (MTDS) and an independent public debt management agency (PDMA). - TA/Training engagement: - MCM: support to the development of MTDS and PDMA, with the WB; - FAD: support to MCM TA as needed. - Achieved outcomes: - Strategy to manage sovereign bond maturities for 2019-22 approved by cabinet in March 2018; - Liability Management Act enacted in March 2018; - MTDS launched by MOF and CBSL in April 2019. - Future program outcomes: - Cabinet to approve a plan to establish a PDMA by end-September 2019; - Annual Borrowing Plan consistent with MTDS to be prepared by December 2019. ### Public Financial Management - Objective: Transition from cash-based to commitment-based expenditure management. Improve quality of infrastructure spending through better public investment management. - TA/Training engagement: - WB (lead): support to new PFM Act development; - FAD: TA on commitment control and follow up on 2017 PIMA. TA on cash buffers in 2019; - SARTTAC: support to FAD on selected topics. - Achieved outcomes: - New IT system (ITMIS) piloted for MOF and Ministry of Health in 2016; - MOF introduced commitment recording and control systems by Jan 2018 by modifying the existing CIGAS IT system. - Future program outcomes: - Initial roll out of ITMIS to 60 major spending agencies by September 2019; - Roll out ITMIS for fully IT-based commitment control by June 2020. ### Fiscal Risks Mitigation and SOE Reforms - Objective: Mitigate fiscal risks by reforming SOE governance, energy pricing, and PPP framework, while improving transparency and oversight of the SOE sector. - TA/Training engagement: - FAD: diagnostics and reform proposals for electricity and fuel pricing as well as PPP framework. TA on draft Statements of Corporate Intent (SCI). - Achieved outcomes: - SCIs published for 5 major SOEs in 2017; - Report on fuel and electricity non-commercial obligations in 2018 and 2019 budgets; - Establishment of Bulk Supply Transaction Account for electricity and introduction of automatic fuel pricing mechanism in May 2018; - New MOF unit to assess PPP fiscal risks established in April 2019. - Future program outcomes: - Compliance reports based on KPIs of 5 SOEs with SCIs for up to 2018 H1 to be submitted to cabinet by end-May 2019; - SCIs for additional 10 SOEs to be published in May 2019; - Cabinet to approve an automatic pricing mechanism for electricity by October 2019. ### Statistics - Objective: Transition fiscal reporting from the 1986 Government Financial Statistics Manual (GFSM) to GFSM 2014 and the 2011 Public Sector Debt Statistics Guide for Compilers and Users (PSDSG), while expanding coverage beyond budgetary central government. - TA/Training engagement: - SARTTAC: assistance with the transition to 2014 GFSM through training and TA; - STA: assistance to SARTTAC as required based on past STA TA on GFS. - Achieved outcomes: - Cabinet approval in October 2018 of a multi-year plan to transition to accrual-based accounting for general government; - Dedicated unit within MOF established in April 2019 to manage transition to fiscal reporting consistent with GFSM 2014. - Future program outcomes: - MOF to compile GFSM cash and debt tables for budgetary and extra-budgetary central government by June 2019. ### Transitioning Monetary, Exchange Rate, and Financial Frameworks - Overarching objective: Transition to inflation targeting with a flexible exchange rate regime and strengthen the financial sector to ensure price stability and resilience against shocks. Transition to Inflation Targeting - Objective: Develop legal framework and capacity for inflation targeting. - TA/Training engagement: - MCM: diagnostics and support in developing inflation targeting roadmap; - LEG: assistance to draft amendments to Monetary Law Act (MLA); - ICD: assistance to develop a Forecasting and Policy Analysis System (FPAS) and align monetary policy communication with best practices. - Achieved outcomes: - CBSL’s roadmap to transition to inflation targeting and a flexible exchange rate regime adopted in 2017; - Amendments to MLA approved by cabinet in March 2019; - CBSL developed model-based FPAS and uses it to inform policy formulation. - Future program outcomes: - Cabinet to submit to parliament the amendments to the MLA by July 2019; - CBSL to continue improving forecasting capacity and integrate FPAS more firmly into policy decision-making and communication. Exchange Rate Regime - Objective: Promote greater exchange rate flexibility to help reserve buildup and improve resilience to external shocks. - TA/Training engagement: - MCM: diagnostics on exchange rate policy; - SARTTAC: hands-on operational assistance on the implementation of the CBSL’s FX intervention strategy. - Achieved outcomes: - Flexible exchange rate regime adopted in 2017; - CBSL operationalized a Request for Quotes system in July 2018. - Future program outcomes: - CBSL to continue to strengthen external buffers and promote greater exchange rate flexibility. Financial Sector Stability, Regulation, and AML/CFT - Objective: Strengthen the resilience of the financial sector, including non-banks; strengthen macroprudential surveillance; improve the AML/CFT regime; and improve contingency planning for crisis prevention, preparedness and management. - TA/Training engagement: - WB (lead): Support draft of new Banking Act; - MCM: diagnostics and reform priority on financial sector issues, including through Financial Sector Stability Review in January 2019; - LEG: AML/CFT diagnostics and reforms to enhance the AML/CFT regime roadmap; - SARTTAC: assistance in providing TA and training on selected topics. - Achieved outcomes: - Basel III migration started in 2017; - New Resolution and Enforcement Department established in CBSL in 2018; - Banks and finance companies started adoption of International Financial Reporting Standard 9 (IFRS 9) in 2018; - Higher capital and liquidity standards, in line with Basel III, established for banks and finance companies in 2019. - Future program outcomes: - CBSL to strengthen macroprudential policy framework and stress testing capabilities, under new MLA; - CBSL to harmonize regulation and supervision for banks and non-banks; - Cabinet approval by end-2019 of Banking Act, including new resolution regime; - Financial Intelligence Unit and other stakeholders to implement AML/CFT measures identified by FATF and LEG TA. Statistics (price and national accounts) - Achieved outcomes: - National consumer price index released in 2018. - Future program outcomes: - Department of Census and Statistics to release rebased and improved national accounts in 2019, and a rebased consumer price index in 2020. ### Program Performance and Macroeconomic Outlook - Recent macro developments: - Real GDP growth decelerated to 3.2 percent in 2018, from 3.4 percent in 2017; - Annual inflation fell to 2.8 percent at end-2018, from 7.1 percent at end-2017; - Current account deficit widened to 3.2 percent of GDP, from 2.6 percent of GDP in 2017; - The rupee depreciated by 13 percent in real effective terms in 2018; - Gross international reserves fell to US$6.9 billion as of end-2018. - Outlook: - Growth projected at 3.6 percent in 2019, reaching 5 percent over the medium term; - Annual inflation: recovered to 4.3 percent as of March; expected to reach 4.5 percent in 2019 and hover at 5 percent over the medium term; - Authorities issued US$2.4 billion in the international bond market in March 2019; CBSL resumed foreign exchange purchases to rebuild reserve buffers. - Program performance summary: - End-June 2018 QPC on the primary balance met through expenditure restraint; - End-December QPC on the primary balance missed by Rs 50 billion; - End-December net official international reserves (NIR) target missed by US$2,392 million; - Reserve money target was below the adjusted indicative target by Rs 46 billion as of end-December 2018; - Shortfalls reflect weaker growth, delays in implementing 2018 budget measures, underperformance in trade tax collections due to import duty waivers, foreign exchange sales by CBSL in response to market pressure, and shortfalls in project loans; - Exchange restrictions temporarily introduced in 2018 have been removed; - Corrective actions: submission of the 2019 budget to Parliament as a prior action (Parliament approved the 2019 budget on April 5, 2019); revamped FX strategy to allow for exchange rate flexibility; resumption of net FX purchases as market conditions allow; - Progress on structural measures includes implementation of five structural benchmarks (with some delay), central bank reform, debt management, and targeted social protection policy reforms; - Authorities requested completion of the Fifth Review under the extended arrangement and disbursement of SDR 118.5 million; requested a one-year extension of the current arrangement until June 2, 2020, adding one review, and a rephasing of purchases evenly over the remainder of the arrangement; - Authorities requested waivers on nonobservance of end-December 2018 QPC on the primary balance, NIR, and the continuous PC on non-introduction/intensification of exchange restrictions under the arrangement and Article VIII, Section 2(a). ### IMF Capacity Development Missions since May 2017 (selected engagements) - Tax policy and administration: multiple missions on design and implementation of new Inland Revenue Act, VAT and indirect tax reforms, VAT administration, VAT compliance pilot evaluation, income tax training, auditing techniques, and IRA implementation readiness (providers include LEG, FAD, SARTTAC, STX). - Fiscal rules and macro-fiscal: FAF customized training for MOF staff (SARTTAC/FAD, Apr 22-26, 2019); design of new fiscal rules and macro-fiscal unit (FAD, Mar 13-26, 2019). - Public debt management: MTDS support (MCM, Jul 30-Aug 10, 2018). - Public financial management: PFM TA scoping (SARTTAC, May 22-26, 2017); PIMA (FAD/SARTTAC, Dec 7-20, 2017). - Fiscal risks and SOE reforms: fuel and electricity pricing reforms (FAD, Apr 18-May 2, 2018); PPP diagnostics (FAD, Sep 26-Oct 9, 2018). - Transition to inflation targeting and exchange rate regime: FPAS and macroeconomic modeling (ICD), exchange rate and monetary policy design (MCM), foreign exchange intervention policy (SARTTAC). - Financial sector and AML/CFT: AML/CFT missions (LEG), Financial Sector Stability Review (MCM, Jan 10-23, 2019), institutional framework for macroprudential policy (MCM, Jul 9-16, 2018). - Statistics: price statistics and national accounts assistance (SARTTAC), government finance statistics (SARTTAC). *Source: Part I: Reform Progress under the EFF-Supported Program (1lkaea2019001) — IMF PDF content provided.* ### 4. The main priority for fiscal policy remains a sustainable reduction of the fiscal ### 4. The main priority for fiscal policy remains a sustainable reduction of the fiscal ### Fiscal consolidation: outcomes and medium-term targets - Overall fiscal deficit reduced to 5.5 percent of GDP in 2017 through rationalizing current expenditure and bolstering VAT collections. - Fiscal deficit further reduced to 5.3 percent of GDP in 2018, supported by the Inland Revenue Act (IRA) (April 2018) and additional reductions in VAT tax expenditures. - Primary balance improved to a surplus of 0.6 percent of GDP in 2018, from a balance in 2017, but was 0.4 percentage points of GDP lower than programmed at the time of the Fourth Review. - Program targets and commitments: - Aim to bring the overall central government deficit down to at least 3.5 percent of GDP by 2020 (Prime Minister’s November 2015 speech). - Primary surplus targets: 1.5 percent of GDP by 2019 and 2.4 percent of GDP by 2020. - Planned revenue-to-GDP increases: 1.7 percentage points of GDP in 2019 and 0.9 percentage points of GDP in 2020. - 2019 budget targets a primary surplus of Rs 228 billion (1.5 percent of GDP). - 2020 fiscal target: overall fiscal deficit down to 3.5 percent of GDP; primary balance of 2.4 percent of GDP (additional 0.9 percentage points of GDP in fiscal effort). - Medium-term aim: overall fiscal deficit of 2 percent of GDP and public debt including guarantees down to 70 percent of GDP by 2024 and 50 percent of GDP by 2030. ### Revenue performance and shortfalls (2018) - Primary surplus achieved in 2018: Rs 91 billion (0.6 percent of GDP), short of program target of 1 percent of GDP due to revenue underperformance. - Tax revenue to GDP declined by 0.6 percentage points to 11.9 percent in 2018, missing the program’s end-December indicative target by 1.4 percentage points. - Factors contributing to revenue shortfall: - Weaker domestic demand. - Delay in implementing 2018 budget measures. - Underperformance in trade tax collections due to removal of some para-tariffs and import duty waivers for (i) fuel and (ii) other consumer goods. - Reductions in external taxes and introduction of VAT exemptions on certain items during the political crisis. - Expenditure management: goods and services and capital projects spending was backloaded through tight commitment control to meet the end-June primary balance target; political crisis in late 2018 caused further delays to capital projects, rescheduled for 2019. - Non-commercial obligations (NCOs) target missed at end-December 2018 for fuel and electricity (net of government transfers); expected gradual improvement in CPC and CEB performance in 2019 given the monthly fuel price adjustment formula launched in May 2018 and planned electricity mechanism in late 2019. ### 2019 budget measures and social/capital spending protections - Revenue measures to yield about Rs 116 billion (0.7 percent of GDP) in 2019: - Increase excise rates for vehicles, tobacco, alcohol, diesel, and other goods and services. - Unwind import duty waivers for fuel and other goods. - Other revenue measures and tax administration improvements (including risk-based VAT audit for large taxpayers). - All excise rates for vehicles, tobacco and alcohol in the package implemented in March 2019. - Identified IRA amendments with an annual fiscal cost of at most 0.1 percent of GDP to support investment and inclusive growth; offset by other budget measures; no other IRA changes envisaged under the 2019 budget. - Preservation of space for social and productive capital spending, including delayed 2018 capital projects. - Samurdhi cash transfers budget increased by Rs 10 billion to enroll new eligible families under means-tested criteria once new social registry operational. - Contingency budgeting for weather-related natural disasters: allocate Rs 20 billion (0.2 percent of GDP) over the medium term to a Disaster Management Contingency Fund. - If retail fuel prices or electricity tariffs dip below cost-recovery levels, government will compensate CPC or CEB for NCOs within 2019 budget envelope. - Commitment to pursue gender budgeting and initiatives to boost female labor force participation. - Budget includes tax expenditure statement, plan to rationalize tax expenditures, and estimated fiscal cost of NCOs for SOEs (prior action; end-November 2018 SB). ### Fiscal rules, Medium-Term Fiscal Framework (MTFF), and fiscal-legislative reforms - Intention to revise the Fiscal Management (Responsibility) Act of 2003 (FM(R)A) with IMF technical assistance to align fiscal rules with medium-term debt-reduction objectives and contain enforcement mechanisms. - Planned steps and timeline (subject to noted delays): - Cabinet approval of policy note outlining key elements of FM(R)A amendments by end-May 2019 (delay from end-March 2019 structural benchmark). - Cabinet approval of relevant amendments/legislation by end-September 2019 (proposed structural benchmark) to enable Parliamentary approval before 2020 budget cycle. - Amendments to include legally binding fiscal targets, a clearly defined escape clause, and an automatic correction mechanism. - Upgrade MTFF with IMF technical assistance to provide realistic top-down guidance for budgeting and investment planning starting with the 2020 budget cycle; ensure MTFF is a binding constraint over the annual budget and guides multi-year investment planning. ### Public debt management and contingent liabilities - Active Liability Management Act approved by Parliament in March 2018 to enable proactive management of international sovereign bond maturities and extend maturities. - Cabinet paper approved January 2018 outlining strategy to manage international sovereign bond maturities between 2019 and 2022 (end-June 2018 structural benchmark). - Medium-Term Debt Strategy (MTDS) for 2019–23 approved in early April 2019 with delay (end-October 2018 structural benchmark); MTDS: - Quantifies main risks of public debt portfolio. - Specifies currency and maturity composition and strategy. - Presents debt issuance options based on cost-risk tradeoffs. - Is consistent with monetary and fiscal objectives. - Published in April on MOF and CBSL websites. - Working group from CBSL and MOF to produce Annual Borrowing Plan (ABP) by end-December 2019; budget to include annual review of debt management activities benchmarked against MTDS beginning 2020. - Quarterly debt management reviews against ABP to be prepared and published from 2020Q1 onwards. - Plan to establish an independent debt management agency: - Submit plan for cabinet approval by end-September 2019 (delayed from end-March 2019 structural benchmark). - Agency to have financial and administrative autonomy, conduct issuance and secondary market activities in line with MTDS, and evaluate/approve debt, derivatives, and guarantees. - Indicative target for end-December 2019 on government guarantees: Rs 838 billion to cap outstanding guarantees at 5.4 percent of GDP. - Outstanding guarantees rose from 4.2 percent of GDP at end-December 2017 to 5.2 percent of GDP at end-December 2018 due to new guarantees for water and transportation projects, breaching the IT ceiling of Rs 718 billion. ### Transparency, fiscal reporting, and accounting reforms - Quarterly fiscal performance reports to Parliament since 2017Q1. - Tax expenditure statements included in 2017, 2018, and 2019 Budgets; inclusion of non-commercial obligations of CPC and CEB in 2018. - Commitment to improve fiscal statistics in line with 2014 Government Finance Statistics Manual (GFSM): - On track to compile GFSM-compatible tables on cash operations and debt stock of budgetary and extra-budgetary central government by June 2019 with IMF technical assistance. - Cabinet approval in October 2018 of strategy and timetable to transition to accrual-based accounting for general government with IMF TA and external consultants. - Dedicated MOF unit established and staffed to support multiyear transition to 2014 GFSM; annual reports to cabinet on progress. ### Revenue mobilization: tax policy measures and IRA features - Cabinet suspended Board of Investment Act in May 2016, centralizing power to grant tax exemptions in Ministry of Finance. - VAT changes: - November 2016 VAT amendment: rate raised from 11 percent to 15 percent and base broadened 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 completed in November (delayed from end-June 2017 structural benchmark) concluded VAT expenditure is 1.3 percent of GDP. - August 2018 VAT amendment broadened base by eliminating exemptions for textiles, electronic goods and mobile phones, and condominiums. - Temporary reinstatement of exemption by regulation for imported fabric pending removal of corresponding para-tariffs; temporary exemption for imported timber introduced in November 2018. - Inland Revenue Act (IRA) effective April 1, 2018: - Removes tax exemptions to broaden base; modernized principle-based drafting; introduces capital gains tax on immovable property; increases taxes on dividends and interest income; establishes transparent investment-based tax incentives. - Planned IRA amendments (in consultation with IMF staff), calibrated not to exceed 0.1 percent of GDP: - Exempt from withholding tax earnings from both local and foreign currency government securities. - Exempt from withholding tax interest on ordinary loans and advances from non-resident financial institutions for five years. - Exempt from withholding tax payment of royalties for earnings below Rs 50,000 per month, subject to a maximum of Rs 500,000 per year, applying only to certain cultural occupations (artists and writers). - Withholding tax rate on rents of 10 percent to apply only to rents above Rs 50,000 per month. - Exempt from withholding tax interest earned by children less than 18 years of age, up to Rs 50,000 per year. - Exempt from withholding tax interest earned on foreign currency deposits for a period of 5 years. - Allow additional deduction of 35 percent of salary costs for start-up IT companies for 5 years under Sixth Schedule terms. - Expand income tax concessions under Second and Sixth schedule by accelerated depreciation for existing businesses for 5 years (excluding land; limited to depreciable assets). - No other amendments to the IRA planned under the 2019 budget. ### Strengthening tax administration - Income tax administration: - IRA launched April 1, 2018; outreach strategy ongoing. - New forms and instruction manuals completed; call centers operational. - Cabinet approved contract to upgrade RAMIS in February 2019 for electronic filing compatibility. - IRD to develop plan to audit employers’ PAYE withholding obligations and service fees to professionals (identify employers not in PAYE using third-party data) by June 2019. - VAT administration: - IRD cleared backlog of 79,000 unprocessed VAT returns in final quarter of 2018; will settle associated payments by end-June 2019. - Electronic filing of VAT returns to prevent future backlogs. - Adopted VAT compliance strategy with risk-based audits; implemented in construction, banking, housing, and hotel industries. - Risk-based audits to extend to large taxpayers in remaining sectors by December 2019. - Dedicated division for risk-based audit established; risk management unit to be set up by June 2019. - Customs administration: - ASYCUDA IT system improved; reforms to shift from physical controls to risk-based system audits. - Automation of risk management and organizational/HR improvements underway. - Risk management directorate established; staff dedicated to risk management increased to more than 20 officers. - Development of a single window for trade services to enhance tax collections through information sharing. - IT and organizational reform: - Initial RAMIS glitches addressed; many problems rectified. - IRD restructuring along functional lines, creation of design and monitoring unit, management efficiency improvements, strengthening Large Taxpayer Unit, enhanced use of taxpayer identification numbers. - IMF technical assistance to develop Inland Revenue and Customs reform plan; Cabinet to approve a note describing key reform elements in June 2019. ### Expenditure reforms - Emphasis on improving spending efficiency and prioritization to preserve social and capital spending while rationalizing low-priority expenditures. - Strengthening public financial management, notably commitment control, financial planning, and discipline. - Improved transparency and accountability in budget execution through quarterly reporting to Parliament since 2017Q1. - Strengthening process to appraise and select capital projects envisaged in the budget. *Source: IMF country report excerpt (Sri Lanka) as provided in the supplied content unit.* ### 14. A disciplined and prioritized approach to government spending complements ### 14. A disciplined and prioritized approach to government spending complements revenue-based fiscal consolidation ### Spending priorities, disaster resilience, and gender budgeting - Keep the overall spending envelope under control while reallocating spending within this envelope to bolster medium-term prospects for robust and inclusive economic growth, including social protection, health, education, and infrastructure. - Cope with increased frequency of weather-related natural disasters through mitigation and adaptation measures, including contingent budgeting and enhanced insurance schemes for natural disasters. - Aim to foster female labor force participation through gender budgeting (see paragraph 36). ### Social safety nets and Welfare Benefits Board (WBB) - Established a Welfare Benefits Board (WBB) under the MOF to rationalize and broaden coverage of social assistance schemes through a consolidated national database for social assistance beneficiaries. - Under the Social Safety Nets Project, the WBB is developing a new Social Registry, an online database of applicants for welfare programs, to be used to select beneficiaries. - WBB responsibilities and rollout: - Assess applications starting with four major welfare programs: Samurdhi, Elderly Benefit, Disabled Benefit, and Chronic Kidney Disease Benefit. - New selection criteria based on objective and verifiable characteristics developed with technical support from the World Bank. - Cabinet approval of eligibility criteria for the four programs obtained in March 2019 with a delay (end-August 2018 structural benchmark). - Regulations and gazettal of criteria planned by end-June. - Enrollment in the four programs to be expanded to include the neediest applicants within the 2019 budget appropriation. - Plan to have the new Social Registry in place by May 2019 and begin collecting new applications as soon as regulations are gazetted. - Pending operationalization of the new Social Registry, use existing database maintained by the Samurdhi Department to process new applications according to the new eligibility criteria. - Expansion of social safety nets intended to mitigate distributional impact of ongoing reforms on poor and vulnerable families. ### Public Financial Management (PFM) reforms and IT systems - New guidelines for public development-project proposals issued in September 2018 to guide project appraisal, sectoral project pipelines, and the Public Investment Programme to be published in July each year. - Plan to develop a database of investment projects to identify those with long implementation delays and introduce stringent selection criteria and appraisal processes. - CIGAS modifications: - MOF modified existing PFM IT system (CIGAS) to impose quarterly spending ceilings for all ministries (end-January 2018 structural benchmark). - Quarterly ceilings aim to prevent contracting beyond commitment ceilings and enable intra-year spending adjustments. - Integrated Treasury Management Information System (ITMIS): - Expected to significantly expand PFM capabilities, including commitment control, budget preparation, treasury operations, expenditure management, and accounting. - Adoption process delayed due to requirements finalization and customization issues; detailed rollout plan developed; CIGAS will remain operational during transition. - ITMIS roll-out implemented on a staggered basis, with full roll-out expected by June 2020. - First phase began in January 2019 with the Ministry of Finance; roll out to other agencies from April 2019 beginning with 20 priority agencies. - Staff training underway; first phase to be completed by September 2019 with ITMIS rolled out to at least 60 spending agencies that account for approximately 65 percent of the total budget. - New Public Financial Management (PFM) Act: - Cabinet approved a note in October 2018 outlining a new PFM Act, with World Bank support. - Law designed to improve budget process and control fiscal risks, including from Public Private Partnerships (PPPs), align public investment management, and enable government to maintain cash buffers that can be carried across financial years. - Legislative drafting being finalized; draft law to be submitted to Parliament by end-2019. - Strengthening PPP framework: - National Agency for PPPs created in 2017; plans to upgrade legal framework and guidelines for PPPs by end-March 2019 to ensure integration in the Public Investment Programme and a gateway process with MOF as gatekeeper. - A unit established and staffed in April 2019 under the Ministry of Finance to coordinate and assess fiscal risks associated with PPPs. - Government will share plans for large-scale projects, including Colombo Port City, with the IMF and discuss program implications. ### State enterprises: liabilities, disclosure, and restructuring - Sri Lanka has about 200 public enterprises representing a substantial share of economic activity. - Identified outstanding financial obligations of SOEs totaling Rs 1.4 trillion by end-2017, including Rs 1.1 trillion for CPC, CEB, SriLankan Airlines, and the Sri Lanka Ports Authority, posing risks to public finances. - Statements of Corporate Intent (SCIs): - SCIs signed and published in April 2017 for five largest SOEs: CPC, CEB, NWSDB, AASL, and SLPA. SCIs include mission, objectives, multiyear plan, capex and financing plans, and explicit KPIs. - First compliance report on performance against KPIs submitted to cabinet in May 2018 covering 2017H1; 2017H2 report submitted in early April 2019. - Third report on 2018H1 period to be submitted by end-May 2019. - Plan to expand SCIs coverage to an additional 10 SOEs by end-April 2019. - Audits and financial statements: - Among SOEs with SCIs, 2016 audited financial statements published only for NWSDB, AASL, and SLPA; NWSDB and SLPA have yet to have 2017 financial statements audited. - Ensure audit and publication of remaining 2016 and 2017 statements by June 2019, in coordination with the Auditor General’s office. - Starting in 2020, aim to ensure audited statements are readily available by September of the following year. - SriLankan Airlines restructuring: - Comprehensive restructuring determined as least risky and most cost-effective option. - New Board and CEO appointed in May 2018 and approved a restructuring plan; cabinet approval was delayed and Board replaced during the political crisis. - Committee formed in early January 2019 to prepare a new report to the President on restructuring options. - Cabinet paper with recommendations submitted in April 2019; recommendations include entering a joint venture with a strategic partner (not in competition) and strengthening corporate governance via clear Board-Management separation and a Statement of Corporate Intent with KPIs. - Cabinet approval expected by end-May 2019. - Based on cabinet decision, Board expected to prepare strategic plan and operating business model with measures to reduce operational and financial costs and minimize future losses by end-September 2019 (proposed structural benchmark). The Board will oversee restructuring and ensure timely implementation. ### Energy pricing reforms - Completed a report outlining the cost of non-commercial obligations (NCOs) for fuel and electricity in November 2017 with a delay (end-September 2017 structural benchmark), supported by IMF TA. - To estimate cost of electricity NCOs correctly, CEB and PUC established a Bulk Supply Transactions Account (BSTA) in May (end-March 2018 structural benchmark) to settle transactions between generators, transmission operator, and distributors as per November 2015 tariff methodology. - BSTA updates and reporting: - Updating the BSTA requires regular reporting by CEB to PUC of cash flow; reporting arrangements broke down in 2018. - Updated the BSTA for end-September 2018 in March 2019 and plan to have the BSTA for end-December 2018 updated by June 2019. - Going forward, ensure monthly submissions by CEB to PUC of related bank statements and other transactions. - Fiscal recognition and targets: - Recognized 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 set on the cost of NCOs for fuel and electricity (net of government transfers) for 2018Q1-Q4, 2019Q1-Q4 and 2020Q1 (see the Technical Memorandum of Understanding). - Fuel pricing mechanism: - Cabinet approved automatic pricing mechanism for fuel in May 2018 (end-March 2018 structural benchmark), based on a cost reflective pricing formula developed in 2015. - Computing cost-reflective prices and implementing price changes when warranted in line with Cabinet decision. - Pricing process disrupted during the political crisis of late 2018; pricing formula reinstated and implementing necessary price changes to bring fuel prices back to cost-reflective levels by end-June 2019. - Electricity pricing mechanism: - Political crisis delayed electricity pricing reform. - Cabinet appointed a technical committee in October 2018 to identify an automatic electricity pricing mechanism; committee expected to present report to cabinet by June 2019. - Cabinet approval of implementation of the electricity pricing mechanism based on the 2015 tariff methodology expected by end-October 2019 (end-September 2018 structural benchmark). - Mechanism features: - (i) January 2020 as the starting date of the formula-based tariff adjustment; - (ii) regular, formula-based updates of end-user tariffs on a biannual basis, based on guidance from the technical committee; - (iii) government commitment to cover within the budget envelope any remaining electricity subsidies during the transition to full-cost recovery. - Continue to report financial performance of CPC and CEB on a quarterly basis (see the Technical Memorandum of Understanding). - Additional governance and market studies: - Plan a detailed market study on fuel product cost and margins and reference prices led by independent third parties. - For electricity, CEB and PUC plan necessary studies and audits to validate inputs to tariff methodology, including CEB’s dispatch practice. ### Monetary policy, CBSL legal framework, and exchange rate strategy - Monetary policy focus: - Keep inflation in the mid-single digits. - CBSL raised interest rates on its lending and deposit facilities by 50 and 75 basis points, respectively, in November 2018. - With inflation expected to gradually converge towards the 5 percent target, CBSL maintained policy rates unchanged in the last monetary policy meeting held in March. - To address persistent liquidity shortage, CBSL reduced statutory reserve ratio (SRR) from 7½ to 5 percent since November. - Plan to maintain SRR at the current level. - Monetary policy to remain prudent and data-dependent; stand ready to tighten policy interest rates as warranted. - Monetary policy will be monitored through the MPCC (see the Technical Memorandum of Understanding), supported by monitoring of reserve money developments. - Strengthening CBSL legal framework and move to FIT: - Current impediments: monetary financing, non-core activities, and inadequate autonomy. - Cabinet approved a note (end-March 2018 structural benchmark) in early April 2018 outlining broad areas for amendment in the Monetary Law Act (MLA). - Draft amendments to MLA prepared in consultation with IMF staff; amended MLA draft approved by cabinet in March 2019 with a delay (end-December 2018 structural benchmark). - Plan to submit bill to amend MLA to Parliament by July 2019 (proposed structural benchmark). - Amendments will, among other issues: - (i) establish domestic price stability as the primary objective of the CBSL, with monetary policy decision-making functions shifted to a new Monetary Policy Board; - (ii) establish financial system stability as a core objective of the CBSL; - (iii) address central bank lending to the government related to purchases of treasury bills in the primary market and advances to the government; - (iv) eliminate quasi-fiscal activities of the CBSL; - (v) strengthen institutional, personal, and financial autonomy, accountability, and transparency; and - (vi) streamline decision-making and monetary policy formulation. - Roadmap to flexible inflation targeting and flexible exchange rate (formulated October 2017): - Roadmap approved by the Monetary Board; time-bound reform measures consistent with IMF TA in May 2017. - Objectives and actions include: - (i) clear separation between fiscal and monetary policies; - (ii) retain CBSL role in smoothing excessive exchange rate volatility while guarding against conflicts of objectives; - (iii) adopt FX intervention policies consistent with a flexible exchange rate regime; - (iv) improve foreign exchange market functionality, including gradual liberalization of financial account transactions, while strengthening regulatory compliance under the Foreign Exchange Act; - (v) safeguard financial sector stability and address risks associated with greater FX flexibility; - (vi) develop technical infrastructure, including improved forecasting and modeling capabilities with continued IMF TA; - (vii) establish policy decision-making anchored on inflation targets and how unanticipated shocks will be addressed; - (viii) strengthen public-awareness through an outreach program as cornerstone of CBSL communication during the IT transition. - Exchange rate policy and FX market development: - CBSL will strengthen market-oriented approach and transition durably to a more flexible exchange rate regime. - Continue to develop: - (i) a deeper and more liquid foreign exchange market to facilitate the exchange rate as a shock absorber and increase FX market resilience; - (ii) adequate systems to review and manage exchange rate risks. - FX strategy aims to allow greater exchange rate flexibility while rebuilding foreign reserves and maintaining them at adequate levels. - Operationalization supported by CBSL implementation in July of a Request for Quotes (RFQ) system for direct dealing (end-December 2018 structural benchmark). - RFQ setup allows market-based and transparent implementation of CBSL FX transactions at best price as envisioned under the program. *Source: 1lkaea2019001 - 14. A disciplined and prioritized approach to government spending complements* ### 25. The CBSL is committed to rebuild reserves and allow the exchange rate to function ### 25. The CBSL is committed to rebuild reserves and allow the exchange rate to function ### Reserve strategy, FX intervention, and exchange rate flexibility - After purchasing US$460 million in January-April 2018, the CBSL overperformed the end-March NIR target. - Tightening in global financial conditions and political developments in 2018Q4 derailed the CBSL’s reserve buildup strategy for the remainder of 2018. - FX intervention by the CBSL in response to market pressures in 2018Q4 was sizable, resulting in a breach of the end-December NIR target. - The CBSL allowed for increasing exchange rate flexibility during the period, expected to facilitate external adjustment in 2019. - Commitments and operational plans: - Resume FX purchases to rebuild net international reserves (NIR) to US$6.9 billion by end-December 2019. - The CBSL is on track to meet the revised NIR target for end-June, with US$100.5 million already purchased in 2019Q1. - The CBSL is committed to build NIR at a faster pace should market conditions improve more than expected. - Limit FX sales to stemming excessive volatility in the event of disorderly market conditions. - Consult with the IMF staff monthly on FX market developments and reserves building, or on a higher frequency in case of significant deviations from the envisaged reserves path and the proposed policy response. - Strengthen communications to clarify the interaction between the intervention strategy and reserve accumulation plans. - Swap liabilities: - Gradual winding down of FX swaps with domestic commercial banks from $1.4 billion at end-February 2018 to $0.88 billion at end-March 2019. - Plan to further reduce swap liabilities gradually. ### Exchange restrictions and Article VIII obligations - Temporary exchange restrictions introduced in 2018 to ease balance of payments pressures were removed. - September 2018: licensed commercial banks advised to open letters of credit only if covered by a minimum cash margin for some vehicles and specified non-essential consumer goods. - October 2018: minimum cash margin required for importation of certain non-essential consumer goods under Documents Against Acceptance terms; advised authorized dealers not to release FX for conversion of Sri Lankan Rupees for making advance payments for importation of certain non-essential consumer goods. - These measures led to nonobservances of the continuous performance criterion on non-introduction/intensification of exchange restrictions and were inconsistent with Article VIII obligations. - These temporary measures were eliminated in March 2019. - For the remainder of the program, commitments: - Will not impose or intensify restrictions on the making of payments and transfers for current international transactions. - Will not introduce or modify multiple currency practices. - Will not conclude bilateral payments agreements that are inconsistent with Article VIII. - Will not impose or intensify import restrictions for balance of payments reasons. - The CBSL and the government will abstain from providing subsidized exchange guarantees for foreign currency borrowing. - Recent regulatory change: - Sri Lanka enacted the Foreign Exchange Act which modernized FX-related regulations. ### Capital flow management measures (CFMs) - 2016 measure: repatriation requirement of export proceeds to encourage exporters to keep FX within the domestic financial system. - January 2019: lowered threshold for foreign investments in rupee-denominated government securities to 5 percent of the total outstanding stock, from 10 percent before, to reduce capital flow volatility. - These measures are understood to constitute CFMs under the IMF’s Institutional View on capital flows. - Planned adjustments: - Loosen the repatriation requirement by extending the period to repatriate export proceeds from 120 to 180 days, with funds in the business foreign currency accounts maintained by exporters of goods freely remittable. - Assess removing the repatriation requirement with timing linked to progress with macroeconomic adjustments (especially net international reserves) envisaged under the program. - Consider loosening back the threshold for nonresident investments in rupee-denominated government securities as market volatility declines and the CBSL’s reserve position strengthens. ### Financial sector policies and prudential reforms - Recent measures implemented: - Introduced new capital and liquidity requirements, effective January 2019, for banks in line with Basel III standards. - Implemented a new capital adequacy framework for licensed finance companies and specialized leasing companies. - Required banks and finance companies to adopt IFRS 9 accounting standards (expected-loss-based provisioning). - Adopted a more risk-based approach to financial system supervision. - IMF conducted a Financial Sector Stability Review (FSSR) in January 2019 and provided recommendations. - Harmonization and regulatory timeline: - CBSL issued Directions in 2018 harmonizing financial customer protection, loan-to-value ratios for motor vehicle-related credit facilities, credit ratings, capital adequacy requirements, valuation of immovable properties, and outsourcing of business operations. - CBSL will issue Directions to harmonize provisioning for bad and doubtful debts by end-September 2019. - CBSL will issue Directions on the corporate governance framework by end-March 2020. - Banking Act reform (with World Bank support): - Facilitate consolidated supervision, stronger provisions for mergers, acquisitions and consolidation, support digital banking, and strengthen corporate governance. - Additional supervisory and regulatory actions: - Continue monitoring credit growth and non-performing loans (NPLs) and report to the Monetary Board. - Ensure all banks and NBFIs abide by the new capital requirements and fully adopt IFRS 9. - Develop regulations and processes governing real estate purchases to minimize investment of illicitly obtained funds; encourage condominium sector regulators to establish frameworks to safeguard deposits of condominium buyers. - Improve management of exchange rate risk in the financial sector amid greater exchange rate flexibility. - Review and update the Finance Business Act and the Microfinance Act to modernize the financial sector. ### Macroprudential framework, stress testing, and contingency planning - Macroprudential mandate: - Approval of the MLA will give the CBSL a macroprudential mandate. - With IMF technical assistance and a resident advisor, plans include: - Enhance collection and analysis of data to improve monitoring of systemic financial stability. - Develop additional macroprudential tools to contain systemic financial risks. - Align stress-testing methodologies with best international practices: develop a macro-financial scenario-based approach; conduct stress tests for liquidity, contagion and indirect foreign exchange risks; enhance bottom-up stress test procedures; introduce dynamic elements to solvency stress tests. - Extend stress tests to non-bank deposit taking institutions. - Increase resources devoted to the macroprudential function and stress-testing, including establishing a dedicated stress-testing unit. - Contingency and resolution framework upgrades: - As part of Banking Act amendments, plan to: - Institute a resolution regime for banks and NBFIs based on international best practices. - Include a separate chapter to provide a stronger legal foundation to the deposit insurance system. - Cabinet expected to approve draft legislation by end-December 2019. - Further actions: - Strengthen the CBSL’s emergency liquidity assistance (ELA) framework by issuing ELA precondition guidelines. - Develop resolution plans for all systemic banks. - Require all financial institutions to prepare recovery plans for CBSL review and approval. - Establish a dedicated committee for crisis preparedness and management in coordination with the Ministry of Finance. - Develop a communication strategy and regular crisis exercises to simulate responses to specific stress situations. ### AML/CFT progress and next steps - 2018 achievements: - FIU, relevant ministries and stakeholders made progress addressing APG recommendations and FATF action plan. - Sri Lanka received upgraded ratings from the APG for six FATF Recommendations in July 2018. - Amendments to the Mutual Assistance in Criminal Matters Act (MACMA) No. 24 of 2018 passed in August 2018 allow assistance on the basis of reciprocity. - Amendments to Trust Act, No. 6 of 2018 passed in March 2018 establish a central register of trusts and empower collection of beneficial ownership (BO) information of trusts. - Issued customer due diligence (CDD) rules and guidelines for DNFBPs; cabinet approval obtained to amend the Companies Act No 7 of 2007 to require BO disclosures to a BO registry to be operationalized in the near future. - Financial institutions are jointly supervised on a risk-sensitive basis by the FIU and respective sector regulators. - Issued regulations implementing UN targeted financial sanctions (TFS) relating to proliferation financing (PF) concerning DPRK in October 2017 and Iran in July 2018. - FATF engagement: - FATF Plenary scheduled an on-site visit to Sri Lanka for May 2019 to verify implementation of the FATF action plan; the on-site team will make recommendations to the June 2019 FATF Plenary, which could result in Sri Lanka exiting FATF’s improving global AML/CFT compliance lists. - Going forward: - Further enhance implementation of AML/CFT measures by enforcing TFS provisions relating to terrorist financing and PF and BO and politically-exposed persons requirements. - Strengthen risk-based supervision over financial sector and high-risk DNFBPs (real estate dealers, casinos, gem and jewelry dealers), including imposing actions where appropriate. - Ensure adequate resources are available for the FIU. ### Structural reforms to boost trade, investment, and inclusive growth - Trade and investment integration: - Entered into a Free Trade Agreement with Singapore in January 2018. - Started negotiations on new Free Trade Agreements with China and Thailand, and an Economic and Technology Cooperation Agreement with India. - GSP plus trade status with EU—reinstated in May 2017—has started to have a positive impact on exports. - Measures to reduce costs and bolster competitiveness: - Removed around 1,200 para-tariffs since 2017. - Plan to reduce the special economic purpose tax, CESS, by 20-30 percent on most items in 2019. - Ports and Airports Levy (PAL) will be reduced by 5 percentage points on selected imports of machinery and equipment. - Conducted a stock-taking review of the trade regime; will prepare a strategy to rationalize remaining para-tariffs over the medium term and identify new revenue sources to offset revenue losses, obtaining cabinet approval by March 2020 (delay of end-March 2019 structural benchmark). - With World Bank support: - Launched a Trade Information Portal to improve transparency. - Developing a National Single Window to simplify border clearance procedures. - Launched a web portal to streamline and fast track investment approval under a single window virtual platform (Board of Investment) in 2018. - Formulated a new Trade Policy and a National Export Strategy to increase trade facilitation efficiency, remove barriers to foreign investment entry and establishment (including access to land), enhance access to finance, and strengthen financial market infrastructure. - Business environment reforms: - Progress under the Roadmap on Investment Climate Reforms. - Launched single windows to streamline registering property and getting construction permits. ### Governance, anti-corruption, and legal reforms - 2018-2019 actions: - July 2018: amended a section of the Bribery Act to allow High Courts to hear bribery and corruption cases. - Approved a law to establish lower courts dedicated to bribery and corruption cases; appeals to be handled by a three-member special High Court after amendment of the Judicature Act. - By end-July 2019: draft comprehensive legislation to consolidate laws related to bribery and corruption to comply with UNCAC. - Draft law will: (i) reform the Bribery Act, widening the definition of bribery offenses; (ii) amend the Declaration of Assets and Liabilities Act to cover assets legally owned and beneficially owned by a comprehensive range of public officials and their close family members, enforce dissuasive sanctions for non-compliance or false declarations, and verify and make publicly available online relevant data; and (iii) clarify mandates and expand powers of the Commission to Investigate Allegations of Bribery or Corruption (CIABOC). - Expected submission to cabinet and subsequently to Parliament in 2020. - Established a task force to prepare a policy paper to formulate a law on the recovery of assets. - Launched the National Action Plan for Combating Bribery and Corruption in March 2019 with a roadmap for 2019-23 covering prevention measures, value-based education and community engagement, institutional strengthening of CIABOC and law enforcement agencies, and law and policy reforms. - Prepared manuals and trained CIABOC investigators and prosecutors. ### Measures to increase female labor force participation - Gender budgeting and KPIs: - Launched gender budgeting in all ministries in 2018 with twelve key performance indicators (KPIs) covering issues from encouraging women entrepreneurs in SMEs to providing greater vocational training. - Placed focal contact staff in each ministry to monitor compliance and conducted awareness programs in 10 ministries. - Will evaluate effectiveness of KPIs and prepare an assessment report by May 2019. - Child care and early childhood policies: - Cabinet approved establishment of 2000 new child care facilities in collaboration with the private sector in June 2018. - With World Bank support, will train 10,000 staff to be employed in these child care facilities. - Plan to open After-School and Vacation Care Centers (ACVC) in selected public schools. - Cabinet approved a national policy on early childhood care and development in March 2019. - Formulating a National Day Care Policy expected to be approved by cabinet in June. - Labor market measures: - Will facilitate part-time and flexible work arrangements by taking legislative measures as needed. - Consider actions to facilitate greater participation of women on boards of listed companies. - Improve access to tertiary education and vocational training and conduct training programs to motivate women towards non-traditional income generation avenues and promote vocational and technical education for women and girls. ### Risks and contingencies - Main domestic risks: - Weaker than projected revenues due to implementation delays in fiscal reforms. - Lower-than-expected growth and/or new pressures on the trade account. - Weaker than expected performance of state-owned enterprises. - Reacceleration of credit growth, particularly in construction, which would add to macro-financial vulnerabilities. - Main external risks: - Trade tensions in key economies leading to weaker global growth and lower demand for Sri Lankan exports, FDI and remittances. - Resumption of market volatility and portfolio outflows raising government borrowing costs and hampering the buildup of foreign reserves. - Potential consequences: - These risks could further challenge public debt and external sustainability. - Policy readiness: - Should such risks materialize, the government stands ready to adjust policies promptly, in close consultation with IMF staff. *Source: 1lkaea2019001 - 25. The CBSL is committed to rebuild reserves and allow the exchange rate to function* ### 38. Our program will be subject to semiannual reviews with performance criteria and ### Our program will be subject to semiannual reviews with performance criteria and indicative targets set out in Table 1 attached to this MEFP and the Technical Memorandum of Understanding (TMU) ### Review schedule and requirements - Reviews occur semiannually. - Completion of the sixth review requires observance of the quantitative performance criteria for end-June 2019 and continuous performance criteria, as specified in Table 1 attached to this MEFP. - Completion of the seventh review requires observance of the quantitative performance criteria for end-December 2019 and continuous performance criteria, as specified in Table 1 attached to this MEFP. - The reviews will also assess progress toward observance of the structural benchmarks specified in Table 2 attached to this MEFP. ### Table 1 — Quantitative Performance Criteria (PC) and Indicative Targets (IT) - Data presented are cumulative from the beginning of the year, unless otherwise noted. - Central government primary balance (floor, in billion rupees): - 2020 end‐Jun. Prog. 45; Adj. Prog 45; Act. 4; Met/ not met: 6 Met - end‐Sep.(IT) Prog. 90; Adj. Prog 90; Act. 70; Met/ not met: Not Met - end‐Dec. Prog. 141; Adj. Prog 141; Act. 91; Met/ not met: Not Met - end‐Mar.(IT) Prog. 75; Prog 14; Prog 6; Prog 228; Prog 43 - Program net official international reserves (Program NIR, floor, in million US$)1/2/: - 2020 end‐Jun. Prog. 1,133; Adj. Prog 2,427; Act. 1,799; Met/ not met: Not Met - end‐Sep.(IT) Prog. 2,098; Adj. Prog 1,493; Act. 231; Met/ not met: Not Met - end‐Dec. Prog. 1,771; Adj. Prog 2,072; Act. ‐320; Met/ not met: Not Met - end‐Mar.(IT) Prog. 1,352; Prog 1,881; Prog 1,568; Prog 106 - Continuous performance criteria (cumulative from beginning of the program): - New external payment arrears by the nonfinancial public sector and the CBSL (ceiling, in million US$): 0 0 0 Met (repeated for review dates) - Monetary policy consultation clause — Year‐on‐year inflation in Colombo Consumers Price Index (in percent)3/: - Outer band (upper limit): 7.7 7.7 ... ; 8.1 8.1 ... ; 7.8 7.8 ... ; 7.6 7.7 7.8 7.8 - Inner band (upper limit): 6.2 6.2 ... Within ; 6.6 6.6 ... Within ; 6.3 6.3 ... Outside ; 6.1 6.2 6.3 6.3 - Actual / Center point: 4.7 4.7 4.1 inner ; 5.1 5.1 5.2 inner ; 4.8 4.8 3.1 inner ; 4.6 4.7 4.8 4.8 - Inner band (lower limit): 3.2 3.2 ... band ; 3.6 3.6 ... band ; 3.3 3.3 ... band ; 3.1 3.2 3.3 3.3 - Outer band (lower limit): 1.7 1.7 ... ; 2.1 2.1 ... ; 1.8 1.8 ... ; 1.6 1.7 1.8 1.8 - Indicative targets: - Central government tax revenue (floor, in billion rupees): 924 924 845 Not Met; 1,428 1,428 1,278 Not Met; 1,934 1,934 1,712 Not Met; 838 1,466 2,094 487 - Reserve money of the CBSL (ceiling, end of period stock, in billion rupees)4/: 1,025 1,025 999 Met; 1,045 1,045 1,015 Met; 1,069 1,007 961 Met; 1,025 1,052 1,070 1,145 - Cost of non‐commercial obligations (NCOs) for fuel and electricity (net of government transfers) (ceiling, in billion rupees)5/: 0 0 54 Not Met; 0 0 74 Not Met; 0 0 116 Not met; 0 0 0 0 - Treasury guarantees (ceiling, in billion rupees): ... ... ... 718 750 Not met ... ... 838 ... - Memorandum items (selected): - Net official international reserves (CBSL's conventional definition, end of period stock, in million US$, market exchange rate)1/: 7,424 ... 7,746; 7,877 ... 5,948; 7,475 ... 5,495; 6,972 7,201 6,888 6,994 - CBSL's outstanding liabilities in FX swaps with domestic commercial banks (in million US$): ... ... 885; ... ... 702; ... ... 723; ... ... ... ... - Foreign program financing by the central government (in million US$)2/: 0 ... 125; 125 ... 125; 225 ... 125; 0 0 0 0 - Net borrowings from SLDBs and FCBUs by the central government (in million US$)2/: ‐150 ... ‐195; ‐1,118 ... ‐685; ‐685 ... ‐687; ‐108 ‐108 ‐108 0 - External commercial loans by the central government (in million US$)2/: 1,500 ... 2,497; 3,500 ... 2,497; 3,497 ... 3,497; 2,426 3,426 3,426 500 - Proceeds from commercialization of public assets to non‐residents (in million US$)2/: 400 ... 682; 682 ... 682; 682 ... 682; 0 0 0 0 - Amortization of official external debt by the central government (in million US$)2/: 572 ... 637; 1,055 ... 1,089; 1,276 ... 1,304; 645 1,044 1,288 440 - Interest payments of official external debt by the central government (in million US$)2/: ... ... ... ... ... ... 827 1,230 1,654 404 - Project loans and grants disbursed to the central government (in million US$)2/: ... ... ... ... ... ... 218 353 488 210 - Cost of NCOs for fuel (net of government transfers)5/: 0 ... 22; 0 ... 33; 0 ... 6 6 0000 - Cost of NCOs for electricity (net of government transfers)5/: 0 ... 32; 0...41; 0...50; 0 0 0 0 - Notes (as presented in the table): - 2/ Program NIR will be adjusted upward/downward by the cumulative amounts of (i) foreign program financing by the central government, (ii) net borrowings from SLDBs and FCBUs by the central government, (iii) external commercial loans (including Eurobonds and syndicated loans) by the central government, (iv) the amount of project loans and grants, and (v) proceeds from commercialization of public assets to non‐residents, that are higher/lower than assumed under the program; and by the cumulative amount of amortization and interest payment of official external debt by the central government that is lower/higher than assumed under the program. Program NIR will be adjusted upward/downward by the cumulative amounts of 50 percent of the government securities - 6/ Given the delay in completing the Fifth review, end‐December QPCs have become controlling. - 1/ The CBSL's conventional definition of net official international reserves (NIR) includes outstanding liabilities in foreign exchange swaps with domestic commercial banks. The Program NIR excludes the outstanding liabilities in foreign exchange swaps with domestic commercial banks from the CBSL's conventional NIR definition. See TMU for details. - 5/ NCOs refer to the obligation of CPC and CEB to supply fuel and electricity at administered prices. See TMU for how to measure the cost of NCOs. - 4/ See TMU for details on the calculation of reserve money for the test date. - 3/ See the TMU for how to measure year‐on‐year inflation. ### Table 2 — Structural Benchmarks under the EFF‑Supported Program - A. Proposed New Structural Benchmarks (target completion dates and requirements) - Submit to Parliament the bill to amend the Monetary Law Act, in line with the amendments approved by cabinet in March 2019 and IMF staff recommendations. Target: End-July 2019. - Cabinet approval of amendments to relevant legislation to strengthen fiscal rules, in line with IMF staff recommendations. Target: End-September 2019. - Board of SriLankan Airlines to prepare an effective strategic plan and operating business model with measures to reduce the company’s operational and financial costs and minimize future losses. Target: End-September 2019. - Submit to Parliament the 2020 budget that is in line with the program targets and includes: (i) a tax expenditure statement, (ii) a plan to rationalize tax expenditures in 2020 as agreed with IMF staff, and (iii) the estimated fiscal cost of non‑commercial obligations (including subsidies) for SOEs. Target: End-November 2019. - B. Existing Structural Benchmarks (status and comments — selected items) - Senior management at the Ministry of Finance and CBSL to approve a Medium‑Term Debt Strategy (MTDS) for 2019-23. Target: End‑October 2018. Status: Not met (implemented with a delay). Comment: MTDS was approved on April 5, 2019. - Submit to Parliament the 2019 budget that is in line with the program targets and includes: (i) a tax expenditure statement, (ii) a plan to rationalize tax expenditures in 2019 as agreed with IMF staff, and (iii) the estimated fiscal cost of non‑commercial obligations (including subsidies) for SOEs. Target: End‑November 2018. Status: Not met (implemented as a prior action). Comment: 2019 budget submitted to Parliament on March 5, 2019 as prior action for the fifth review. - Cabinet to approve a policy note outlining key elements of amendments to the Fiscal Management (Responsibility) Act of 2003. Target: End‑March 2019 (proposed reset to end‑May 2019). Status: Not met. Comment: IMF technical assistance mission took place in March 2019; proposed reset to end‑May 2019. - Cabinet to approve a plan with timetable for establishment of an independent debt management agency. Target: End‑March 2019 (proposed reset to end‑September 2019). Status: Not met. Comment: IMF/WB technical assistance mission scheduled for July 2019; proposed reset to end‑September 2019. - Cabinet to approve measures to reduce operational and financial costs of SriLankan Airlines and eliminate future losses. Target: End‑July 2018. Status: Not met. Comment: Expert committee presented recommendations in January 2019; paper submitted to cabinet in April with recommendations to approve by end‑May 2019. - Cabinet to approve automatic electricity pricing mechanism (agreed with IMF staff) ensuring retail prices above cost‑recovery levels and a financial position of Ceylon Electricity Board capable of covering debt service. Target: End‑September 2018 (proposed reset to end‑October 2019). Status: Not met. - Cabinet to approve eligibility criteria for four major targeted cash transfer programs (Samurdhi, Elderly Benefit, Disabled Benefit, and Chronic Kidney Disease Benefit). Target: End‑August 2018. Status: Not met (implemented with a delay). Comment: New eligibility criteria approved by cabinet in March 2019 in consultation with the World Bank. - Cabinet to approve a strategy to rationalize para‑tariffs over the medium term, together with new revenue sources to offset revenue losses. Target: End‑March 2019 (proposed reset to end‑March 2020). Status: Not met. Comment: More time needed to identify new revenue sources. - Cabinet to approve the amended Monetary Law Act (MLA) for submission to Parliament by March 2019 to strengthen CBSL mandate and support inflation targeting. Target: End‑December 2018. Status: Not met (implemented with a delay). Comment: Amended MLA approved by cabinet in March 2019. - CBSL to operationalize a “Request for Quotes” (RFQ) system permitting competitive bidding by all banks that participate in FX trading. Target: End‑December 2018. Status: Met. Comment: RFQ implemented in July 2018. - C. Past Structural Benchmarks (selection of met and unmet items with dates) - Submit to Parliament the 2017 budget in line with the program targets. Target: End‑November 2016. Status: Met. Comment: Submitted November 10, 2016. - Submit to Parliament the 2018 budget in line with program targets and including tax expenditure statement and plan to rationalize tax expenditures. Target: End‑November 2017. Status: Met (updated at second review). - Publish a tax expenditure statement as part of the official government budget. Target: End‑December 2016. Status: Met. - Approve by cabinet a time‑bound strategy (agreed with IMF staff) to reduce or eliminate tax expenditures. Target: End‑December 2016. Status: Not met. - Submit to Parliament a new Inland Revenue Act with a view to simplifying and broadening the income tax. Target: End‑March 2017. Status: Not met (implemented as a prior action). Comment: New IRA submitted to Parliament on July 5th. - Complete by MOF a diagnostic review of the VAT system. Target: End‑June 2017. Status: Not met (implemented with delay). Comment: Review completed in November 2017 with IMF TA inputs. - Roll out by MOF Inland Revenue Department new IT systems (RAMIS) and web‑based tax filings. Target: End‑December 2016. Status: Met. - MOF to publish a detailed IRA tax manual. Target: End‑January 2018. Status: Not met (implemented with delay). Comment: Manual published in May 2018. - Establish by MOF a commitment record system and quarterly expenditure commitment ceilings for the 2016 and 2017 budgets. Target: End‑December 2016. Status: Not met (implemented partially). Comment: Modified IT system (CIGAS) and manual reporting enabled monthly tracking. - MOF to roll out ITMIS with automated commitment control module for Ministry of Finance. Target: End‑January 2017. Status: Met. - Cabinet to approve a debt management strategy for international sovereign bonds maturing over 2019‑22. Target: End‑June 2018. Status: Met. Comment: Cabinet approved tender offers and parallel new issues in January 2018. - Record the fiscal cost of non‑commercial obligations (including subsidies) for SOEs in the central government budget, starting in 2017. Target: End‑November 2016. Status: Not met (implemented in effect for major SOEs). Comment: Statement of Corporate Intent includes NCO information for large SOEs; SCIs published April 2017. - MOF to complete a report outlining the cost of non‑commercial obligations for fuel and electricity. Target: End‑September 2017. Status: Not met (implemented with delay). Comment: Report published as an annex to the 2018 budget speech in November. - Cabinet to approve automatic fuel pricing mechanism (agreed with IMF staff) ensuring retail prices above cost‑recovery levels and a financial position of Ceylon Petroleum Corporation capable of covering debt service. Target: End‑March 2018. Status: Not met (implemented with delay). Comment: Cabinet approved adoption of a cost‑reflective fuel pricing mechanism in May 2018. - CEB and the Public Utilities Commission (PUC) to establish a Bulk Supply Transactions Account and start using it to settle transactions as specified in the November 2015 tariff methodology. Target: End‑March 2018. Status: Not met (implemented with delay). Comment: Account established in May 2018; PUC published monthly data for 2016‑17. - Develop a roadmap for flexible inflation targeting and flexible exchange rate regime. Target: End‑October 2017. Status: Met. Comment: IMF TA mission in May 2017; Monetary Board approved the roadmap. - Approval by cabinet of a policy note outlining key elements of amendments (or replacement) to the MLA, in consultation with the IMF. Target: End‑March 2018. Status: Not met (implemented with delay). Comment: Cabinet approved a policy note in April 2018. *SRI LANKA INTERNATIONAL MONETARY FUND* ### 1. This Technical Memorandum of Understanding (TMU) sets out a framework for ### This Technical Memorandum of Understanding (TMU) sets out a framework for monitoring the performance of Sri Lanka under the program supported by the Extended Arrangement under the Extended Fund Facility (EFF) ### Overview of monitoring framework and targets - The TMU specifies performance criteria and indicative targets (including adjustors) for semiannual reviews. - Quantitative performance criteria and indicative targets (as listed in Table 1 attached to the MEFP) include: - a quantitative performance criterion on central government primary balance (floor); - a quantitative performance criterion on net official international reserves (floor); - a continuous quantitative performance criterion on new external payment arrears by the nonfinancial public sector and the CBSL (ceiling); - a monetary policy consultation clause; - an indicative target on central government tax revenue (floor); - an indicative target on reserve money of the CBSL (ceiling); - an indicative target on cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling); - an indicative target on treasury guarantees (ceiling). - Central government definition: includes line ministries, departments, and other public institutions. Excludes the Central Bank of Sri Lanka (CBSL), state-owned enterprises, parastatals and other agencies that do not receive subventions from the central government. - 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 and measurement: - Primary balance (cash basis) = central government revenues and grants minus expenditures and net lending, plus interest payments. - Proceeds from privatization or commercialization of public assets to residents or non-residents will not be recorded as part of central government revenues. - Spending is recorded in the period when cash disbursements are made. - For program monitoring, primary balance on cash basis is measured as the overall balance of the central government plus the interest payment of the central government. - Overall balance is measured from the financing side, as the negative of the sum of listed financing items (a)–(g) below. - Financing item amounts for 2015 (measured as described): - Primary balance: Rs –241 billion (overall balance Rs –768 billion; interest payment Rs 527 billion). - a) Net borrowings from issuances of 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. - Adjustor for project loan disbursements in 2019: - If gross cash disbursement of project loans by end-June/end-December 2019 is higher than Rs 45/95 billion, the primary balance floor for end-June/end-December 2019 will be adjusted downward by the difference between the actual amount and Rs 45/95 billion. - The downward adjustment is capped at Rs 20 billion. - If gross cash disbursement is lower than Rs 45/95 billion, the primary balance floor will not be adjusted. ### Performance criterion on Net Official International Reserves (NIR) - Program NIR measurement: - Program NIR = (a) CBSL’s conventional NIR definition minus (b) CBSL’s outstanding liabilities in foreign exchange swaps with domestic commercial banks (net short positions). Measurement uses market values and program exchange rates and gold price (paragraph 9). - Historical Program NIR (evaluated at market exchange rates): - end-2015: US$2,893.1 million. - end-2016: US$2,032.1 million. - end-2017: US$5,104.0 million. - end-2018: US$4,773.0 million. - CBSL conventional NIR (gross foreign assets minus liabilities and DST special accounts), evaluated at market exchange rates: - end-December 2015: US$5,028.8 million. - end-December 2016: US$4,529.0 million. - end-December 2017: US$6,597.4 million. - end-December 2018: US$5,494.6 million. - CBSL net short positions in FX swaps with domestic commercial banks: - end-December 2015: US$ 2,135.7 million. - end-December 2016: $2,496.9 million. - end-December 2017: US$1,495.2 million. - end-December 2018: US$723.2 million. - Policy to wind down FX swap liabilities: - Discontinue provision of FX swaps on concessional terms and gradually reduce outstanding net short positions of FX swaps with commercial banks as described in the MEFP. - Valuation assumptions for program measurement: - All foreign-currency related assets and liabilities converted into U.S. dollar terms at the exchange rates prevailing on Jan 2, 2019 (Table 1). - Monetary gold valued at US$1,281.295 per troy ounce (price prevailing on Jan 2, 2018). - Exchange rates (Rates as of January 2, 2019): - U.S. dollar: 182.5464 Sri Lankan Rupee per currency unit - British pound: 231.113 - Japanese yen: 1.673 - Canadian dollar: 134.225 - Euro: 208.705 - Chinese yuan: 26.578 - SDR: 253.8563 - NIR adjustors (Table 2 based; cumulative, in U.S. dollar terms): - If actual amounts differ from program assumptions for: - (i) foreign program financing by the central government, - (ii) net borrowings from SLDBs and FCBUs by the central government, - (iii) external commercial loans (including international sovereign bonds and syndicated loans) by the central government, - (iv) project loans and grants disbursed to the central government, - (v) proceeds from commercialization of public assets to non-residents, - then the program NIR floor will be adjusted upward/downward by the cumulative differences on the test date. - Proceeds from commercialization of public assets are defined as cash receipts from the sale or lease of publicly held assets (including publicly held land, public holdings of infrastructure or commercial real estate, and public or quasi-public enterprises). - These adjustors apply for end-June 2019 and thereafter. - Official external debt adjustor: - If the sum of amortization of official external debt and interest payments on official external debt by the central government (in U.S. dollar terms) is higher/lower than assumed, the program NIR floor will be adjusted downward/upward by the cumulative differences on the test date. - Official external debt refers to external debt owed to multilateral and official bilateral creditors (as defined in the 2013 External Debt Statistics: Guide for Compilers and Users). - These adjustors apply for end-June 2019 and thereafter. - Program assumptions (cumulative from the beginning of the year, in million US$) — selected entries: - Net borrowings from SLDBs and FCBUs by the central government: -108, -108, -108, 0 (for June-2019, Sept-2019, Dec-2019, Mar-2020). - External commercial loans (including Eurobonds and syndicated loans) by the central government: 2,426, 3,426, 3,426, 500. - Amortization of official external debt by the central government: 645, 1,044, 1,288, 440. - Interest payments of official external debt by the central government: 827, 1,230, 1,654, 404. - Project loans and grants disbursed to the central government: 218, 353, 488, 210. - Foreign program financing by the central government: 0, 0, 0, 0. - Proceeds from commercialization of public assets to non-residents: 0, 0, 0, 0. ### Continuous performance criterion on new external payment arrears - Criterion: Non-accumulation of new external payment arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL (ceiling). - Nonfinancial public sector definition: follows the 2001 Government Finance Statistics Manual and the 1993 System of National Accounts; includes the central government (as defined) and nonfinancial public enterprises (boards, enterprises, agencies in which the government holds a controlling stake). - External payments arrears definition: debt-service obligations (principal and interest) to nonresidents that have not been paid at the time they are due, as specified contractually, subject to any applicable grace period. - Overdue debt and debt service obligations that are in dispute are not considered external payments arrears for program monitoring. ### Monetary policy consultation clause and inflation measurement - Inflation target bands around the projected 12-month rate of inflation in consumer prices are specified in Table 1 attached to the MEFP. - Inflation measure: headline Colombo Consumers Price Index (CCPI) (new CCPI index 2013=100). - Year-on-year inflation for a test date is measured as: - { CCPI*(t) – CCPI*(t-12) } / CCPI*(t-12) - where: - t = the month within which the test date is included - CCPI(t) = CCPI index (all items) for month t - CCPI(t-k) = CCPI index (all items) as of k months before t - CCPI*(t) = { CCPI(t-2) + CCPI(t-1) + CCPI(t) } / 3 - CCPI*(t-12) = { CCPI(t-14) + CCPI(t-13) + CCPI(t-12) } / 3 - Consultation triggers: - If observed year-on-year inflation for end-June 2019 or end-December 2019 falls outside the outer bands specified in Table 1 attached to the MEFP: - 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) the reasons for the deviation; and (iii) proposed policy response. - 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 specified in Table 1 attached to the MEFP for end-June 2019, end-September 2019, end-December 2019, and end-March 2020: - Authorities will complete a consultation with IMF staff on the reasons for the deviation and the proposed policy response. ### Indicative targets: definitions and measurement rules - Indicative target on central government tax revenue (floor): - Central government tax revenue = revenues from taxes collected by the central government. - Excludes revenues from asset sales, grants, and non-tax revenues. - Revenue target is calculated as the cumulative flow from the beginning of the year. - For 2015, central government tax revenue defined in this manner was Rs. 1,356 billion. - Indicative target on reserve money of the CBSL (ceiling): - Reserve money components: currency in circulation (with banks and with the rest of the public); financial institutions’ domestic currency deposits at the CBSL; deposits of specified government agencies (National Defense Fund GL Acc. No. 4278; Buddha Sasana Fund A/C GL Acc. No. 4279; Road Maintenance Trust Fund GL Acc. No. 4281). - At end-December 2015, reserve money defined in this manner 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 to the extent of any shortfall in compliance with the requirement. - Formula for changes in required reserve regulations (notation preserved): - ܤݎ = ∆ ܯ∆ / ݎ ଴ + ܤ∆ݎ + ∆ܤ∆ - where ܯ∆ denotes the change in reserve money;ݎ ଴ denotes the reserve requirement ratio prior to any change; ܤ ଴ denotes the reservable base in the period prior to any change; ݎ∆ is the change in the reserve requirement ratio; and ܤ∆ denotes the immediate change in the reservable base as a result of changes to its definition. - Indicative target on cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers) (ceiling): - NCOs refer to obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery. - Indicative target is the cost of fuel and electricity NCOs net of government transfers (i.e., NCOs not compensated by central government budget). - Measurement of cost of NCOs for fuel (quarterly): 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 fuel supplies (transport, power generation, aviation, industries, kerosene and LPG, agrochemicals). If revenues (net of taxes) exceed cost of sales, cost of fuel NCOs = zero. - Government transfers to cover fuel NCOs = central government current transfers disbursed to CPC. - Measurement of cost of NCOs for electricity (quarterly): total expenditures (including energy purchases and allowed revenue for transmission) minus total sales revenues from 5 distribution licensees under CEB, as shown in the Bulk Supply Transaction Account managed by CEB. If total sales revenues exceed total expenditures, cost of electricity NCOs = zero. - Government transfers to cover electricity NCOs = central government current transfers disbursed to CEB. - For program monitoring, cost of fuel and electricity NCOs net of government transfers uses specified quarterly aggregation formulas (preserving lags). Examples: - Test date end-June 2018: { NCO(2017Q4) + NCO(2018Q1) } – { G(2018Q1) + G(2018Q2) } - Test date end-September 2018: { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) } - Test date end-December 2018: { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) + NCO(2018Q3) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) + G(2018Q4) } - Test date end-June 2019: { NCO(2018Q4) + NCO(2019Q1) } – { G(2019Q1) + G(2019Q2) } - Test date end-September 2019: { NCO(2018Q4) + NCO(2019Q1) + NCO(2019Q2) } – { G(2019Q1) + G(2019Q2) + G(2019Q3) } - Test date end-December 2019: { NCO(2018Q4) + NCO(2019Q1) + NCO(2019Q2) + NCO(2019Q3) } – { G(2019Q1) + G(2019Q2) + G(2019Q3) + G(2019Q4) } - Test date end-March 2020: NCO(2019Q4) – G(2020Q1) - Notation: - NCO(q) = NCO_fuel(q) + NCO_electricity(q) - G(q) = G_fuel(q) + G_electricity(q) - G(q) = central government current transfers to CPC and CEB disbursed during quarter “q”. - Indicative target on treasury guarantees: (definition and ceiling reference included in list of targets; measurement rules are in the MEFP/Table 1 and text beyond excerpt). *Source: This Technical Memorandum of Understanding (TMU), as provided in the IMF document content unit 1lkaea2019001.* ### 22. Treasury guarantees are defined as outstanding debt guarantees issued by the central ### 22. Treasury guarantees are defined as outstanding debt guarantees issued by the central government. ### Definition and scope - 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. - Issued guarantees are defined as 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. ### Valuation (explicit figures) - 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 (coverage and providers) - 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. - Formats for data reporting: - Fiscal performance: Tables 3 and 4. - Monetary targets: Table 5. - External sector performance: Tables 6 and 7. - Financial performance of three state-owned enterprises—CEB, CPC, and SriLankan Airlines: Tables 8, 9, and 10, respectively (quarterly). - Performance against the indicative target on the cost of fuel and electricity NCOs (net of government transfers): Tables 11 and 12 (quarterly). - Performance against the indicative target on treasury guarantees: Table 13 (quarterly). ### Timelines for data submission (explicit deadlines) - Fiscal targets (Table 3 and Table 4): - Data will be furnished within no more than five weeks after the end of each month, except: - Data on salaries and wages, goods and services, subsidies and transfers (and its subcomponents) will be furnished within no more than seven weeks after the end of each month. - Data on total recurrent expenditure and interest payments will be furnished within no more than five weeks after the end of each month. - External and monetary targets (Tables 5, Table 6, and Table 7): - Data will be furnished within no more than three weeks after the end of each month. - State-owned enterprises (Tables 8–10): - Data will be furnished within no more than 2 months after the end of each quarter. - Indicative target on the cost of fuel and electricity NCOs (Tables 11 and 12): - Data will be furnished within no more than 5 weeks after the end of each quarter. - Indicative target on treasury guarantees (Table 13): - Data will be furnished within no more than two months after the end of each quarter. ### Monitoring templates (major table purposes) - Table 3: Central Government Operations (fiscal aggregates and subcomponents; In millions of rupees). - Table 4: Central Government Financing (domestic and foreign financing breakdown; In millions of rupees). - Table 5: Balance Sheet of the Central Bank of Sri Lanka (assets, liabilities, reserve money; In millions of rupees). - Table 6: Foreign Exchange Cashflows of the Central Bank and the Government (In millions of U.S. dollars). - Tables 7–13: (Referenced for external sector, SOE financials, cost of fuel and electricity NCOs, and treasury guarantees monitoring as specified above). *Source: Excerpt from IMF country documentation (Sri Lanka) provided in the supplied content.* ### 3. Net flow at current rates (1-2) ### 1lkaea2019001 - 3. Net flow at current rates (1-2) ### Recent incidents and immediate economic implications - Political tensions: 51-day episode commenced with removal of the sitting Prime Minister and appointment of a new Prime Minister on October 26, 2018, ending with reinstatement of the ousted Prime Minister on December 16, 2018 after a Supreme Court ruling. - Economic effects: sovereign rating downgrades by the three major rating agencies; EFF program put on hold; Parliament passed a Vote on Account covering first 4 months of 2019; full 2019 budget presented in March 2019 (a Prior Action for the 5th Review). - Market outcome: Government returned to the international sovereign bond market in March 2019 and raised US$ 2.4 billion at competitive interest rates. - Easter Sunday Attacks (April 21, 2019): - Human cost: over 250 people killed, including about 44 from 14 foreign nationalities, and hundreds injured. - Policy response: emergency regulations reintroduced; measures to reassure safety and security and prevent further incidents. - Economic outlook: tourism expected to be adversely affected in the short-term; fiscal and external current account deficits could be wider than projected before the event; extent of impact depends on speed of restoring normalcy. ### Program performance under the EFF - Quantitative and indicative outcomes (end-December 2018 QPC/IT): - Inflation: fell below the lower inner band under the MPCC for December but remained within the outer band. - Primary balance: QPC not met due to sizable revenue underperformance, but improved compared to the previous year. - NIR: QPC missed due to significant intervention in the foreign exchange market amid external pressures and political tensions. - Reserve money: end-December Indicative Target met. - Tax revenues: Indicative Target missed. - Continuous QPC on accruing no new external arrears: met. - Structural Benchmarks: five SBs completed, with some delays. - Authorities request: approval of the 5th Review of the EFF with a one-year program extension, recalibrated program targets, and re-phasing of foreign exchange purchases. ### Economic growth and outlook - Recent performance: - Growth: subdued at 3.2 percent in 2018. - Medium-term projections and drivers: - Growth momentum expected to improve gradually to around 5 percent. - Drivers: successful implementation of growth strategy, improved fiscal discipline, structural reforms, higher FDI inflows, low inflation environment, competitive exchange rate, and greater private sector participation. ### Monetary policy, inflation, and exchange rate management - Inflation developments: - NCPI headline inflation: decelerated from 7.3 percent at end 2017 to 0.4 percent by end 2018, accelerating to 2.9 percent by March 2019. - CCPI headline inflation: decelerated from 7.1 percent (year-on-year) at end 2017 to 2.8 percent by end 2018, accelerating to 4.5 percent by April 2019. - Monetary stance: - CBSL signaled end to tightening cycle in April 2018 and moved to a neutral stance; provided forward guidance of possible easing. - April 29, 2019 directive: licensed banks and non-bank financial institutions instructed to reduce deposit rates by linking short-term rates to the standing deposit facility rate of the CBSL and long-term rates to the Treasury bill rate to expedite monetary transmission. - Objective: maintain prudent, data-dependent stance and act if inflationary pressures emerge. - Institutional reforms and targets: - Aspiration to adopt flexible inflation targeting (FIT) framework by 2020. - Amendments to the Monetary Law Act (MLA) approved by Cabinet; to be submitted to Parliament in July 2019. Amendments include strengthening price stability mandate, Central Bank independence, fiscal-monetary coordination, restrictions on CBSL financing of fiscal deficit, governance improvements, and expanded macroprudential authority. - Exchange rate and reserve operations: - Market-based exchange rate policy with interventions to stem excessive volatility and build reserves. - Net supply to market: CBSL supplied around US$ 1.1 billion to the market during 2018 to reduce excessive volatility. - Nominal exchange rate movements: - Depreciated by 16.4 percent in 2018. - Appreciated by 4.2 percent during Q1 2019. - Cumulative appreciation up to April 22, 2019: 4.8 percent. - Since April 21, 2019, the rupee has depreciated by 1.4 percent against the US dollar. - Operational reforms: RFQ system introduced for CBSL forex intervention to deepen market activity and enhance transparency. - Policy going forward: continue flexible, competitive exchange rate within FIT regime; foreign exchange sales limited to stemming disorderly volatility; continue reserve accumulation to rebuild adequate reserve buffers over the medium-term. ### Financial sector resilience and reforms - Soundness indicators: - Financial sector remains sound with high capital and adequate liquidity buffers despite some increase in NPLs. - Regulatory and supervisory reforms: - Ongoing implementation of Basel III requirements and IFRS 9 to enhance resilience. - New Banking Act being drafted with World Bank assistance to strengthen regulation and supervision. - Resolution/enforcement actions for distressed licensed finance companies and lingering problems. - Macroprudential measures (e.g., LTVs on motor vehicles) remain operational. - Inclusion and sustainability: - Roadmap for Sustainable Finance launched on 10 April 2019 with IFC support. - Progress on National Financial Inclusion Strategy formulation. - AML/CFT: - Authorities engaged with stakeholders to complete FATF time-bound action plan. - Asia Pacific Joint Group (AP/JG) acknowledged significant progress and that Sri Lanka has largely addressed the FATF Action Plan. - Expected to exit the “Grey List” during the second half of 2019. ### Fiscal policy, SOE reforms, and public finances - Fiscal consolidation and revenue mobilization: - Primary surplus: 0.6 percent of GDP in 2018 (0.02 percent in 2017). - Budget deficit target: expected to reduce to 3.2 percent of GDP by 2023. - Central government debt: expected to decline to 70 percent of GDP. - Tax reforms: VAT reforms introduced in 2016/17; new Inland Revenue Act in 2018 to strengthen domestic revenue mobilization. - Tax administration strengthening underway; measures to protect vulnerable segments via more effective social protection schemes. - Fiscal framework institutionalization: - Revisions to the Fiscal Management (Responsibility) Act with IMF TA to include binding fiscal rules, accountability provisions, escape clauses, and automatic correction mechanisms. - Public Financial Management Act being developed with World Bank support to improve budget process and control PPP risks; new PPP guidelines nearing finalization. - SOE fiscal risk mitigation: - Automatic fuel pricing formula introduced; establishment of a bulk supply transaction account (BSTA) to revise electricity prices to reflect costs. - Automatic electricity pricing mechanism expected to be submitted to the Cabinet in October 2019. - SriLankan Airlines (SLA) restructuring: expert committee report to the President in January 2019; paper submitted to Cabinet in April 2019 with recommendations; Board of SLA to prepare strategic plan and operating business model while overseeing restructuring. - Divestiture of Hambantota Port highlighted as key measure to improve public sector performance. - Statements of Corporate Intent (SCIs) framework initially signed with 5 SOEs expected to expand to another 10 SOEs. ### Debt management - Recognized challenges: high outstanding liabilities and large upcoming refinancing needs. - Institutional reforms: - Active Liability Management Act (ALMA) introduced to smooth the redemption cycle and permit advance refinancing/pre-financing beyond financial years covered by the Annual Appropriation Act. - Medium-Term Debt Management Strategy (MTDS) launched in April 2019. - Work in progress to establish an independent debt management agency in line with international best practices. ### External sector and trade - Current account and reserves: - Current account deficit increased to 3.2 percent of GDP in 2018 due to merchandise trade deficit, stagnant workers’ remittances, and rising foreign interest payments. - Services exports (tourism and computer services) estimated to have grown substantially. - Authorities expect the current account deficit to taper over the medium-term as trade account and services improve and remittances recover. - Expected increase in FDI to help finance the current account deficit with lower reliance on debt-related inflows. - Foreign reserves: US$ 7.2 billion by end-April 2019, equivalent to about 4.1 months of imports. - Trade policy and export promotion: - Priority on improving exports and investment through greater integration with global markets via bilateral trade negotiations with China, India, and Thailand to widen market access and diversify products and markets. - New Trade Policy (NTP) initiated focusing on trade liberalization, investment promotion, and participation in production sharing networks. - Trade Adjustment Program (TAP) introduced to support smooth transition for firms and workers to new market conditions; Trade and Productivity Commission and a Joint Steering Committee approved by Cabinet in March 2019 to implement TAP. - Para tariffs being phased out. *Source: Statement by Subir Gokarn, Executive Director for Sri Lanka and Mahinda Siriwardana, Alternate Executive Director, May 13, 2019, and accompanying IMF staff report excerpts.* ### Conclusion ### Conclusion ### Policy agenda and reforms - Our authorities' policy agenda towards achieving rapid, inclusive and sustainable growth has been continuously supported by the Fund’s technical assistance (TA) as well as by the policy reforms implemented. - The authorities also value the efforts towards integration of capacity development and program objectives by the IMF along with the World Bank. ### Role of the EFF arrangement - The continuation of the EFF arrangement will boost investor confidence and help the country, particularly in passing through this challenging period. ### Outlook and confidence - Our authorities are confident that with the implementation of envisaged reform agenda, Sri Lanka’s economy will gradually return to a trajectory of high growth with greater macroeconomic stability. *Source: 1lkaea2019001 - Conclusion* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1lkaea2019001.pdf_