## 1lkaea2019003

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### Executive summary and recent developments
- The Sri Lankan economy is gradually recovering from the Easter Sunday terrorist attacks.
- Real GDP growth:
  - Revised to 2.7 percent in 2019, down from 3.6 percent at the fifth review.
  - Projected to strengthen to 3.5 percent in 2020 as tourism and related activities normalize.
- Program performance and financing:
  - Authorities remain committed to complete the EFF-supported program despite setbacks.
  - Significant revenue shortfalls after the attacks made fiscal targets no longer within reach; corrective actions are being taken.
  - End-June net international reserve target was met; preliminary data indicate end-September indicative NIR target was met.
  - The purchase available upon completion of this review will be equivalent to SDR 118.5 million, bringing total purchases under the EFF to SDR 952.23 million.
  - Total three-year Extended Arrangement availability: 1,070.780 SDR millions (185.000 percent of Quota).
- Key challenges and vulnerabilities:
  - High public debt and low external buffers: public debt projected at 90 percent of GDP in 2019.
  - Reserves at end-September: 3.3 months of imports and 61 percent of the IMF ARA metric.
  - Heightened external and domestic uncertainty increases downside risks.
- Date noted: October 21, 2019.

### Economic impact of the Easter Sunday attacks and sectoral developments
- Tourism and related sectors:
  - Tourist arrivals: 2.3 million in 2018 generating US$4.4 billion (5 percent of GDP).
  - Projected pre-attack arrivals for 2019 were 2.5 million (7 percent increase).
  - Tourist arrivals declined by 71 percent (y-o-y) in May 2019, moderating to a 27 percent (y-o-y) decline as of end-September 2019.
  - Year-to-date tourist arrivals remain 20 percent lower as of end-September compared to the same period of 2018.
  - Authorities’ expectation: total arrivals about 2 million in 2019 (decline of about 14 percent relative to 2018) and full recovery by 2020.
- Broader real sector:
  - Real GDP growth: 3.7 percent (y-o-y) in 2019Q1; slowed to 1.6 percent (y-o-y) in 2019Q2.
  - Accommodation, wholesale and retail trade, and transportation (about 23 percent of GDP) fell by 0.6 percent (y-o-y) in 2019Q2, versus growth of 3.3 percent (y-o-y) in 2019Q1.
  - Industrial production fell by 0.8 percent (y-o-y) in April but recovered in subsequent months.
- Inflation and prices:
  - Headline inflation: 3.4 percent (y-o-y) in August, rose to 5 percent in September driven by weather-related food price increases.
  - Core inflation remained stable at 5.6 percent.
  - 3-month moving-average inflation rate: 3.9 percent (y-o-y), within the inner target band.
- External sector and reserves:
  - Current account: US$448 million surplus in 2019Q1; US$581 million deficit in 2019Q2; US$133 million deficit in 2019H1 after tourism and remittances weakened.
  - Net portfolio outflows: nearly US$80 million after the attacks; later net outflows of over US$150 million amid renewed pressures in late August.
  - The rupee depreciated by over 4 percent since the attacks as of end-September.

### Outlook and risks
- Projections:
  - Real GDP growth: 2.7 percent in 2019; 3.5 percent in 2020.
  - Inflation: projected at 5.4 percent by end-year 2019 and expected to remain in the mid-single digits in the medium term.
  - Current account deficit: expected to improve to 2.6 percent of GDP in 2019.
- External and domestic risks (intensified after the attacks):
  - External: tightening global financial conditions; trade tensions and weaker global growth.
  - Domestic: slower tourism recovery; protracted political uncertainty; vulnerability to natural disasters.
  - Upside factor: lower energy prices would reduce the current account deficit.

### Policy guidance and structural reforms
- Fiscal policy:
  - Sustain fiscal discipline; authorities targeting a primary surplus of 0.2 percent of GDP in 2019 and 0.7 percent of GDP in 2020 (to be achieved mostly through new revenue measures of 0.6 percent of GDP).
  - Revenue mobilization in 2020 required to place public debt on a downward path while preserving space for critical social and investment spending.
  - New fiscal rule framework with a long-run debt anchor of 50 percent of GDP; cabinet approved draft legislation to implement the new fiscal responsibility framework in October (end-September SB).
- SOEs and fiscal risks:
  - Advance SOE reforms in the electricity sector; CEB losses continued at -0.5 percent of GDP in 2019H1.
  - 2018 combined loss of major SOEs: 1.1 percent of GDP.
  - SriLankan Airlines (SLA): Board approved strategic plan in August; cabinet endorsed recapitalization and strategic partner options in October.
- Monetary policy and reserves:
  - CBSL to maintain data-dependent monetary policy; adopt flexible inflation targeting via new Central Bank Act.
  - CBSL reduced policy rate corridor by 100 basis points to 7–8 percent since May; policy rates unchanged on October 10.
  - Gross international reserves expected to reach US$8.2 billion by year-end (3.6 months of imports or 65 percent of ARA), up from US$6.9 billion as of end-2018.
  - FX policy: allow exchange rate flexibility and resume FX purchases as market conditions stabilize.
- Financial sector and AML/CFT:
  - Harmonize regulation and supervision of financial institutions; strengthen macroprudential framework and contingency framework.
  - Sri Lanka removed from FATF Improving Global AML/CFT Compliance list in October after on-site visit in September verified implementation.
- Structural reform priorities:
  - Liberalize trade by gradually removing para-tariffs while addressing revenue impact.
  - Strengthen governance and anti-corruption framework.
  - Promote women’s economic empowerment.
  - Build climate resilience.
  - Enhance social protection.

### Program modalities, mission engagement, and conditionality
- Extension and rephasing:
  - On May 13, 2019, Executive Board approved an extension of the arrangement by one year, until June 2, 2020, with rephasing of remaining disbursements.
- Mission engagement:
  - Discussions held in Colombo during September 10–25, 2019; mission head Manuela Goretti and team included named staff and Mr. Siriwardana (OED) participated.
- Program conditionality and adjustments:
  - Authorities requested waiver of nonobservance of the end-June QPC on the primary balance.
  - QPC and/or ITs for end-December and end-March recalibrated.
  - Structural benchmark to submit 2020 budget to Parliament reset to end-April 2020 (from end-November 2019).

### External position and reserves (Annex I highlights)
- REER and external gaps:
  - After a 13 percent depreciation in 2018, REER appreciated by 1.5 percent as of September 2019.
  - EBA-based current account gap: -0.9 percent of GDP for 2018.
  - REER gap estimated at 5–7 percent for 2018 under EBA and EBA-lite.
- Reserve adequacy:
  - Reserves at end-September: 3.3 months of imports; 61 percent of ARA metric.
  - GIR decreased from US$7.9 billion at end-2017 to US$6.9 billion at end-2018; expected to strengthen to US$8.2 billion in 2019.
- External debt and sustainability:
  - External debt estimated at 59 percent of GDP at end-2018.
  - Public debt increased to about 90 percent of GDP at end-2018; central government debt 83.3 percent of GDP.
  - Foreign-currency denominated debt: about 50 percent of total.
  - Under the program scenario, public debt projected to decline from 90 percent of GDP in 2018 to 79.2 percent in 2024.
  - Stress tests: a 30 percent real depreciation could raise external debt-to-GDP to about 80 percent by 2024; combined shocks could raise debt-to-GDP to 101 percent in 2024.
  - SOE contingent liability shock (8 percent of GDP in 2019) would raise debt-to-GDP to 101 percent initially and 94 percent in 2024.

### Program performance and policy discussions — selected outcomes
- Fiscal performance:
  - Primary balance missed end-June QPC by 0.9 percent of GDP and end-September IT by 1.3 percent of GDP.
  - Estimated impact of attacks: projected to reduce overall revenues by approximately 2.3 percent of GDP in 2019 relative to the fifth review.
  - Corrective actions: curtail non-critical recurrent and capital spending; implement delayed revenue proposals; introduce new revenue measures.
  - Authorities pre-financed external repayments in 2019 with international bond issuances: March US$2.4 billion and June US$2 billion. Next international bond redemption of US$1 billion is due October 2020.
  - Multi-year plan to establish an independent debt management agency approved by cabinet in October (end-September SB).
- SOE governance and NCOs:
  - End-June and end-September ITs on Non-Commercial Obligations (NCOs) of CPC and CEB were missed.
  - End-June indicative target on NCOs missed by 0.35 percent of GDP; end-September target missed by 0.6 percent of GDP.
  - CEB losses continued throughout 2019H1 at -0.5 percent of GDP.
- Monetary policy, reserves, and legal reform:
  - New Central Bank Act to establish price stability as primary objective, adopt flexible exchange rate, end monetary financing, and give CBSL macroprudential mandate.
  - CBSL committed to build NIR to meet end-December target and to resume FX purchases as conditions permit.
  - Reserve accumulation by end-June 2019 included net FX purchases of US$212 million; gross international reserves expected US$8.2 billion by year-end.
- Financial sector:
  - Capital and liquidity requirements raised in 2019H1; NBFI minimum capital requirement raised from Rs 1 billion to Rs 1.5 billion and scheduled to increase to Rs 2.5 billion by 2021.
  - Private sector credit growth slowed to 7.2 percent (y-o-y) as of August 2019, from 15 percent on average in 2018.
  - IFRS 9 phased over four years is lowering profitability; license of one small NBFI canceled in September.
- CBSL emergency and near-term credit measures:
  - May 2019: moratorium on performing loan payments due through March 2020 for tourism industry (about 3½ percent of total credit).
  - Rescheduled payments rolled into new loans at concessionary rates with no change to credit risk classification.
  - April: caps on deposit rates introduced (later removed); September: caps on lending rates introduced and directed banks to reduce lending rates by at least 200 basis points compared to end-April levels; lending caps to be reviewed in March 2020.
  - IMF cautioned on distortionary impacts and welcomed intention to phase out/review measures by March 2020.

### Staff recommendation, monitoring, and outlook
- Staff supports completion of the sixth review, subject to continuation of corrective actions and program commitments.
- Key monitoring items and program targets:
  - Quantitative performance criteria and indicative targets include central government primary balance (floor), Program NIR (floor), continuous PC on new external payment arrears (ceiling), indicative target on central government tax revenue (floor), reserve money (ceiling), NCOs net of government transfers (ceiling), and treasury guarantees (ceiling).
  - Reporting requirements and timelines specified for fiscal, monetary, external, and SOE data (deadlines range from 3 weeks to 2 months after end of period depending on data series).
- Outlook summary:
  - Growth projected to strengthen to 3.5 percent in 2020.
  - Inflation expected to stabilize near mid-single digits; end-2019 inflation projected at 5.4 percent.
  - Continued emphasis on revenue-based fiscal consolidation, reserve rebuilding, flexible exchange rate, SOE reforms, and strengthening financial sector supervision.

### Key tables and numeric highlights (selected exact figures preserved)
- Real GDP growth (selected years): 2016: 4.5; 2017: 3.4; 2018: 3.2; 2019: 2.7; 2020 (Proj.): 3.5.
- Central government debt (percent of GDP): 2016: 79.0; 2017: 77.4; 2018: 83.3; 2019: 82.2; 2020 (Proj.): 83.2.
- Total revenue and grants (percent of GDP): 2016: 14.1; 2017: 13.7; 2018: 13.4; 2019: 15.1; 2020 (Proj.): 12.8.
- Total expenditure and net lending (percent of GDP): 2016: 19.5; 2017: 19.2; 2018: 18.6; 2019: 19.6; 2020 (Proj.): 18.6.
- Primary balance (percent of GDP): 2016: -0.2; 2017: 0.0; 2018: 0.6; 2019 (CR/19/135): 1.5; 2020 (Proj.): 0.2.
- Gross official reserves (end of period, US$ millions): 2016: 6,019; 2017: 7,959; 2018: 6,919; 2019 (CR/19/135): 8,650; 2020 (Proj.): 8,168.
- Current account balance (US$ millions): 2016: -1,743; 2017: -2,309; 2018: -2,814; 2019 (CR/19/135): -2,380; 2020 (Proj.): -2,282.
- Fund credit outstanding (millions of SDR): 2019: 952.2; 2020: 1,060.8; 2021: 1,020.8; 2022: 916.4.
- EMBIG (average 01-Apr-19 through 30-Jun-19): 338 bp.
- Stress-test highlight: a 30 percent real depreciation could raise external debt-to-GDP to about 80 percent by 2024.
- Major sovereign bond issuances in 2019: March US$2.4 billion; June US$2 billion. Next redemption: US$1 billion due October 2020.
- Program NIR end-2018 and program NIR historical: end-2018 US$4,773.0 million; end-2017 US$5,104.0 million.
- Reserve money change examples: 2016: 27.1 percent; 2017: 9.8 percent; 2018: 2.3 percent; 2019 (CR/19/135): 11.3 percent.

*Source: IMF staff report content (1lkaea2019003).*

### 1.1 billion (US$1.5 billion, or 185 percent of quota in the IMF at that time of approval of the

### SRI LANKA — SIXTH REVIEW UNDER THE EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY AND REQUESTS FOR WAIVER OF NONOBSERVANCE AND MODIFICATION OF PERFORMANCE CRITERION

### Executive summary and recent developments
- The Sri Lankan economy is gradually recovering from the Easter Sunday terrorist attacks.
- Real GDP growth:
  - Revised to 2.7 percent in 2019, down from 3.6 percent at the fifth review.
  - Projected to strengthen to 3.5 percent in 2020 as tourism and related activities normalize.
- Program performance:
  - Authorities remain committed to complete the EFF-supported program despite setbacks.
  - Fiscal targets are no longer within reach due to significant revenue shortfalls after the attacks; corrective actions are being taken.
  - The end-June net international reserve target was met.
  - The Central Bank of Sri Lanka (CBSL) is committed to rebuild reserves while allowing for greater exchange rate flexibility.
  - Five key structural benchmarks under the program have been implemented, albeit with some delays.
- Key challenges:
  - High public debt and low external buffers leave the economy vulnerable to shocks.
  - Heightened external and domestic uncertainty increases downside risks.
  - Sustained policy discipline and rebuilding of reserve buffers are critical to strengthen resilience while supporting investment and growth.
- Financial support under review:
  - The purchase available upon completion of this review will be equivalent to SDR 118.5 million, bringing total purchases under the EFF to SDR 952.23 million.
- Date noted in document: October 21, 2019.

### Economic impact of the Easter Sunday attacks and sectoral developments
- Tourism and related sectors:
  - Tourist arrivals: reached 2.3 million in 2018 generating US$4.4 billion (5 percent of GDP).
  - Projected pre-attack arrivals for 2019 were 2.5 million (7 percent increase).
  - Tourist arrivals declined by 71 percent (y-o-y) in May 2019, moderating to a 27 percent (y-o-y) decline as of end-September 2019.
  - Year-to-date tourist arrivals remain 20 percent lower as of end-September compared to the same period of 2018.
  - Authorities’ expectation: total arrivals about 2 million in 2019 (decline of about 14 percent relative to 2018) and full recovery by 2020.
- Broader real sector:
  - Real GDP growth: 3.7 percent (y-o-y) in 2019Q1; slowed to 1.6 percent (y-o-y) in 2019Q2.
  - Accommodation, wholesale and retail trade, and transportation (about 23 percent of GDP) fell by 0.6 percent (y-o-y) in 2019Q2, versus growth of 3.3 percent (y-o-y) in 2019Q1.
  - Industrial production fell by 0.8 percent (y-o-y) in April but recovered in subsequent months.
- Inflation and prices:
  - Headline inflation fell to 3.4 percent (y-o-y) in August, then rose to 5 percent in September driven by weather-related food price increases.
  - Core inflation remained stable at 5.6 percent.
  - The 3-month moving-average inflation rate stood at 3.9 percent (y-o-y), within the inner target band.
- External sector and reserves:
  - Current account: US$448 million surplus in 2019Q1 due to a near 20 percent decline in imports and strong export growth; turned to a US$581 million deficit in 2019Q2 and a US$133 million deficit in 2019H1 after tourism and remittances weakened.
  - Imports contraction included large falls in vehicles and gold.
  - Financial market turbulence:
    - Net portfolio outflows of nearly US$80 million after the attacks; later net portfolio outflows of over US$150 million amid renewed pressures in late August.
    - The rupee depreciated by over 4 percent since the attacks as of end-September.

### Outlook and risks
- Projections:
  - Real GDP growth: 2.7 percent in 2019; 3.5 percent in 2020.
  - Inflation: projected at 5.4 percent by end-year 2019 and expected to remain in the mid-single digits in the medium term.
  - Current account deficit: expected to improve to 2.6 percent of GDP in 2019 due to lower imports and stronger exports.
- Risks (intensified after the attacks):
  - External risks:
    - A tightening in global financial conditions could trigger capital flow pressures.
    - Trade tensions and weaker global growth could lower exports, tourism, and growth.
  - Domestic risks:
    - Tourism recovery could take longer than projected, weighing on credit quality and bank profitability.
    - Protracted political uncertainty could impact program implementation and investor sentiment.
    - Vulnerability to natural disasters remains.
  - Upside factor:
    - Lower energy prices would reduce the current account deficit and support energy pricing reforms.

### Policy guidance and structural reforms
- Fiscal policy:
  - Sustaining fiscal policy discipline is critical to strengthen resilience and support growth amid important downside risks.
  - Authorities are taking actions to mitigate revenue shortfalls from the attacks and preserve program gains.
  - Sustained revenue mobilization in 2020 is needed to place public debt on a downward path while preserving space for critical social and investment spending.
  - The new fiscal rule framework and establishment of an independent public debt management agency over the medium term will help anchor public debt sustainability.
- State-owned enterprises and fiscal risks:
  - Advancing SOE reforms in the electricity sector is critical to reduce fiscal risks.
- Monetary policy and reserves:
  - The Central Bank of Sri Lanka should maintain a data dependent monetary policy.
  - The new Central Bank Act is a milestone toward adoption of flexible inflation targeting.
  - Efforts to build reserves should be sustained to protect the economy against shocks, allowing for exchange rate flexibility in the event of market pressures.
- Financial sector and AML/CFT:
  - Sri Lanka has made important progress in strengthening the AML/CFT regime.
  - Recommended actions: harmonize regulation and supervision of financial institutions; strengthen the macroprudential policy framework; upgrade the contingency framework to safeguard financial stability.
- Structural reform priorities to boost competitiveness and inclusive growth:
  - Liberalize trade by gradually removing para tariffs while addressing revenue impact.
  - Strengthen governance and anti-corruption framework.
  - Promote women’s economic empowerment.
  - Build climate resilience.
  - Enhance social protection.

### Program modalities and mission engagement
- Extension and rephasing:
  - On May 13, 2019, the Executive Board approved an extension of the arrangement by one additional year, until June 2, 2020, with rephasing of remaining disbursements.
- Review and mission:
  - Staff supports authorities’ request for completion of the sixth review.
  - Discussions were held in Colombo during September 10–25, 2019 with officials including Prime Minister Wickremesinghe, Minister of Finance Samaraweera, Governor Coomaraswamy, and others.
  - Mission team included Manuela Goretti (head), Pablo Morra, Andrew Hodge, Saji Thomas, Vassili Prokopenko, Fei Liu, Tubagus Feridhanusetyawan, and Amitha Sundararaj; Mr. Siriwardana (OED) participated.

*International Monetary Fund — October 21, 2019*

### 7.      Sri Lanka’s external position was broadly in line with fundamentals and

### 7.      Sri Lanka’s external position was broadly in line with fundamentals and

### External position and reserves
- Following a depreciation of 13 percent in 2018, the real effective exchange rate (REER) appreciated by 1.5 percent as of September 2019.
- The EBA-based current account gap was estimated at -0.9 percent of GDP for 2018.
- The REER gap was estimated at 5–7 percent for 2018 under EBA and EBA lite (Annex I).
- Based on year-to-date developments, the external position is expected to remain broadly in line with fundamentals in 2019.
- External debt is sustainable, but rollover risks remain high over the medium term, in the context of relatively low reserve coverage and volatile financial markets:
  - Reserves at end-September: 3.3 months of imports.
  - Reserves at end-September: 61 percent of the IMF Assessing Reserve Adequacy (ARA) metric.
- Authorities’ view: short-term external liability component of the ARA metric may be overstated by FX deposits of commercial banks on account of workers’ remittances, which are stable and do not pose risks to reserves.
- The CBSL will continue to strengthen its market-oriented approach to exchange rate policy.

### PROGRAM PERFORMANCE AND POLICY DISCUSSIONS

#### A.   Advancing Fiscal Consolidation
- Fiscal performance in 2019 was significantly affected by the prolonged impact of the 2018 political crisis and the Easter attacks.
- The primary balance fell short of targets:
  - Missed end-June quantitative performance criterion (QPC) by 0.9 percent of GDP.
  - Missed end-September indicative target (IT) by 1.3 percent of GDP.
- Drivers of shortfalls:
  - 2019Q1: frontloading of expenditure (0.6 percent of GDP) from clearing arrears and externally-financed capital projects carried over from 2018; revenues slightly lower due to weaker-than-projected imports (notably vehicles) still subject to exchange and other restrictions.
  - 2019Q2 and 2019Q3: widened underperformance due to sharp fall in imports and indirect tax revenues following the attacks; tax revenues were 0.2 percent of GDP short of the indicative target in June and 1.0 percent of GDP in September.
  - Income tax receipts remained robust due to broadening of the tax base from the Inland Revenue Act (IRA).
- Estimated impact of attacks: projected to reduce overall revenues by approximately 2.3 percent of GDP in 2019 relative to the fifth review.
- Policy response and targets:
  - Authorities are curtailing non-critical recurrent and capital spending, implementing delayed revenue proposals in the 2019 budget, and introducing new revenue measures.
  - Authorities remain committed to achieve a primary surplus of 0.2 percent of GDP in 2019.
  - Target for 2020: primary surplus of 0.7 percent of GDP, to be achieved mostly through new revenue measures (0.6 percent of GDP).
  - Revenue mobilization focus: greater reliance on broad-based indirect taxation, reductions in tax expenditures, and gradual phasing out para-tariffs, while preserving space for critical social spending and public investment.
- Budget process note:
  - Cabinet submitted a Vote on Account (VOA) to authorize government expenditure for the first four months of 2020; the 2020 budget is expected to be approved and submitted after the elections (end-November 2019 Structural Benchmark, SB, proposed to be reset to end-April 2020).
- Fiscal rules and debt:
  - Public debt projected at 90 percent of GDP in 2019.
  - Authorities plan to revamp fiscal responsibility framework (prepared with IMF TA, endorsed by cabinet in July (end-May SB)):
    - Long-run debt anchor for central government debt of 50 percent of GDP.
    - Achieved through annual operational targets on the fiscal deficit, supported by an automatic correction mechanism and well-defined escape clauses.
  - Cabinet approved draft legislation to implement the new fiscal responsibility framework in October (end-September SB).
- Debt management and pre-financing:
  - Authorities pre-financed borrowing needs throughout the election period and advanced reforms to debt management.
  - External repayments for 2019 were fully financed with international bond issuances: March (US$2.4 billion) and June (US$2 billion).
  - Authorities have started to pre-finance 2020 borrowing needs under the Active Liability Management Act.
  - Next international bond redemption of US$1 billion is not due until October 2020.
  - Multi-year plan to establish an independent debt management agency, with IMF TA, approved by cabinet in October (end-September SB).
- Structural fiscal reforms continuing:
  - Revenue Administration: reforms to support revenue yields from the IRA and other tax policy reforms; reform plan to modernize the Inland Revenue Department and Customs administration, supported by IMF TA, with key elements to be implemented by end-December 2020 (strategic and risk-based tax administration, modernized human resources practices, improved communication with taxpayers).
  - PFM and PIM: work, with World Bank support, on a PFM Act to improve regulatory framework and lower PPP risks; new PPP guidelines being finalized; a new fiscal unit dedicated to assessing related fiscal risks is being operationalized.
  - Fiscal transparency: compiling fiscal statistics in accordance with GFSM2014, with IMF TA.

#### B.   Strengthening SOE Governance and Reducing Fiscal Risks
- Fiscal risks from SOEs remain elevated despite recent improvements.
- 2018 combined loss of major SOEs: 1.1 percent of GDP.
- 2019Q1: CPC and SLA realized a profit of 0.35 percent of GDP due to higher retail fuel prices, stronger rupee, and SLA cost reductions.
- 2019Q2: performance deteriorated as Easter attacks depressed SLA’s sales and CPC’s import and debt service costs rose.
- CEB losses: continued throughout 2019H1 at -0.5 percent of GDP due to hydro-power shortages, high generation costs, and lack of adjustments in retail prices.
- End-June and end-September ITs on Non-Commercial Obligations of CPC and CEB were missed.
- Compliance reports as of end-June 2018 for five largest SOEs with Statements of Corporate Intent (SCIs) showed progress on operational efficiency but limited success meeting financial targets; eight additional SOEs signed SCIs in June.
- SriLankan Airlines (SLA) restructuring:
  - Board approved a strategic plan and new operating business model in August to reduce costs and minimize future losses (end-September 2019 SB).
  - Cabinet endorsed measures in October including options to recapitalize the company, bring in a strategic partner with a Sri Lankan majority, and restructure some financial liabilities.
  - Next step: launch request for qualifications from investors to commence PPP process.
- Electricity sector reforms:
  - Fuel price adjustment formula reinstated in December 2018; retail gasoline and diesel prices gradually brought back to cost recovery levels by June 2019.
  - Authorities restarting complementary reforms in electricity sector after delays.
  - New technical committee to develop plan to phase in an automatic electricity pricing mechanism and calibrate cross-subsidization to minimize distributional impact.
  - Mission urged addressing outstanding power generation and governance issues, starting with a special external audit of CEB’s heat rates and dispatch methodology, in line with Public Utility Commission recommendations.
  - Cabinet approval of a plan to introduce an electricity pricing mechanism based on the technical committee’s recommendations is now expected to be implemented with a delay by end-April 2020 (end-October 2019 SB).
  - These reforms should proceed in parallel with further strengthening of social safety nets (¶24).

#### C.   Modernizing the Monetary Policy Framework and Rebuilding Reserves
- Central Bank Act reform:
  - New Act will set legal and institutional foundations for transition to flexible inflation targeting (FIT).
  - Key elements:
    - Clarifies the mandate of the CBSL, establishing price stability as its primary objective, with financial stability as a core objective.
    - Adopts a flexible exchange rate regime.
    - Ends monetary financing of the fiscal deficit.
    - Gives the CBSL a clear macroprudential policy mandate.
    - Strengthens CBSL autonomy, governance, and accountability frameworks (Annex IV).
  - Staff advised against government representation in the CBSL’s new decision-making bodies; however, Parliament’s Committee on Public Finance recommendation kept the Secretary to the Treasury as a voting member of the new Governing Board.
  - Authorities finalizing legal draft with the Attorney General’s office; final cabinet approval and submission to Parliament expected with a delay (end-July SB).
  - CBSL plans to strengthen economic modeling and policy analysis, and enhance communication with IMF TA, including publication of an inflation report in 2020.
- Monetary policy stance:
  - CBSL reduced the policy rate corridor by 100 basis points to 7–8 percent since May, amid weak domestic demand, tight credit conditions, and subdued inflation.
  - In the monetary policy review on October 10, the CBSL maintained policy rates unchanged.
  - Staff and authorities agreed monetary policy should remain prudent and data-driven, with the CBSL ready to adjust policy rates as warranted by evolving macroeconomic conditions and global external conditions.
- Reserve rebuilding and FX policy:
  - Reserve accumulation by end-June 2019 was in line with program target, with net FX purchases of US$212 million.
  - Preliminary data indicate end-September indicative NIR target was met by a small margin amid renewed market pressures and CBSL intervention to curb excess volatility.
  - CBSL committed to allow exchange rate flexibility and resume FX purchases as market conditions stabilize to meet end-December NIR target.
  - Gross international reserves expected to reach US$8.2 billion by year-end, equivalent to 3.6 months of imports or 65 percent of the Fund’s reserve adequacy metric, up from US$6.9 billion as of end-2018.
  - Staff welcomed cabinet decision to increase period to repatriate export proceeds from 120 to 180 days and reiterated advice to phase out the requirement based on progress with program adjustments and to loosen limit on foreign investment in rupee-denominated government securities (Annex I).

#### D.   Safeguarding Financial Sector Stability
- Capital and liquidity requirements:
  - Capital and liquidity ratios of banks and NBFIs increased in 2019H1 with introduction of higher requirements.
  - Since January 2019, banks are subject to higher capital and liquidity requirements, in line with Basel III standards.
  - Minimum capital requirement for NBFIs raised from Rs 1 billion to Rs 1.5 billion and scheduled to increase further to Rs 2.5 billion by 2021.
- Asset quality and profitability pressures:
  - Deteriorating credit quality and tighter regulation are weighing on profitability, particularly among NBFIs.
  - Slower growth has markedly raised non-performing loan (NPL) ratios.
  - Phased introduction of stricter accounting standards (IFRS 9) over a four-year period is lowering profitability.
  - Risks are greater for NBFIs, which cater to higher-risk borrowers and have lower capital buffers.
  - The license of one small NBFI with longstanding financial difficulties was canceled in September.
- Credit growth:
  - Credit growth to the private sector slowed to 7.2 percent (y-o-y) as of August 2019, from 15 percent on average in 2018.
  - Deceleration observed across all sectors except personal loans.
  - Slowdown driven by weaker credit demand and more cautious lending by banks amid tighter financial conditions, slower economic growth, and political uncertainty ahead of elections.
  - Credit conditions expected to gradually improve over the medium term as recovery takes hold and domestic uncertainty dissipates.

*Source: IMF staff.*

### 22.      The CBSL adopted temporary measures to support the tourism sector and ease

### 22.      The CBSL adopted temporary measures to support the tourism sector and ease 

### CBSL emergency measures and near-term credit developments
- In May 2019 the CBSL launched a moratorium on performing loan payments, due through March 2020, by the tourism industry, which account for about 3½ percent of total credit to the private sector.
- Rescheduled payments are rolled into a new loan at a concessionary rate, with no change to the credit risk classification.
- To facilitate a faster reduction in lending rates and support credit to the private sector:
  - The CBSL introduced caps on deposit rates in April.
  - These were removed and replaced by caps on lending rates in September, which in turn are to be reviewed in March 2020.
  - The CBSL directed banks to reduce lending rates by at least 200 basis points in comparison with those prevailing as of end-April.
- IMF mission cautions:
  - Distortionary impact on the functioning of the financial system.
  - Potential unintended negative effects of interest rate caps on private credit and financial inclusion.
  - Welcomed authorities’ intention to phase out and/or review the measures by March 2020.

### Financial sector policy framework and supervisory reforms
- Authorities are preparing, with WB support, a new Banking Act, expected to be finalized by December 2019, to:
  - Strengthen bank regulation and supervision.
  - Upgrade the resolution framework for banks and NBFIs, including the deposit insurance framework.
- Remaining divergences between banks and deposit-taking NBFIs include:
  - Minimum capital requirement.
  - Various liquidity requirements.
  - Large exposure limits.
  - Risk management.
- Supervisory approaches:
  - Banks: more risk-oriented supervision.
  - NBFIs: compliance-based methods.
- Harmonization and regulatory actions:
  - CBSL continuing harmonization; a new Direction on provisioning for bad and doubtful debts being finalized.
  - A Direction on corporate governance expected to be issued by March 2020.
- Macroprudential framework enhancements:
  - Planned with support from an IMF resident advisor.
  - Focus: improve data collection and analysis, enhance stress testing capabilities and analysis of macroprudential policy instruments, and strengthen internal organization.

### Structural reforms for inclusive growth and governance
- Social safety nets and female employment:
  - New electronic social registry and new eligibility criteria for welfare benefits (prepared with WB support and submitted for ratification to Parliament last September) to better target and support expansion of social programs.
  - Progress on gender-responsive budgeting: appointing gender focal points in all government agencies and collecting key performance indicators.
  - National Policy on Day Care Centers prepared; training of early childcare development officers commenced with WB support.
- Trade and investment climate:
  - Significant number of para-tariffs remain despite recent reductions.
  - Cabinet approved a 5-year plan to rationalize remaining para-tariffs (approved in October, ahead of schedule end-March 2020 SB), with IMF TA.
  - Plan to compensate for revenue losses: replace suspended-VAT with an automated VAT refund system, broaden the excise tax base, auction government licenses, and remove duty exemptions for SOE projects.
  - Approved National Innovation and Entrepreneurship Strategy to support R&D by SMEs.
  - Continued implementation of the National Export Strategy, including simplification of border clearance procedures.
  - Trade Information Portal contains information from more than 40 different regulatory agencies.
- Governance and anti-corruption:
  - FATF removed Sri Lanka from the Improving Global AML/CFT Compliance list in October after an on-site visit in September verified implementation of the FATF action plan.
  - Authorities started implementing the National Action Plan for Combating Bribery and Corruption.
  - Work ongoing to consolidate laws related to bribery and corruption and to establish a Directorate of Assets Declaration within CIABOC to verify declarations through electronic systems; plans to widen definition of bribery, broaden scope of the Declaration of Assets and Liabilities Act and expand powers of CIABOC.
  - Strengthening anti-corruption courts led to convictions increasing from around 20 per year during 2009-16 to nearly 60 per year during 2017-18.
  - Ongoing efforts to support sound and transparent fiscal governance, especially in SOEs, are critical to prevent corruption.

### Program modalities, financing, and risks
- Program conditionality recalibrated:
  - Authorities requested a waiver of nonobservance of the end-June QPC on the primary balance, missed due to exceptional circumstances.
  - QPC and/or ITs for end-December and end-March recalibrated (MEFP, Table 1).
  - Structural benchmark: submission to Parliament of the 2020 budget proposed to be reset to end-April 2020 (MEFP, Table 2).
- Capacity to repay the Fund and financing:
  - Fund’s exposure relatively low, with outstanding Fund credit peaking at 6.7 percent of exports in 2020 (Table 9).
  - Program fully financed for the remainder of the program period, supported by corrective actions, existing cash buffers, pre-financing efforts for first half of 2020, and expectations of continued capital market access.
- Elevated risks noted post-attacks, which could require further adjustment or financing if realized, including:
  - (i) renewed market and FX pressures;
  - (ii) lower growth;
  - (iii) implementation delays in fiscal or SOE reforms.

### Staff appraisal, outlook, and policy recommendations
- Growth outlook:
  - Growth projected to strengthen to 3.5 percent in 2020 as tourist arrivals and related activities gradually recover.
- Fiscal stance:
  - Authorities target a primary surplus of at least 0.2 percent of GDP in 2019 to preserve program gains.
  - Revenue-based fiscal consolidation should advance in 2020 to place public debt on a downward path while preserving critical social and investment spending.
  - Priorities: mobilize revenues, broaden tax base, improve compliance, increase spending efficiency.
  - Plans to revamp fiscal rules and establish an independent public debt management agency to help anchor public debt sustainability.
  - Advancing energy sector reforms and addressing cost inefficiencies and subsidies in the electricity sector critical to reduce fiscal risks from SOEs.
- Monetary and reserve policy:
  - CBSL should maintain a data-dependent monetary policy and continue rebuilding reserve buffers supported by a flexible exchange rate.
  - CBSL should stand ready to adjust policy rates as warranted and allow exchange rate flexibility in the event of market pressures, limiting FX intervention to smoothing excess volatility.
- Legal and institutional reform:
  - Approval of the new Central Bank Act will strengthen CBSL’s mandate, governance, accountability, and transparency and establish infrastructure for flexible inflation targeting.
- Financial stability and regulatory forbearance:
  - Continue harmonizing supervision and regulation of financial institutions, enhance macroprudential policy framework and stress testing capabilities, and upgrade the contingency framework.
  - Recent temporary measures on regulatory forbearance and lending rates to support tourism and ease credit conditions should be promptly removed as conditions stabilize to avoid unintended distortions to the financial system.
- Structural reform priorities to bolster competitiveness and inclusive growth:
  - Remove remaining para-tariffs while addressing revenue impact.
  - Continue governance and anti-corruption agenda with focus on SOEs.
  - Promote women’s economic empowerment and enhance social protection.

*Source: 1lkaea2019003 - 22.      The CBSL adopted temporary measures to support the tourism sector and ease*

### 36.      Staff supports the completion of the sixth review,  considering the progress so far

### 36.      Staff supports the completion of the sixth review,  considering the progress so far

### Staff recommendation and program conditionality
- Staff supports the completion of the sixth review, considering the progress so far and the authorities’ continued commitment to strong policies and reforms.
- Staff supports the authorities’ request for a waiver of nonobservance of a performance criterion and modification of program conditionality.

### Real sector: recent dynamics and indicators (Figure 1)
- Real GDP growth (Table 1, selected years): 2016: 4.5; 2017: 3.4; 2018: 3.2; 2019 (CR/19/135): 3.6; 2020 (Proj.): 2.7; 2021 (CR/19/135): 4.0; 2022 (Proj.): 3.5; 2023 (Proj.): 4.3; 2024 (Proj.): 4.5; later projections: 4.6, 4.8.
- Inflation (average, Colombo CPI, Table 1): 2016: 4.0; 2017: 6.6; 2018: 4.3; 2019 (CR/19/135): 4.5; 2020 (Proj.): 4.4; 2021 (CR/19/135): 4.7; 2022 (Proj.): 4.8; 2023 (Proj.): 5.0; 2024 (Proj.): 5.0; subsequent entries: 5.0.
- Inflation (end-of-period, Colombo CPI, Table 1): 2016: 4.5; 2017: 7.1; 2018: 2.8; 2019 (CR/19/135): 4.5; 2020 (Proj.): 5.4; 2021 (CR/19/135): 4.8; 2022 (Proj.): 4.8; 2023 (Proj.): 5.0; 2024 (Proj.): 5.0; later: 5.0.
- Core inflation (end-of-period, Table 1): 2016: 5.8; 2017: 4.3; 2018: 3.1; 2019 (CR/19/135): 5.5; 2020 (Proj.): 5.5; 2021 (CR/19/135): 5.0; 2022 (Proj.): 5.0; 2023 (Proj.): 4.8; 2024 (Proj.): 4.7; later: 4.7.

### Fiscal sector: revenue, expenditure, balances (Figure 2; Tables 2a–2c)
- Total revenue and grants (percent of GDP, Table 2b): 2016: 14.1; 2017: 13.7; 2018: 13.4; 2019 (CR/19/135): 15.1; 2020 (Proj.): 12.8; 2021 (CR/19/135): 16.0; 2022 (Proj.): 13.9; 2023 (Proj.): 14.8; 2024 (Proj.): 15.4; subsequent: 15.5; 15.6.
- Total expenditure and net lending (percent of GDP, Table 2b): 2016: 19.5; 2017: 19.2; 2018: 18.6; 2019 (CR/19/135): 19.6; 2020 (Proj.): 18.6; 2021 (CR/19/135): 19.6; 2022 (Proj.): 19.1; 2023 (Proj.): 19.1; 2024 (Proj.): 19.2; later: 19.3.
- Central government balance (percent of GDP, Table 1): 2016: -5.3; 2017: -5.5; 2018: -5.3; 2019 (CR/19/135): -4.5; 2020 (Proj.): -5.7; 2021 (CR/19/135): -3.5; 2022 (Proj.): -5.3; 2023 (Proj.): -4.4; 2024 (Proj.): -3.8; later: -3.7; -3.7.
- Primary balance (percent of GDP, Table 1): 2016: -0.2; 2017: 0.0; 2018: 0.6; 2019 (CR/19/135): 1.5; 2020 (Proj.): 0.2; 2021 (CR/19/135): 2.4; 2022 (Proj.): 0.7; 2023 (Proj.): 1.5; 2024 (Proj.): 2.0; later: 2.0; 2.0.
- Central government debt (percent of GDP, Table 1 and 2b): 2016: 79.0; 2017: 77.4; 2018: 83.3; 2019 (CR/19/135): 82.2; 2020 (Proj.): 83.2; 2021 (CR/19/135): 79.9; 2022 (Proj.): 82.4; 2023 (Proj.): 80.7; 2024 (Proj.): 78.2; later: 75.8; 73.3.

### Central government operations (levels, Table 2a and Table 2c)
- Total revenue and grants (in billions of rupees, Table 2a): 2016: 1,694; 2017: 1,840; 2018: 1,932; 2019 (CR/19/135): 2,358; 2020 (Proj.): 1,989; 2021 (CR/19/135): 2,723; 2022 (Proj.): 2,337; 2023 (Proj.): 2,717; 2024 (Proj.): 3,108; later: 3,448; 3,808.
- Total expenditure and net lending (in billions of rupees, Table 2a): 2016: 2,334; 2017: 2,573; 2018: 2,693; 2019 (CR/19/135): 3,067; 2020 (Proj.): 2,875; 2021 (CR/19/135): 3,325; 2022 (Proj.): 3,233; 2023 (Proj.): 3,518; 2024 (Proj.): 3,867; later: 4,268; 4,712.
- Interest payments (in billions of rupees, Table 2a): 2016: 611; 2017: 736; 2018: 852; 2019 (CR/19/135): 937; 2020 (Proj.): 913; 2021 (CR/19/135): 1,009; 2022 (Proj.): 1,010; 2023 (Proj.): 1,086; 2024 (Proj.): 1,169; later: 1,269; 1,396.
- Overall balance (in billions of rupees, Table 2a): 2016: -640; 2017: -733; 2018: -761; 2019 (CR/19/135): -709; 2020 (Proj.): -886; 2021 (CR/19/135): -602; 2022 (Proj.): -896; 2023 (Proj.): -801; 2024 (Proj.): -758; later: -820; -904.

### Financial sector and monetary indicators (Figures 3–5; Tables 4a–4b; Table 7)
- Banking sector capital adequacy (Table 7, selected): Regulatory capital to risk weighted assets ranged from 15.0 (Q1 2016) to 16.5 (Q2 2019); Tier 1 capital/risk weighted assets ranged from 11.7 to 13.3 over the series.
- Gross NPL to total gross loans (Table 7): ranged from 2.5 to 4.8 across quarters, with Q2 2019 at 4.8.
- Return on equity (after tax, Table 7): ranged from 10.1 to 18.2 across quarters; Q2 2019 value: 10.1.
- Broad money (end-period percent change, Table 4a and 4b): 2016: 18.4; 2017: 16.7; 2018: 13.0; 2019 (end-period CR/19/135): 12.8; 2020 (Proj.): 7.0; other entries: 10.6 etc.
- Reserve money (percent change, Table 1 and Table 4a): 2016: 27.1; 2017: 9.8; 2018: 2.3; 2019 (CR/19/135): 11.3; 2020 (Proj.): -0.8; 2021 (CR/19/135): 11.5; 2022 (Proj.): 9.9; 2023 (Proj.): 11.0; 2024 (Proj.): 11.3; later entries: 11.5; 11.8.

### External sector, reserves, and balance of payments (Figures 4–5; Tables 5a–5b; Table 6)
- Current account balance (in millions of U.S. dollars, Table 5a): 2016: -1,743; 2017: -2,309; 2018: -2,814; 2019 (CR/19/135): -2,380; 2020 (Proj.): -2,282; 2021 (CR/19/135): -2,378; 2022 (Proj.): -2,595; 2023 (Proj.): -2,522; 2024 (Proj.): -2,466; later: -2,471; -2,614.
- Exports (millions of U.S. dollars, Table 5a): 2016: 10,310; 2017: 11,360; 2018: 11,890; 2019 (CR/19/135): 12,566; 2020 (Proj.): 12,306; 2021 (CR/19/135): 13,251; 2022 (Proj.): 12,798; 2023 (Proj.): 13,480; 2024 (Proj.): 14,219; later: 14,994; 15,816.
- Imports (millions of U.S. dollars, Table 5a): 2016: -19,183; 2017: -20,980; 2018: -22,233; 2019 (CR/19/135): -23,437; 2020 (Proj.): -20,694; 2021 (CR/19/135): -24,681; 2022 (Proj.): -22,764; 2023 (Proj.): -24,128; 2024 (Proj.): -25,482; later: -26,883; -28,356.
- Gross official reserves (end of period, Table 1 and Table 5a memos, in millions of U.S. dollars): 2016: 6,019; 2017: 7,959; 2018: 6,919; 2019 (CR/19/135): 8,650; 2020 (Proj.): 8,168; 2021 (CR/19/135): 9,580; 2022 (Proj.): 9,120; 2023 (Proj.): 9,707; 2024 (Proj.): 10,492; later: 11,222; 11,678.
- Gross external financing needs (Table 6, in millions of U.S. dollars): 2016: -3,999; 2017: -4,351; 2018: -5,416; 2019 (CR/19/135): -6,189; 2020 (Proj.): -5,738; 2021 (Proj.): -5,442; 2022 (Proj.): -5,500; 2023 (Proj.): -4,985; 2024 (Proj.): -5,432.
- External financing gap and financing composition (Table 6): External financing gap entries for 2016–2024: 518; 598; 377; 328; 288; 0; 0; 0; 0. Financing composition includes sovereign bonds (e.g., 2016: 1,500; 2017: 1,500; 2018: 2,500; 2019: 4,900; 2020: 2,000; 2021: 1,500; 2022: 2,000; 2023: 2,000; 2024: 2,000).

### Program financing and IMF arrangements (Table 8; Table 9)
- Three-Year Extended Arrangement availability and amounts (Table 8): June 3, 2016: 119.894 SDR millions (20.714 percent of Quota); November 18, 2016: 119.894 SDR millions (20.714); April 20, 2017: 119.894 SDR millions (20.714); November 20, 2017: 177.774 SDR millions (30.714); April 20, 2018: 177.774 SDR millions (30.714); April 3, 2019: 118.500 SDR millions (20.473); October 20, 2019: 118.500 SDR millions (20.473); April 3, 2020: 118.550 SDR millions (20.485). Total: 1,070.780 SDR millions (185.000 percent of Quota).
- Projected payments to the Fund (Table 9, Fund repurchases and charges in millions of SDR): 2019: 5.53; 2020: 2.86; 2021: 2.81; 2022: 26.21; 2023: 48.9; 2024: 85.8; 2025: 192.4; 2026: 179.2; 2027: 146.2; 2028: 79.5; 2029: 53.5; 2030: 13.3; later years: 3.3; 3.3; 3.3.
- Fund credit outstanding (Table 9, in millions of SDR): 2019: 952.2; 2020: 1,060.8; 2021: 1,020.8; 2022: 916.4; 2023: 787.4; 2024: 618.8; 2025: 440.3; 2026: 271.8; 2027: 133.3; 2028: 59.3; 2029: 9.9; 2030–2033: 0.00.

### Key projections and risks
- Growth and inflation trajectory (from Table 1): projected recovery with Real GDP growth rising from 2.7 (2020) to 4.8 (later projection) and headline inflation stabilizing near 5.0 percent in 2023–24 projections.
- Fiscal consolidation path reflected in rising primary balances in projections: primary balance (percent of GDP) moves from 0.2 (2020) to 2.4 (2021 CR/19/135) and stabilizes around 2.0 in later projections.
- External sector remains a source of vulnerability: current account deficits persist in the -2.1 to -3.2 percent of GDP range across 2016–24; gross external financing needs remain sizable (e.g., -6,189 million U.S. dollars in 2019 CR/19/135).

*Source: IMF staff report content (1lkaea2019003).*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### External position and 2018 developments
- Sri Lanka’s external position in 2018 was broadly in line with fundamentals and desirable policies, though lower-than-adequate reserve coverage continues to pose vulnerabilities to shocks.
- The current account deficit widened to 3.2 percent of GDP in 2018, from 2.6 percent in 2017, due to lower agricultural exports and higher oil prices.
- A temporary surge in vehicle imports (including about 0.5 percent of GDP identified as temporary in a footnote) contributed to widening the current account deficit.
- FDI inflows strengthened (large-scale capital projects such as the Hambantota Port and the Colombo Port City project), while portfolio flows declined amid global financial volatility and a political crisis.
- Gross international reserves (GIR) decreased from US$7.9 billion at end-2017 to US$6.9 billion at end-2018.
- Sri Lanka remains a net debtor: net external liabilities increased from 53 percent of GDP in 2012 to 57 percent of GDP in 2018.
  - FDI accounts for nearly 25 percent of external liabilities.
  - Other investment (debt portfolios or bank loans) accounts for about 60 percent of external liabilities.
  - About 85 percent of total liabilities are long-term.
  - The government accounts for about 2/3 of total external liabilities.

### Projections and medium-term outlook
- The current account deficit is projected to narrow to 2.6 percent of GDP in 2019, driven by lower imports and stronger export growth following the depreciation of the rupee in 2018.
- GIR is expected to strengthen to US$8.2 billion in 2019, reflecting sovereign bond issuance and FX purchases by the CBSL.
- The current account deficit is expected to gradually decline to around 2 percent of GDP by 2024, as fiscal consolidation advances.
- Capital inflows are expected to continue at around 3-4 percent of GDP per year over the next five years.

### External Balance Assessment (EBA), REER, and external sustainability
- Based on the EBA CA model:
  - Current account norm: -2.4 percent of GDP.
  - Cyclically-adjusted current account balance: -3.4 percent of GDP in 2018.
  - Outturn: -3.2 percent of GDP in 2018.
  - EBA-based current account gap for 2018: -0.9 percent of GDP.
  - Policy gaps (mainly a large fiscal deficit and above-trend credit growth) explained -0.3 percent of GDP; residual -0.6 percent of GDP.
  - The estimated current account gap points to a REER overvaluation of about 5 percent.
- EBA-lite REER model: REER overvaluation of about 7 percent.
- External Sustainability (ES) approach: REER undervaluation of about 9 percent.
- Staff places greater weight on the EBA CA and EBA-lite REER models and assesses the external position as broadly in line with medium-term fundamentals and desirable policies in 2018 and preliminarily in 2019 (with projected CA deficit of 2.6 percent of GDP in 2019 and assuming a broadly unchanged CA norm).

### Reserve adequacy and exchange rate policy
- GIR declined from 69 percent of the Fund’s Assessing Reserve Adequacy (ARA) metric at end-2017 to 56 percent at end-2018, below the recommended adequacy range of 100-150 percent.
- GIR are expected to increase back to about 65 percent of the ARA metric at end-2019, equivalent to about 3.6 months of imports, and continue improving over the medium term.
- The CBSL is transitioning to flexible inflation targeting, planned to be fully adopted by 2020, with a more flexible exchange rate regime.
- The CBSL implemented a Request for Quotes (RFQ) system for direct dealing since July 2018 to support a more market-based and transparent implementation of FX transactions and develop a deeper and more liquid foreign exchange market.

### Capital flow management
- Removal of capital flow management measures (CFMs) should be properly sequenced with macroeconomic adjustment and supporting reforms.
- Authorities plan to remove the repatriation requirement of export proceeds introduced in 2016 as progress is made under the EFF program; Cabinet agreed in October to extend the repatriation period from 120 to 180 days.
- Following sizable capital outflows from the local currency bond market in 2018, in January 2019 the CBSL lowered the threshold for foreign investments in rupee-denominated government bonds from 10 to 5 percent of the total outstanding stock, tightening a long-standing CFM on inflows.
  - Staff advised, in the absence of a capital inflow surge, to loosen back the measure and to take advantage of portfolio inflows to build reserves and deepen the domestic bond market.
  - As of September 2019, foreign investors hold about 2 percent of the total outstanding stock of rupee-denominated government bonds.

### Debt sustainability overview (Annex II material included)
- Public debt:
  - Public debt increased to about 90 percent of GDP at end-2018.
  - Composition at end-2018:
    - Central government debt: 83.3 percent of GDP.
    - Outstanding loans guaranteed by the central government: 5.2 percent of GDP.
    - Outstanding Fund credit: 1.6 percent of GDP.
  - Domestic debt accounted for about 42 percent of GDP.
  - External debt composition: multilateral and bilateral loans 20.6 percent of GDP; international sovereign bonds and syndicated loans 15.4 percent of GDP; nonresidents’ holdings of treasury bills and bonds 1.1 percent of GDP.
  - Foreign-currency denominated debt: about 50 percent of total.
  - Debt owed to official and multilateral creditors: about a quarter of the total.
  - Sri Lanka’s debt-to-GDP ratio remains higher than the median for emerging economies (53 percent; excluding major oil exporters).
- Nonfinancial SOEs:
  - Financial obligations of non-financial SOEs estimated at 14.6 percent of GDP as of end-2018.
  - Three major SOEs (Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Airlines) recorded a combined loss of 1.3 percent of GDP in 2018.
  - About 40 percent of SOE financial obligations are guaranteed by the central government.
- External debt and exposures:
  - External debt estimated at 59 percent of GDP at end-2018.
    - Public sector external debt: 36 percent of GDP by the general government and 2 percent by the central bank.
    - Private external debt: around 21 percent of GDP.
  - Ratio of external debt to exports of goods and services: 258 percent in 2018.
  - 85 percent of private and public debt is medium or long term.
  - More than half of central government’s external debt stock is denominated in U.S. dollars.
  - Major creditors (shares of external central government debt): Asian Development Bank 12.7 percent; China 9.1 percent; Japan 10.0 percent; World Bank 9.5 percent; India 2.6 percent; Other 52.3 percent.
  - Chinese loans to the Sri Lankan public sector, including SOEs: 15 percent of central government external debt, or 7 percent of total public debt at end-2018.
- Baseline DSA assumptions and projections:
  - Real GDP growth projected to rise to 4.8 percent by 2024.
  - Inflation estimated to reach 5 percent over the medium term.
  - Fiscal deficits programmed to decrease from 5.3 percent of GDP in 2018 to 3.7 percent of GDP by 2023.
  - The primary balance is projected to fall to 0.2 percent of GDP in 2019, before increasing to 0.7 percent of GDP in 2020.
  - Interest rates for newly issued debt assumed to decrease gradually over the medium term, with debt composition shifting towards more costly domestic instruments.
  - Publicly guaranteed debt projected at 5.2 percent of GDP at end-2019 and kept constant as a percent of GDP through 2024.
  - External debt projections incorporate a reduction in the current account deficit from 3.2 percent of GDP in 2018 to around 2 percent of GDP over the medium term and planned Fund purchases and creditor disbursements.
- Public debt trajectory and risks:
  - Under the program scenario, public debt projected to decline from 90 percent of GDP in 2018 to 79.2 percent in 2024.
  - Gross financing needs projected to decrease to around 15 percent of GDP by 2024.
  - Downside risks: slower-than-expected fiscal consolidation, contingent liabilities, currency shocks; stress tests indicate high risks to public debt sustainability.
  - If fiscal consolidation stalls and primary balance returns to its historical level (-1.1 percent of GDP), debt-to-GDP would decline to about 87 percent in 2024 under that scenario.
  - Individual shocks:
    - Primary balance shock: lower primary surplus by 0.5 percentage points of GDP for 2019–20.
    - GDP growth shock: around 2 percentage points lower than in the program scenario for 2019–20.
    - Exchange rate shock: 15 percent real depreciation in 2019 vis-à-vis the program scenario.
    - Interest rate shock: increase by 300 basis points for new borrowings during 2018–21 vis-à-vis the program scenario.
  - Combined shocks: debt-to-GDP would reach 101 percent in 2024.
  - SOE contingent liability shock (central government liable for additional debt of 8 percent of GDP in 2019): debt-to-GDP would jump to 101 percent initially and decline to 94 percent of GDP in 2024.
  - In combined and contingent liability shock scenarios, gross financing needs would range between 18 to 24 percent of GDP by 2024.
  - The envisaged improvement in the cyclically-adjusted primary balance of around 2 percentage points of GDP over 2019−24 is higher than in 69 percent of international experiences, highlighting the challenges of the fiscal consolidation plan.
- External debt projections:
  - Under the program scenario, external debt projected to decrease from about 59 percent of GDP in 2018 to around 54 percent in 2024, driven by GDP growth, fiscal consolidation, and current account adjustments.

*Source: Annex I. External Sector Assessment (content unit: 1lkaea2019003).*

### 9.      Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate

### 1lkaea2019003 - 9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate

### Vulnerabilities and near-term risks
- Currency risk, notably related to the U.S. dollar, is high.
- A large rupee depreciation could pose a significant risk: stress tests show that a 30 percent real depreciation could raise the external debt-to -GDP ratio to about 80 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, lumpy repayments and external financing at non-concessional terms gradually substituting for concessional financing point to the need to speedily build buffers.
- Lower-than-expected GDP or export growth would deteriorate debt dynamics.

### Key DSA and market indicators (selected)
- EMBIG (average over the last 3 months, 01-Apr-19 through 30-Jun-19): 338 bp.
- Public DSA heat-map and stress-test framework used: benchmarks include 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.
- Stress-test result highlighted: a 30 percent real depreciation shock (one-time in 2017 scenario) features among extreme adverse scenarios that substantially raise external debt ratios and gross financing needs.

### Baseline debt dynamics (selected projections and metrics)
- Stress-test finding summarized: 30 percent real depreciation could raise external debt-to-GDP to about 80 percent by 2024.
- Public sector debt baseline and projection data appear in the Public Sector DSA tables and figures (see staff projections across 2019–2024 in the DSA figures).
- Gross external financing need (in billions of US dollars), historical and projections: 11.7, 11.5, 12.4, 12.8, 13.8, 12.1, 13.2, 12.7, 12.7, 13.3, 13.3 (presented in the External Debt Sustainability Framework table).
- External debt (in percent of GDP) baseline historical and projections include values such as: 54.3, 55.7, 56.3, 57.5, 58.8, 63.8, 62.3, 59.7, 58.1, 56.2, 54.4 (as reported in the External Debt Sustainability Framework table).

### Stress tests and scenarios (framework and outcomes)
- Macro-fiscal and external stress tests applied include: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Macro-Fiscal Shock; Contingent Liability Shock (SOE contingent liability shock); Historical and Constant Primary Balance scenarios.
- Outcomes illustrated (figures): adverse shocks can push gross nominal public debt well above baseline trajectories and raise public gross financing needs as percent of GDP and percent of revenue substantially in stress scenarios.
- External bound tests apply permanent one-half standard deviation shocks (individual) and combined shocks; a 30 percent one-time real depreciation scenario is highlighted.

### Proposed fiscal framework (Annex III) — objectives and main components
- Objective: underpin public debt reduction over the medium to long term.
- Background: existing Fiscal Management (Responsibility) Act (FMRA) has been in place since 2003 and is described as poorly calibrated with frequent non-compliance.
- Development: new framework developed with IMF technical assistance; Cabinet approved a note outlining key elements in July and the necessary legislation in October (as described).
- Three main components:
  - Fiscal Rules:
    - A debt rule: central government debt should be reduced to the long-run objective of 50 percent of GDP by 2035.
    - A ceiling on guarantees to contain contingent liabilities.
    - A procedural rule: authorities must present a Medium-Term Fiscal Framework (MTFF) before each budget, with medium term macroeconomic and fiscal forecasts implying a steady pace of debt reduction on average over the medium term toward the 2035 objective.
    - There must also be a minimum amount of debt reduction in each year over the medium term.
    - The overall fiscal balance in the MTFF becomes a binding operational target for the next year; both the budget passed by Parliament and the final outturn should be consistent with the target.
  - Correction Mechanism and Escape Clause:
    - The MTFF must be updated each year; fiscal slippages or shocks affecting debt (e.g., exchange rate depreciation) must be reflected with the projected pace of debt reduction updated to remain on track to the long-run objective.
    - An escape clause allows temporary deviation from the fiscal rules in precisely defined circumstances, including a major economic slowdown, natural disasters, or crystallization of contingent liabilities.
  - Reporting and Oversight:
    - The MTFF should be presented each year before the budget in a new Fiscal Responsibility Report (FRR), a high-level document to communicate the government’s fiscal strategy.
    - The Minister of Finance will be responsible for compliance with the fiscal rules framework.
    - Parliament’s Committee on Public Finance will have an increased role to review FRRs and examine performance against the fiscal rules.

*Source: IMF staff (material from 1lkaea2019003).*

### Annex IV. The New Central Bank Act

### Annex IV. The New Central Bank Act

### Purpose and context
- Reform replaces the existing Monetary Law Act (MLA) from 1949 and adopts best international central banking practices to set legal and institutional underpinnings for implementation of Flexible Inflation Targeting (FIT), planned for 2020, as Sri Lanka’s new monetary policy framework.
- Reform is supported by IMF TA.

### Primary objectives and mandate
- Sets price stability as the CBSL’s primary objective, with financial stability as a core objective.
- Recognizes the CBSL as the macroprudential authority of the country.

### Inflation target
- The target is to be set by the CBSL and the Ministry of Finance and reviewed every three years, except for exceptional circumstances.

### Governance structure
- Establishes three new governing bodies: a Governing Board, a Monetary Policy Board, and an Executive Board.
- Governing Board:
  - To be chaired by the Governor.
  - Composed by the Secretary to the Treasury and three non-executive members.
  - Will be the main governing body of the CBSL.
- Monetary Policy Board:
  - Will be the monetary policy decision-making authority.
  - To be chaired by the Governor.
  - Composed by three Deputy Governors of the CBSL and four external experts, all with voting rights.
- Executive Board:
  - To be chaired by the Governor.
  - Composed by the Senior Deputy Governor and other Deputy Governors of the CBSL.
  - Responsible for managing the operations of the CBSL and implementing decisions of the Governing Board and the Monetary Policy Board.

### Exchange rate regime
- Adopts a flexible exchange rate regime, to be managed by the CBSL.

### Accountability and disclosure requirements
- Mandates disclosure requirements including:
  - An inflation report every six months.
  - A financial stability report once a year.
  - A report on the state of the economy once a year.
  - A statement of the financial situation and operations of the CBSL.
- If the CBSL fails to meet the inflation target within a certain margin, a report is also due to Parliament.

### Government financing and transitional arrangements
- Prohibits CBSL financing of the fiscal deficit.
- The provisional advances by the CBSL, under the current MLA, to provide credit to the government will be phased out through a transitional arrangement.

### Macroprudential framework and coordination
- Macroprudential policy will be coordinated through the establishment of a Financial System Oversight Committee composed of:
  - The Governor.
  - The two Deputy Governors in charge of macroprudential policy and of regulation and supervision.
  - A Deputy Secretary to the Treasury.
  - The Chief Executive Officer of the Insurance Regulatory Commission.
  - The Chief Executive Officer of the Securities and Exchange Commission.
  - Another person appointed by the Governing Board of the CBSL.
- Introduces a new Council for the Coordination of Fiscal, Monetary, and Financial Stability Policies, with members of the CBSL and the Ministry of Finance, with no decision-making authority, to promote exchange of information and views on recent macroeconomic developments, outlook, and risks.

*Source: Annex IV. The New Central Bank Act*

### 1.      The Easter attacks were a significant shock to the Sri Lankan economy. After

### 1. The Easter attacks were a significant shock to the Sri Lankan economy. After

### Economic impact and near-term developments
- Real GDP growth:
  - Rebounded to 3.7 percent (y-o-y) in 2019Q1, from 1.8 percent in 2018Q4.
  - Slowed to 1.6 percent in 2019Q2 driven by a sharp decline in tourism and related services after the April 21 attacks.
- Inflation:
  - Increased to 5 percent (y-o-y) in September 2019, from 3.4 percent in August 2019, driven by higher food prices and the base effect; within the inflation target band.
- External sector and reserves:
  - Current account balance turned into a deficit of US$581 million in 2019Q2, from a surplus of US$448 million in 2019Q1, reflecting the sharp fall in tourism despite an improved goods trade balance.
  - After recovering from 2018 shocks, the rupee recorded a net appreciation of 0.5 percent for the year as of end-September 2019, though temporarily affected by the Easter attacks and renewed capital outflows in August.
- Fiscal revenue and activity:
  - Lower imports and reduced economic activity lowered tax revenues, affecting fiscal performance.

### Outlook and growth projections
- 2019 projection:
  - Real GDP growth projected at 2.7 percent in 2019 (revised down from 3.6 percent at the time of the fifth review).
  - Inflation projected to be 5.4 percent at end-2019 due to weather-related increases in food prices.
- 2020 and medium term:
  - Real GDP growth projected to strengthen to 3.5 percent in 2020 as tourism recovers.
  - Growth expected to gradually return to medium-term trends envisaged at the time of the fifth review, with inflation in mid-single digits.
- Financing:
  - Issued US$4.4 billion in the international bond market in 2019, covering remaining external financing needs for 2019 and beginning to pre-finance 2020.

### Program performance (macroeconomic targets and institutional response)
- Reserve and monetary targets:
  - End-June net international reserves (NIR) target was met; preliminary data indicate the end-September indicative target on NIR was also met.
  - Reserve money target was met, being below the indicative target by Rs 150 billion as of end-June 2019 and Rs 137 billion at end-September 2019.
- Fiscal targets and shortfalls:
  - End-June 2019 Quantitative Performance Criterion (QPC) on the primary balance was missed by Rs 145 billion.
  - End-June indicative target (IT) on tax revenue missed by Rs 25 billion.
  - End-September IT on the primary balance and tax revenues missed by Rs 197 billion and Rs 171 billion, respectively.
  - End-June and end-September ITs on the cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers) were also missed, though by a smaller margin than in December 2018.
- Policy response and institutional reforms:
  - Prompt resumption of FX purchases by CBSL after attacks helped stabilize market conditions.
  - Interim expenditure plan (Vote on Account) submitted to Parliament in October to authorize first four months of 2020 spending, aligned with updated program targets; full 2020 budget to follow after elections.
  - Progress on structural measures: reform of Central Bank law, fiscal responsibility framework, plan to create a debt management agency, and restructuring of SriLankan Airlines (with some delays).

### Fiscal policy: stance, targets, and consolidation strategy
- Fiscal outcomes and targets:
  - Overall fiscal deficit reduced to 5.5 percent of GDP in 2017 and to 5.3 percent of GDP in 2018.
  - Primary balance improved to a surplus of 0.6 percent of GDP in 2018 from a balance in 2017.
  - 2019 budget commitment: reach a primary surplus of 1.5 percent of GDP — no longer achievable due to 2018 political crisis and Easter attacks.
  - Revised 2019 target: primary surplus of at least 0.2 percent of GDP; proposed reset to Rs. 27 billion (0.2 percent of GDP).
  - 2020 revised primary surplus target: 0.7 percent of GDP, to be achieved through new revenue measures totaling 0.6 percent of GDP.
  - Medium-term target: increase primary balance to 2 percent of GDP by 2022.
  - Longer-term objective: reduce central government debt to 50 percent of GDP by 2035.
- Causes of fiscal slippage:
  - Missed end-June QPC on primary balance by 0.9 percent of GDP due to frontloading of expenditure (clearance of arrears and externally financed capital spending carried over from 2018) and revenue underperformance after the Easter attacks.
  - Indirect tax revenues estimated to underperform by over 2 percent of GDP over the full year due to weaker growth and lower imports.
- Corrective measures:
  - Corrective actions of around 1 percent of GDP: reprioritizing current and capital spending; fully implementing delayed revenue measures from the 2019 budget; approving additional revenue measures.
  - Contingency budgeting: Rs. 10 billion (0.1 percent of GDP) to a Disaster Management Contingency for weather-related disasters.
  - Vote on Account limits capital expenditure to ongoing projects delayed in 2019; any new expenditure items to be accommodated within the total 2020 expenditure envelope.
  - Continued quarterly fiscal reporting to Parliament; published 2020 budget speech to contain a tax expenditure statement, plan to rationalize tax expenditures and estimated fiscal cost of NCOs for SOEs.
- Fiscal rules and frameworks:
  - Cabinet approval in July of a policy note outlining key elements of amendments to the Fiscal Management (Responsibility) Act of 2003 (end-May 2019 structural benchmark).
  - New Fiscal Management (Responsibility) Act prepared with IMF TA and approved by cabinet in October 2019 (end-September 2019 structural benchmark).
  - Upgrade Medium-Term Fiscal Framework (MTFF) starting with the 2021 budget cycle to provide binding top-down guidance; IMF technical assistance to support this effort.

### Debt management, contingent liabilities, and transparency
- Debt strategy and institutional steps:
  - Cabinet approved a strategy to manage international sovereign bond maturities between 2019 and 2022 in January 2018 (end-June 2018 structural benchmark).
  - Active Liability Management Act approved by Parliament in March 2018 to enable proactive liability management and extend maturities.
  - Medium-Term Debt Strategy (MTDS) for 2019–23 approved in early April 2019 (delayed from end-October 2018 structural benchmark); MTDS published in April on MOF and CBSL websites.
  - Plan to prepare a preliminary Annual Borrowing Plan (ABP) for January–April 2020 by end-December 2019; full-year ABP to be produced by end-May 2020 at the latest.
  - Quarterly reviews of debt management outturns against the ABP to be prepared starting in 2020Q1 and published from 2020Q1 onwards.
  - Cabinet approved in October 2019 a plan and timetable for establishment of a public debt management agency (PDMA) (end-September 2019 structural benchmark). PDMA features:
    - Reports to and accountable to the Ministry of Finance with significant operational autonomy.
    - Assumes overall policy responsibility for debt management, formulates medium-term debt strategies and annual borrowing plans, directs implementation and auction decisions.
    - Oversees domestic and international market-based financing and participates in evaluation of debt, derivatives, and guarantees.
  - Sovereign Debt Management Committee to be chaired by head of PDMA; CBSL to continue as fiscal agent and provide operational support.
- Contingent liabilities and guarantees:
  - Indicative target for end-December 2019 on government guarantees set at Rs 838 billion to limit outstanding guarantees to 5.4 percent of GDP.
  - Outstanding guarantees rose from 4.2 percent of GDP as of end-December 2017 to 5.2 percent of GDP at end-December 2018, due to new guarantees for water and transportation development projects, breaching the IT ceiling of Rs 718 billion.
- Fiscal transparency and statistics:
  - Quarterly reporting of fiscal performance to Parliament began in 2017Q1.
  - Tax expenditure statements included in 2017, 2018, and 2019 budgets; non-commercial obligations of CPC and CEB included in 2018.
  - Terms of Reference for the GFS Coordination Committee, MOU between CC members, and GFS Migration Plan to be signed and approved by end-December 2019.
  - With IMF TA, on track to compile by December 2020 GFSM-compatible tables on cash operations and debt stock of budgetary and extra-budgetary central government.
  - Cabinet approval in October 2018 of a strategy with timetable to transition to accrual-based accounting for general government with IMF TA support.
  - Dedicated MOF unit established for transition to 2014 GFSM; number of permanent staff to be increased to four by January 2020; annual reports to cabinet on transition progress.

### Revenue mobilization and tax policy measures
- Broad approach:
  - Strategy focuses on broadening the tax base; rationalizing the tax system and removing exemptions, holidays, and special rates; strengthening risk-based revenue administration; bolstering public financial management (commitment control, financial planning, and discipline).
  - Quarterly budget execution reports submitted to Parliament since 2017Q1.
- Key policy measures implemented:
  - May 2016: Cabinet suspended the Board of Investment Act, concentrating power to grant tax exemptions and preferential treatment in the Ministry of Finance.
  - November 2016 VAT amendment: raised VAT rate from 11 percent to 15 percent and broadened VAT base by eliminating exemptions for telecommunication and private healthcare (excluding diagnostic tests, dialysis and OPD services); VAT continues to apply to wholesale and retail trade.
  - Diagnostic review of VAT system (end-June 2017 structural benchmark) completed with delay in November; concluded VAT expenditure is 1.3 percent of GDP.
  - August 2018 VAT amendment broadened the VAT base by eliminating exemptions including for textiles, electronic goods and mobile phones, and condominiums; pending removal of corresponding para-tariffs, a temporary exemption by regulation was reinstated for imported fabric; lower rate for imported timber introduced in November 2018 on a temporary basis.
  - Inland Revenue Act (IRA) effective April 1, 2018: creates a predictable income tax system, removes tax exemptions to broaden base, introduces capital gains tax on immovable property, increases taxes on dividends and interest income, and provides a transparent set of investment-based tax incentives.
- 2019 budget planned IRA amendments (calibrated not to exceed 0.1 percent of GDP):
  - Exempt from withholding tax the earnings from both local and foreign currency government securities.
  - Exempt from withholding tax interest paid on ordinary loans and advances from non-resident financial institutions for a period of five years.
  - Exempt from withholding tax payments of royalty for earnings below Rs 50,000 per month, subject to a maximum of Rs 500,000 per year, applying only to certain individuals (artists and writers).
  - Withholding tax rate on rents of 10 percent to apply only to rents above a threshold of 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 a period of 5 years, irrespective of number of employees, on terms in the Sixth Schedule.
  - Expand income tax concessions under the Second and Sixth schedules by way of accelerated depreciation for existing businesses for 5 years, excluding land and limited to depreciable assets; accelerated depreciation applies instead of regular depreciation under the Fourth Schedule.
  - No other amendments to the IRA are planned under the 2019 and 2020 budget.

_Italic: Source — 1lkaea2019003 - 1. The Easter attacks were a significant shock to the Sri Lankan economy. After_

### 12.      We are stepping up our efforts to strengthen tax administration to support revenue

### 12.      We are stepping up our efforts to strengthen tax administration to support revenue mobilization.

### Income tax
- New IRA launched on April 1, 2018.
- Outreach strategy to ensure the IRA is well understood by taxpayers, including available investment incentives.
- All new forms and associated instructions manuals needed to support implementation have been completed, including those related to Pay-As-You-Earn (PAYE) and withholding taxes; made available electronically in October 2018.
- Call centers are operational to assist taxpayers.
- Cabinet approved a contract to upgrade the revenue administration IT system (RAMIS) in February 2019 to make it compatible with electronic filing of returns under the IRA.
- Financial negotiations on the contract were completed in September 2019.
- To enforce taxpayer compliance and boost income tax collections, IRD will develop a plan to implement audit of employers’ obligation to withhold income taxes for employees (including identification of employers currently not in the PAYE database, using third-party data) and service fees paid to professionals such as doctors, accountants, and lawyers, by December 2019.

### VAT
- IRD cleared a backlog of 79,000 unprocessed VAT returns and will settle all associated payments in October 2019.
- Electronic filing of VAT returns will help prevent similar backlogs and improve on-time filing rates.
- IRD adopted a VAT compliance strategy with risk-based audits; implemented in the construction, banking, housing, and hotel industries.
- Strategy was temporarily suspended in the hotel industry following the Easter Attacks; it will be reinstated by March 2020.
- Risk-based audit will be extended to large taxpayers in all other remaining sectors by December 2019.
- IRD established a strategy division for risk-based audit in February 2019 to analyze data and identify priority compliance risks.
- A dedicated unit to carry out risk-based audits will be established in November 2019.

### Customs
- Customs Department strengthening administration by improving controls, intelligence, and capacity for risk assessment.
- ASYCUDA IT system being used more effectively.
- Reforms to shift from physical controls to risk-based system audits, supported by automation of risk management and improvements in organization structure and HR management.
- Risk-based criteria used to select cargo for audit; work underway to automate this process within ASYCUDA.
- Undervaluation of imported goods identified as a major source of revenue loss; plan to strengthen customs valuation through data verification from major trading partners and enhanced use of valuation databases.
- Risk management directorate established; staff dedicated to risk management activities increased to more than 20 officers.
- Government effort to develop a single window for trade services to enhance tax collections at customs through information sharing among government agencies.
- Next medium-term strategic plan will focus on further strengthening risk-based audit and valuation, with support from IMF TA.

### IT and organizational reform (IRD and Customs)
- By January 2020, Cabinet will approve a note summarizing key reforms and establish a reform steering committee answerable to the Secretary to the Treasury (ST) to oversee progress.
- Reforms under consideration by end-December 2020 include:
  - (i) IRD will make electronic filing by corporations compulsory;
  - (ii) IRD will re-establish a large taxpayer unit, focusing on the largest 500-700 taxpayers comprising 60-70 percent of total revenue collected by IRD;
  - (iii) Ministry of Finance will modify HR practices at IRD and Customs to allow recruitment of qualified experts, incorporate bonuses into the regular pay scales and review the pay rates for each position.
- Ministry of Finance will ensure traders will be given a minimum notice period in advance of changes to customs duty rates or waivers.
- By end-December 2019, MOF will clarify in writing that Customs shall inspect all high-risk cargo, irrespective of whether a trader benefits from Customs Duty deferments granted by the Board of Investment.

### Expenditure reforms and fiscal stance
- Aim to keep overall spending envelope under control, avoid accumulation of arrears, and reallocate spending to social protection, health, education, and infrastructure.
- Plans to cope with increased frequency of weather-related natural disasters through mitigation and adaptation measures, including contingent budgeting and enhanced insurance schemes.
- Intention to foster female labor force participation through gender budgeting (see paragraph 36).

### Social safety nets
- Welfare Benefits Board (WBB) established under the MOF to rationalize and broaden coverage of social assistance schemes through a consolidated national database.
- Under the Social Safety Nets Project, WBB developing a new Social Registry, an electronic database of applicants for welfare programs, to be used to select beneficiaries.
- WBB responsible for assessing 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 from end-August 2018 structural benchmark); criteria submitted to Parliament in September 2019.
- Regulations for clear and transparent selection of beneficiaries by the WBB will be approved by cabinet and gazetted by December 2019.
- Social Registry software received from the developer; plan to eliminate remaining deficiencies with support from a local university.
- New Social Registry expected to be available for use by January 2020.
- As soon as the new registry is operational, the neediest applicants will be selected by the WBB based on the newly approved selection criteria.
- Expansion of social safety nets according to the new eligibility criteria will help mitigate distributional impact of ongoing reforms on poor and vulnerable families.

### Public Financial Management (PFM) reforms
- September 2018: new guidelines issued for public development-project proposals, including guidance on project appraisal, sectoral project pipelines, and 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.
- MOF modified existing PFM IT system (CIGAS) to impose quarterly spending ceilings for all ministries (end-January 2018 structural benchmark).
- New Integrated Treasury Management Information System (ITMIS) expected to expand PFM capabilities; adoption process prolonged due to delays in requirements finalization and customizing ITMIS software.
- ITMIS roll-out to be staggered; full roll-out expected by December 2020.
- During first year of ITMIS implementation, CIGAS will remain operational in parallel for final account cross-checking.
- First phase of ITMIS began in January 2019 with the Ministry of Finance and was completed in April 2019.
- In November 2019, roll out will begin to be extended to other agencies, beginning with 20 priority agencies.
- Staff at each agency are being trained on how to use ITMIS.
- October 2018: Cabinet approved a note outlining a new Public Financial Management (PFM) Act with World Bank support; legislative drafting being finalized and draft law to be submitted to Parliament by end-2019.
- Steps to strengthen institutional framework to manage PPPs: National Agency for PPPs created in 2017; legal framework and guidelines for PPPs upgraded in March 2019 to ensure integration of PPP projects in the Public Investment Programme.
- Unit established and staffed in April 2019 under the Ministry of Finance to coordinate and assess fiscal risks associated with PPPs.
- Plans to share large-scale project plans with IMF and discuss implications under the program, including proposals for special tax and financial regimes.

### State enterprises (SOEs)
- Sri Lanka has about 200 public enterprises.
- With IMF TA, outstanding financial obligations of SOEs totaling Rs 1.4 trillion by end-2016 were identified, including Rs 1.1 trillion for CPC, CEB, SriLankan Airlines, and the Sri Lanka Ports Authority.
- Statements of Corporate Intent (SCIs) were signed and published in March 2017 for five largest SOEs: CPC, CEB, National Water Supply and Drainage Board (NWSDB), Airport and Aviation Services Limited (AASL), and Sri Lanka Ports Authority (SLPA).
- First compliance report on performance against KPIs submitted to cabinet in May 2018, covering 2017H1.
- Report covering 2017H2 submitted in early April 2019; third report on 2018H1 submitted in July 2019.
- Fourth report on 2018H2 to be submitted in November 2019; fifth report on 2019H1 by end-December 2019.
- Coverage of SCIs expanded to an additional 8 SOEs in June 2019; selecting an additional 10 SOEs to have SCIs.
- Among the 13 SOEs currently with SCIs, the 2016 audited financial statements were published only for six SOEs and only one has had a financial statement for 2017 published.
- Will ensure, in close coordination with the Auditor General’s office, the audit and publication of the remaining 2016 and 2017 statements by March 2020.
- Starting in 2020, aim to ensure that audited statements are readily available by September of the following year.

### SriLankan Airlines restructuring
- Comprehensive restructuring selected as least risky and most cost-effective option.
- New Board and CEO appointed in May 2018 and approved a restructuring plan; cabinet approval delayed and Board replaced during political crisis.
- Early January 2019: committee formed to prepare a new report to the President on restructuring options.
- Cabinet paper with key recommendations to advance restructuring approved by cabinet in May 2019; recommendations included entering into a joint venture with a strategic partner not in competition with SriLankan Airlines and strengthening corporate governance and accountability.
- Based on cabinet decision, Board prepared in August an updated strategic plan and operating business model with measures to reduce operational and financial costs and minimize future losses (end-September 2019 structural benchmark); key actions endorsed by cabinet in early October.
- Board will oversee timely implementation of these measures.
- Ministry of Finance outlined options to recapitalize SriLankan Airlines, bringing in a strategic partner while maintaining Sri Lankan majority, and restructuring some financial liabilities through a special purpose vehicle.
- Cabinet authorized the Ministry of Finance to call for requests for qualification from strategic investors.

### Energy pricing reforms
- Plan to complete energy pricing reforms in 2020.
- 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 NCOs for electricity correctly, CEB and the Public Utilities Commission (PUC) established a Bulk Supply Transactions Account (BSTA) in May 2018 (end-March 2018 structural benchmark) and are using it to settle transactions between generators, the transmission operator, and distributors as specified in the November 2015 tariff methodology.
- Updating of the BSTA requires regular reporting by CEB to PUC of its cash flow; reporting arrangements broke down in 2018, delaying BSTA updating.
- BSTA updated to end-June 2019 in early October; plan to update the BSTA for end-December 2019 by April 2020.
- Quasi-fiscal cost of fuel and electricity NCOs recognized as central government expenditure and explicitly accounted for in the EFF program targets (quarterly indicative target set on cost of NCOs for fuel and electricity (net of government transfers) for 2018Q1-Q4, 2019Q1-Q4 and 2020Q1).
- The end-June indicative target on NCOs for fuel and electricity (net of government transfers) was missed by 0.35 percent of GDP; the end-September target was missed by 0.6 percent of GDP.
- 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.
- Since approval, cost-reflective prices computed and price changes implemented when warranted; pricing formula reinstated after disruption and fuel prices brought back to cost-reflective levels by June 2019.
- Plans to carry out a detailed market study on fuel product cost and margins and reference prices, led by independent third parties.
- Electricity pricing reform significantly delayed by political crisis and Easter attacks.
- New technical committee to assess energy efficiency and affordability; committee to present proposals to phase in an automatic electricity pricing mechanism while calibrating cross-subsidization to minimize distributional impact.
- National survey by PUC on energy efficiency and affordability for households and industry expected to be completed by March 2020.
- CEB will conduct a special external audit of heat rates and dispatch methodology by end-April 2020, in line with PUC recommendations.
- Technical committee will present its report to cabinet by end-March 2020.
- Cabinet approval of an implementation plan to introduce the electricity pricing mechanism based on the 2015 tariff methodology and committee recommendations is expected with a delay by end-April 2020 (end-October 2019 structural benchmark).
- Financial performance of CPC and CEB will continue to be reported on a quarterly basis (see the Technical Memorandum of Understanding).

*Source: 1lkaea2019003 - 12.      We are stepping up our efforts to strengthen tax administration to support revenue (PDF).*

### 20.      The focus of monetary policy will remain on keeping inflation in the mid-single

### 20.      The focus of monetary policy will remain on keeping inflation in the mid-single

### Monetary policy stance and operational framework
- The CBSL reduced the interest rates on its deposit and lending facilities by 100 basis points since May 2019, to 7 and 8 percent respectively, amid weak domestic demand conditions and subdued inflation.
- Going forward the authorities will maintain a prudent data-dependent approach and stand ready to adjust the policy interest rates as warranted by evolving macroeconomic conditions.
- Monetary policy will continue to be monitored through the Monetary Policy Consultation Clause (MPCC) (see the Technical Memorandum of Understanding), supported by monitoring of reserve money developments.

### Roadmap to flexible inflation targeting (FIT) and flexible exchange rate regime
- Roadmap formulated in October 2017; consistent with IMF staff recommendations (TA in May 2017) and approved by the Monetary Board.
- Time-bound reform measures are being incorporated into program reviews.
- Objectives and measures of the roadmap include:
  - (i) ensuring a clear separation between fiscal and monetary policies;
  - (ii) retaining a role for the CBSL in smoothing excessive exchange rate volatility while guarding against a real or perceived conflict of objectives;
  - (iii) adopting FX intervention policies consistent with a flexible exchange rate regime;
  - (iv) improving foreign exchange market functionality, including by gradually liberalizing financial account transactions while ensuring regulatory compliance under the Foreign Exchange Act;
  - (v) safeguarding financial sector stability, including by addressing risks associated with greater FX flexibility;
  - (vi) developing technical infrastructure, including through improved forecasting and modeling capabilities with continued support from IMF TA;
  - (vii) establishing a policy decision making process anchored on the choice of the inflation targets and how unanticipated shocks would be addressed;
  - (viii) strengthening public-awareness through an outreach program.

### Strengthening the CBSL legal framework and Central Bank Act
- Progress toward addressing structural impediments identified in the 2016 safeguards assessment (monetary financing, non-core activities, 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 approved by cabinet in March 2019 (end-December 2018 structural benchmark) discussed with stakeholders and Parliament’s Committee on Public Finance.
- New Central Bank Act (replacing the MLA) being finalized based on feedback from the Attorney General’s Office and expected to be submitted to cabinet and Parliament in the coming weeks, with a delay (end-July 2019 structural benchmark).
- The new Central Bank Act aims to:
  - establish domestic price stability as the primary objective of the CBSL, with monetary policy decision-making functions shifted to a new Monetary Policy Board;
  - establish financial system stability as a core objective of the CBSL;
  - address central bank lending to the government including purchases of treasury bills in the primary market and advances to the government;
  - eliminate quasi-fiscal activities of the CBSL;
  - strengthen CBSL institutional, personal, and financial autonomy, accountability, and transparency (including on recapitalization and profit distribution);
  - streamline decision-making and monetary policy formulation process.

### Exchange rate policy, FX market development, and reserves objectives
- CBSL will strengthen a market-oriented approach to exchange rate policy and implement FIT under a flexible exchange rate regime.
- Development priorities:
  - (i) deeper and more liquid foreign exchange market to allow the exchange rate to act as a shock absorber and increase resilience;
  - (ii) adequate systems to review and manage exchange rate risks.
- Operational steps:
  - CBSL implemented in July a Request for Quotes (RFQ) system for direct dealing (end-December 2018 structural benchmark) to allow market-based and transparent FX transactions at best price.
- Reserve rebuilding and intervention strategy:
  - Despite limited intervention after the Easter attacks, CBSL’s net FX purchases in 2019H1 exceeded the programmed amount, overperforming the end-June NIR target by US$122 million.
  - Preliminary data indicate end-September NIR IT was met, with NIR exceeding the target by about US$13.7 million.
  - CBSL committed to meet the end-December NIR target and to step up FX purchases to strengthen reserve coverage.
  - Specific commitments:
    - Continue FX purchases to rebuild gross official reserves to US$8.2 billion by end-December 2019. 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 interaction between intervention strategy and reserve accumulation plans.
  - FX swaps with domestic commercial banks reduced from US$1.4 billion at end-February 2018 to US$0.42 billion at end-September 2019; plan to further reduce swap liabilities gradually.

### Exchange restrictions, capital flow measures, and liberalization path
- By April 2019 all measures introduced in 2018 that resulted in nonobservances of the continuous PC on non-introduction/intensification of exchange restrictions under the arrangement and were inconsistent with Article VIII obligations were eliminated.
- For the remainder of the program, the CBSL and government will not:
  - impose or intensify restrictions on the making of payments and transfers for current international transactions;
  - introduce or modify multiple currency practices;
  - conclude bilateral payments agreements that are inconsistent with Article VIII;
  - impose or intensify import restrictions for balance of payments reasons;
  - provide subsidized exchange guarantees for foreign currency borrowing.
- Capital flow management measures (CFMs):
  - 2016 repatriation requirement of export proceeds introduced; Cabinet approved in October 2019 an extension of the repatriation period from 120 to 180 days.
  - January 2019: threshold for foreign investments in rupee-denominated government securities lowered to 5 percent of the total outstanding stock, from 10 percent before.
  - Funds in business foreign currency accounts maintained by exporters of goods are freely remittable in respect of current transactions and capital transactions.
  - Plan to assess removing the repatriation requirement with timing linked to progress with macroeconomic adjustments (especially net international reserves) under the program.
  - Consider loosening the threshold for nonresident investments in rupee-denominated government securities as market volatility declines and CBSL’s reserve position strengthens.

### Financial sector policies and supervision
- Recent measures implemented to strengthen the financial system:
  - (i) introduced new capital and liquidity requirements, i.e. leverage ratio and net stable funding ratio, effective January 2019, for banks in line with Basel III standards;
  - (ii) implemented a new capital adequacy framework for licensed finance companies and specialized leasing companies;
  - (iii) required banks and finance companies to adopt IFRS 9 accounting standards (expected-loss provisioning);
  - (iv) adopted a more risk-based approach to financial system supervision.
- IMF conducted a Financial Sector Stability Review (FSSR) in January 2019 and provided recommendations to be implemented with IMF technical assistance.
- Temporary support measures after the Easter attacks:
  - CBSL regulation mandating financial institutions to grant a debt service moratorium on performing loans as of April 18, 2019, by the tourism industry through March 2020.
  - CBSL provided directions on deposit interest rates in April (revoked) and issued directions on interest rates on lending by licensed banks in September 2019; the latter will be reviewed in March 2020.
  - These measures are temporary and will be removed as credit market conditions improve to avoid protracted distortions.
- Regulatory and supervisory strengthening:
  - 2018 CBSL Directions 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.
  - Finalizing a Direction harmonizing provisioning for bad and doubtful debts; will issue a Direction harmonizing corporate governance framework by end-March 2020.
  - With World Bank support, working on a new Banking Act to facilitate risk-based and consolidated supervision, stronger merger provisions, support digital banking, and strengthen corporate governance. Implementation supported by IMF TA.
  - Additional measures:
    - (i) monitor credit growth and non-performing loans (NPLs) and report to the Monetary Board;
    - (ii) ensure banks and NBFIs abide by prudential requirements and adopt IFRS 9;
    - (iii) develop regulations/processes governing real estate purchases to minimize illicit funds investment and encourage condominium sector regulators to align with international best practices;
    - (iv) ensure sound management of exchange rate risk amid greater FX flexibility;
    - (iv) review and update the Finance Business Act; repeal the Microfinance Act and propose establishment of the Credit Regulatory Authority administered by the Ministry of Finance.

### Macroprudential framework, stress testing, and contingency planning
- New Central Bank Act will strengthen CBSL’s role in macroprudential policy setting.
- With IMF technical assistance and a resident advisor, planned actions:
  - (i) strengthen organizational efficiency/effectiveness of CBSL macroprudential surveillance, including establishing a dedicated stress-testing unit;
  - (ii) expand data collection on households, the non-financial corporate sector, and the property market;
  - (iii) improve systemic risk monitoring;
  - (iv) enhance analysis of macroprudential policy tools;
  - (v) develop macro-financial scenario-based stress tests of banks, extend stress tests to deposit-taking NBFIs, and upgrade existing stress testing methodologies and models.
- Contingency framework upgrades:
  - As part of Banking Act amendments with World Bank support plan to:
    - (i) institute a resolution regime for banks extended to NBFIs based on international best practices;
    - (ii) include a separate chapter to provide a stronger legal foundation to the deposit insurance system (resources of the deposit insurance fund will not be allowed to be used for emergency liquidity assistance to member institutions).
  - Prepare draft legislation by end-December 2019.
  - Additional steps:
    - (i) strengthen CBSL emergency liquidity assistance (ELA) framework via guidelines prescribing preconditions for ELA;
    - (ii) develop resolution plans for all systemic banks;
    - (iii) require all financial institutions to prepare recovery plans for CBSL review;
    - (iv) establish a dedicated committee for crisis preparedness and management in coordination with the Ministry of Finance;
    - (v) develop a communication strategy and regular crisis exercise program.

### AML/CFT implementation progress
- Financial Intelligence Unit (FIU) and stakeholders made significant progress addressing APG and FATF recommendations and action plan.
- Upgrades in APG ratings:
  - Six FATF Recommendations in July 2018 and five FATF Recommendations in August 2019.
- Legal and regulatory steps:
  - Amendments to the Mutual Assistance in Criminal Matters Act (MACMA) No. 24 of 2018 passed in August 2018 allow assistance on 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; implementing regulations issued in January 2019.
  - Customer due diligence (CDD) rules and guidelines for DNFBPs issued and implementation begun.
  - 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.
  - Regulations implementing UN targeted financial sanctions (TFS) relating to proliferation financing concerning DPRK (in October 2017 and June 2019) and Iran (in July 2018).
- FATF outcome:
  - FATF removed Sri Lanka from its improving global AML/CFT compliance lists in the October 2019 Plenary meeting, after an on-site visit in September 2019 verified implementation of the FATF action plan.
- Going forward measures:
  - enforce provisions relating to TFS for terrorist financing and PF and requirements regarding BO and politically-exposed persons;
  - strengthen risk-based supervision over the 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
- Objectives: greater integration into regional/global supply chains, higher FDI, enhanced private sector investment; need improvements in trade regime and investment climate.
- Trade agreements and status:
  - Free Trade Agreement with Singapore in January 2018;
  - Continued negotiations with China and Thailand, and Economic and Technology Cooperation Agreement with India;
  - GSP plus trade status with EU reinstated in May 2017 and already starting to have a positive impact on exports.
- Para-tariffs and trade regime reforms:
  - Removed around 1,200 para-tariffs since 2017.
  - 2019 budget announced a five-year phase-out period for para-tariffs (e.g., Port and Airport Development Levy (PAL) and the special economic purpose tax (CESS)) on a staggered basis.
  - CESS reduction for construction, tourism, and manufacturing sectors will be fast-tracked to be fully removed in three years.
  - Review of trade regime prepared a cabinet paper to rationalize remaining para-tariffs over the medium term and identify new revenue sources; cabinet approval obtained in October 2019 (end-March 2020 structural benchmark).
  - Approved paper is a first step toward a broader reform of indirect taxation to be developed by the Ministry of Finance in 2020.
- Adjustment and support programs:
  - March 2019: Cabinet approved the Trade Adjustment Program to assist local industries during para-tariff phasing out.
  - May 2019: Cabinet launched the Innovation and Entrepreneurship Strategy 2018-2022 to support export competitiveness of SMEs, promote start-ups, and align public R&D with private sector needs.
- Trade facilitation and investment facilitation:
  - With World Bank support launched a Trade Information Portal to improve transparency; National Single Window being developed to simplify border clearance.
  - Formulated a new Trade Policy and a National Export Strategy (NES) to increase trade facilitation efficiency, remove barriers to foreign investment entry/establishment (including access to land), enhance access to finance, and strengthen financial market infrastructure.
  - Established a dedicated NES Management Unit to coordinate and monitor the NES.
  - Launched a web portal to streamline and fast track the investment approval process under a single window virtual platform to strengthen the one-stop shop for FDI under the Board of Investment in 2018.
  - Progress under the Roadmap on Investment Climate Reforms and launched single windows to streamline property registration and construction permit processes.

*Source: 1lkaea2019003 - 20.      The focus of monetary policy will remain on keeping inflation in the mid-single*

### 35.      We will continue to step-up efforts to strengthen our governance and anti-

### 1lkaea2019003 - 35.      We will continue to step-up efforts to strengthen our governance and anti-

### Governance and anti-corruption framework
- 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 to strengthen enforcement of fraud and high-profile corruption cases.
- Appeals to be handled by a three-member special High Court, following an amendment of the Judicature Act.
- Drafted a comprehensive consolidated law to comply with the United Nations Convention against Corruption (UNCAC); the draft law will:
  - (i) reform the Bribery Act, widening the definition of bribery offenses;
  - (ii) amend the Declaration of Assets and Liabilities Act by covering assets legally owned and beneficially owned by a comprehensive range of public officials and their close family members, enforcing dissuasive sanctions for non-compliance or false declarations, and verifying and making publicly available online relevant data; and
  - (iii) clarify the mandates and expand the powers of the Commission to Investigate Allegations of Bribery or Corruption (CIABOC).
- After public consultations, authorities are working on the second draft of the consolidated law and plan to submit it to cabinet and subsequently to Parliament in the first half of 2020.
- Established a task force to prepare a policy paper to formulate a law on the recovery of assets.
- Launched the National Action Plan (NAP) for Combating Bribery and Corruption in Sri Lanka in March 2019, covering 2019-23, with measures including prevention, value-based education and community engagement, institutional strengthening of CIABOC and law enforcement, and law and policy reforms to strengthen anti-corruption efforts and compliance with international obligations.
- NAP implementation actions:
  - Integrity officers appointed in government departments.
  - CIABOC prepared manuals for investigators and prosecutors and training staff.
  - CIABOC in the process of recruiting 250 investigators and prevention officers to increase capacity.

### Female labor force participation and social policies
- Launched gender budgeting in all ministries in 2018 with twelve key performance indicators (KPIs) covering issues from encouraging women entrepreneurs in small-medium enterprises to providing greater vocational training.
- Placed focal contact staff in 11 entities and 3 provincial councils to monitor KPI compliance and conducted awareness programs; expansion planned to all ministries and provincial councils.
- Will prepare a report to assess the effectiveness of the KPIs in improving implementation of gender budgeting by end-2019 to inform the 2020 budget process.
- Cabinet approved establishment of 2000 new child care facilities in collaboration with the private sector in June 2018; with World Bank support, staff training is underway for these facilities.
- Plan to open After-School and Vacation Care Centers (ACVC) in selected public schools.
- Cabinet approval obtained in March 2019 of a national policy on early childhood care and development, addressing integration of services including health, education, child care, child protection, and children with disabilities.
- Formulating a National Day Care Policy to enhance the policy framework for child care services.
- Will facilitate part-time and flexible work arrangements by taking legislative measures as needed.
- Preparing a draft law to consolidate four labor laws (Shops and Offices Employees Act, Wages Boards Ordinance, Employment of Women, Children and Young Persons Act, and Maternity Benefits Ordinance) into one law.
- Will consider actions to facilitate greater participation of women in boards of listed companies.
- Will improve access to tertiary education and vocational training, including training programs to motivate women towards non-traditional income generation avenues and awareness programs to promote vocational and technical education for women and girls.
- Expected outcome: these measures, by facilitating female labor force participation, are expected to boost growth in the long run.

### Risks and contingencies
- Main domestic risks:
  - (i) lower-than-expected growth and/or new pressures on the trade account;
  - (ii) weaker-than-expected revenue performance and losses in state-owned enterprises;
  - (iii) rising vulnerabilities in the financial sector, amid weakening profitability; and
  - (iv) climate-related risks, which have risen in recent times, threatening growth, inflation and fiscal performance.
- Main external risks:
  - Trade tensions in key economies leading to weaker global growth and lower demand for Sri Lankan exports, as well as lower foreign direct investment and remittances;
  - A tightening in global financial conditions, triggering capital flow pressures, raising government borrowing costs, and hampering the buildup of foreign reserves.
- These risks could further challenge public debt and external sustainability.
- Policy stance: Should such risks materialize, the government stands ready to adjust promptly its policies, in close consultation with the IMF staff.

### Program monitoring and completion conditions
- Completion of the program will be subject to a final review, with performance criteria and indicative targets set out in Table 1 attached to this MEFP and the Technical Memorandum of Understanding (TMU).
- Completion of the seventh and final review will require observance of the quantitative performance criteria for end-December 2019, as well as continuous performance criteria, as specified in Table 1 attached to this MEFP.
- The review will also assess progress toward observance of the structural benchmarks specified in Table 2 attached to this MEFP.

### Selected structural benchmarks, targets, and statuses (Table 2 highlights)
- Monetary and Exchange Rate Policies:
  - Submit to Parliament the bill to amend the Monetary Law Act, in line with IMF staff recommendations. Target: End-July 2019. Status: Not met. Comment: The new Central Bank Act (replacing the MLA) is being finalized and is expected to be submitted to Parliament in the coming weeks.
  - Cabinet to approve the amended Monetary Law Act (MLA) for submission to Parliament by March 2019. Target: End-December 2018. Status: Not met (implemented with a delay). Comment: The amended MLA, prepared with IMF TA, was approved by cabinet in March 2019.
  - CBSL to operationalize a “Request for Quotes” (RFQ) system. Target: End-December 2018. Status: Met. Comment: The CBSL implemented the RFQ system ahead of schedule in July 2018.
- Fiscal Policy Management:
  - Submit to Parliament the 2020 budget in line with program targets including (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. Status: Not met (proposed to be reset to end-April 2020). Comment: Parliament delayed the 2020 budget because of the electoral calendar; approved a Vote on Account during January-April; the 2020 budget will be approved after the elections.
  - Cabinet to approve a plan with a clear timetable for establishment of an independent debt management agency. Target: End-September 2019. Status: Not Met (implemented with a delay). Comment: Cabinet approved the plan in October 2019.
  - Cabinet approval of amendments to relevant legislation to strengthen fiscal rules. Target: End-September 2019. Status: Not met (implemented with delay). Comment: Relevant amendments were approved by cabinet in early October 2019.
  - Cabinet to approve a policy note outlining key elements of amendments to the Fiscal Management (Responsibility) Act of 2003. Target: End-May 2019. Status: Not met (implemented with delay). Comment: Cabinet approval took place in July 2019.
  - Submit to Parliament the 2019 budget in line with program targets (including tax expenditure statement, plan to rationalize tax expenditures in 2019, and estimated fiscal cost of non-commercial obligations for SOEs). Target: End-November 2018. Status: Not met (implemented as a prior action). Comment: The 2019 budget was submitted to Parliament on March 5, 2019 as a prior action for the fifth review.
  - Senior management at MOF 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: The MTDS was approved on April 5, 2019.
- State Enterprise Reform examples:
  - Cabinet to approve automatic electricity pricing mechanism. Target: End-October 2019. Status: Not met. Comment: Authorities will finalize the reform proposal and obtain cabinet approval by end-April 2020.
  - Board of SriLankan Airlines to prepare an effective strategic plan and operating business model. Target: End-September 2019. Status: Met. Comment: Prepared ahead of time in August; key actions endorsed by cabinet in October.
  - Cabinet to approve automatic fuel pricing mechanism. Target: End-March 2018. Status: Not met (implemented with delay). Comment: Cabinet approved adoption of a cost-reflective fuel pricing mechanism in May 2018.
- Revenue Mobilization examples:
  - Cabinet to approve a strategy to rationalize para-tariffs over the medium term. Target: End-March 2020. Status: Met. Comment: Cabinet approval obtained ahead of time in October 2019.
  - MOF to publish a detailed IRA tax manual. Target: End-January 2018. Status: Not met (implemented with delay). Comment: The manual was published in May 2018 after the entry into force of the IRA in April 2018.
  - Submit to Parliament a new Inland Revenue Act. Target: End-March 2017. Status: Not met (implemented as a prior action). Comment: The new IRA was submitted to Parliament on July 5, satisfying the prior action for the second review.

*Source: Excerpt from the MEFP and associated Tables in the cited IMF document.*

### 2017. A comprehensive

### 1lkaea2019003 - 2017. A comprehensive

### Structural benchmarks and implementation status (2016–2018)
- Multi-year plan for reducing or eliminating tax expenditures was not adopted; this remaining step was built into the benchmarks for the 2018-2020 budgets.
- Fully roll out by MOF Inland Revenue Department new IT systems (RAMIS) for major domestic taxes (including income tax and VAT), including web-based tax filings for income tax and VAT.
  - End-December 2016 — Met.
- Adopt by MOF Inland Revenue Department Key Performance Indicators on the number of risk-based VAT audit.
  - End-December 2016 — Met.
  - Note: The Key Performance Indicators for risk-based VAT audit were included in the VAT compliance strategy for large taxpayers.
- Adopt by MOF Inland Revenue Department a VAT compliance strategy that includes a time-bound plan to implement risk-based audit.
  - End-December 2016 — Met.
  - Note: A draft VAT compliance strategy for large taxpayers was developed with support from IMF TA in October 2016.
- Public Financial Management Cabinet to approve a debt management strategy for international sovereign bonds maturing over 2019-22.
  - End-June 2018 — Met.
  - Note: In January 2018, cabinet approved tender offers and parallel new issues to refinance maturing sovereign bonds from 2019 onwards.
- MOF to implement an IT-based commitment control system with commitment ceilings for line ministries for the 2018 budget.
  - End-January 2018 — Met.
  - Note: The existing CIGAS system was modified so that quarterly commitment ceilings were implemented for the 2018 budget.
- MOF to roll out ITMIS with an automated commitment control module for Ministry of Finance.
  - End-January 2017 — Met.
  - Note: The system has been fully rolled out to all ministries. It is being operated in parallel to the existing IT system to ensure it is functioning properly.
- Establish by MOF a commitment record system (with quarterly reports produced no later than one month after the end of each quarter) and quarterly expenditure commitment ceilings for the 2016 budget and the 2017 budget.
  - End-December 2016 — Not met (implemented partially).
  - Note: Through modification of the existing IT system (CIGAS) and manual reporting from line ministries, the MOF is now capable of tracking spending commitment for each line ministry monthly.

### Technical Memorandum of Understanding — Framework and monitored targets
- Purpose: framework for monitoring performance under the Extended Arrangement under the Extended Fund Facility (EFF); specifies performance criteria, indicative targets (including adjustors), monitoring procedures, and reporting requirements for semiannual reviews.
- Quantitative performance criteria and indicative targets listed in Table 1 attached to the MEFP include:
  - a) a quantitative performance criterion on central government primary balance (floor);
  - b) a quantitative performance criterion on net official international reserves (floor);
  - c) a continuous quantitative performance criterion on new external payment arrears by the nonfinancial public sector and the CBSL (ceiling);
  - d) a monetary policy consultation clause;
  - e) an indicative target on central government tax revenue (floor);
  - f) an indicative target on reserve money of the CBSL (ceiling);
  - g) an indicative target on cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling);
  - h) an indicative target on treasury guarantees (ceiling).
- Central government definition: includes line ministries, departments, and other public institutions; excludes CBSL, state-owned enterprises, parastatals and other agencies that do not receive subventions from the central government.
- Debt definition: 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 (cash basis)
- Definition: 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 central government revenues. Spending recorded when cash disbursements are made.
- For program monitoring primary balance = overall balance of the central government plus interest payment of the central government (overall balance measured from financing side as negative of sum of listed financing items).
- 2015 example figures (measured as described):
  - primary balance: Rs –241 billion
  - overall balance: Rs –768 billion
  - interest payment: Rs 527 billion
  - net borrowings from issuances of Treasury Bills, Treasury Bonds, and Rupee Loans: Rs 257.6 billion
  - net borrowings from Sri Lankan Development Bonds (SLDBs) and commercial borrowings: Rs 455.7 billion
  - net borrowings from project and program loans: Rs 69.7 billion (after adjustment)
  - net increases in non-market borrowings, CBSL advances, government import bills, government overdraft, cash items in process of collection, and borrowings from offshore banking units: Rs –10.1 billion
  - net decreases in deposit of the central government in the banking system: Rs –4.4 billion
  - net borrowings from all other bonds, loans, and advances contracted by the central government: Rs –0.5 billion
  - proceeds from privatization or commercialization of public asset to residents and non-residents: Rs 0 billion
- Adjustment for project loan disbursements:
  - If actual gross cash disbursement of project loans by end-June/end-December 2019 is higher than Rs 45/95 billion, the floor on the primary balance for end-June/end-December 2019 will be adjusted downward by the difference between actual amount and Rs 45/95 billion.
  - The downward adjustment of the primary balance target will be capped at Rs 20 billion.
  - If actual gross cash disbursement is lower than Rs 45/95 billion, the floor will not be adjusted.

### Performance criterion on Net Official International Reserves (Program NIR)
- Program NIR measured as difference between:
  a) CBSL’s conventional NIR definition (gross foreign assets less liabilities and DSTs Special Dollar, Japanese Yen, and Chinese Yuan Revolving accounts), evaluated at market values; and
  b) CBSL’s outstanding liabilities (net short positions) in foreign exchange swaps with domestic commercial banks.
- Program NIR end-of-year figures (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 (market exchange rates) at end-December:
  - 2015: US$5,028.8 million
  - 2016: US$4,529.0 million
  - 2017: US$6,597.4 million
  - 2018: US$5,494.6 million
- CBSL outstanding liabilities (net short positions) in FX swaps with domestic commercial banks at end-December:
  - 2015: US$2,135.7 million
  - 2016: $2,496.9 million
  - 2017: US$1,495.2 million
  - 2018: US$723.2 million
- Framework includes discontinuing provision of FX swaps on concessional terms and gradually reducing outstanding net short positions of FX swaps with commercial banks as described in the MEFP.
- Valuation conventions for Program NIR:
  - All foreign-currency related assets and liabilities converted into U.S. dollar terms at exchange rates prevailing on Jan 2, 2019.
  - Monetary gold valued at US$1,281.295 per troy ounce (price prevailing on Jan 2, 2019).
- Exchange rates (Rates as of January 2, 2019) — Sri Lankan Rupee per currency unit:
  - U.S. dollar 182.5464
  - 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 assumptions):
  - If amounts of foreign program financing, net borrowings from SLDBs and FCBUs, external commercial loans (including international sovereign bonds and syndicated loans), project loans and grants disbursed, and proceeds from commercialization of public assets to non-residents are higher/lower in U.S. dollar terms than assumed, the floor on Program NIR will be adjusted upward/downward by the cumulative differences on the test date.
  - Proceeds from commercialization of public assets defined as cash receipts from sale or lease of publicly held assets (includes publicly held land, infrastructure or commercial real estate, public or quasi-public enterprises).
  - Adjustors apply to NIR floor for end-June 2019 and thereafter.
- Additional 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 floor on Program NIR will be adjusted downward/upward by the cumulative differences on the test date.
  - These adjustors apply to NIR floor for end-June 2019 and thereafter.

### Program assumptions (cumulative from beginning of the year, in million US$)
- Table excerpt (selected rows, columns: June-2019 | Sept-2019 | Dec-2019 | Mar-2020):
  - Foreign program financing by the central government: 0 0 0 0
  - Net borrowings from SLDBs and FCBUs by the central government: -108 -108 -108 0
  - External commercial loans (including Eurobonds and syndicated loans) by the central government: 2,426 3,426 3,426 500
  - Proceeds from commercialization of public assets to non-residents: 0 0 0 0
  - 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

### Continuous performance criterion on new external payment arrears
- A continuous performance criterion prohibits accumulation of new external payment arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL.
- Nonfinancial public sector definition: follows 2001 Government Finance Statistics Manual and 1993 System of National Accounts; includes central government and nonfinancial public enterprises (boards, enterprises, agencies with government controlling stake).
- External payment arrears defined as debt-service obligations (principal and interest) to nonresidents not paid when due, subject to any applicable grace period.
- Overdue debt and debt service obligations that are in dispute are not considered external payment arrears for program monitoring purposes.

### Monetary policy consultation clause (inflation bands and triggers)
- Inflation measure: headline Colombo Consumers Price Index (CCPI), Department of Census and Statistics of Sri Lanka; new CCPI index (2013=100) used.
- Year-on-year inflation for each test date measured as:
  - { CCPI*(t) – CCPI*(t-12) } / CCPI*(t-12)
  - where CCPI*(t) = { CCPI(t-2) + CCPI(t-1) + CCPI(t) } / 3 and CCPI*(t-12) = { CCPI(t-14) + CCPI(t-13) + CCPI(t-12) } / 3
- 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) stance of monetary policy and program track; (ii) reasons for deviation; (iii) proposed policy response.
  - When such consultation is triggered, access to Fund resources would be interrupted until consultation and relevant program review are completed.
- If observed year-on-year inflation falls outside the inner bands for end-June 2019, end-September 2019, end-December 2019, and end-March 2020, authorities will complete a consultation with IMF staff on reasons and proposed policy response.

### Indicative targets — definitions and adjustments
- Indicative target on central government tax revenue:
  - Definition: revenues from taxes collected by the central government; excludes revenues from asset sales, grants, and non-tax revenues.
  - Revenue target calculated as cumulative flow from beginning of the year.
  - 2015 reference: central government tax revenue defined in this manner was Rs. 1,356 billion.
- Indicative target on reserve money of the CBSL:
  - Reserve money consists of currency in circulation (with banks and the rest of the public), financial institutions’ domestic currency deposits at the CBSL, and deposits of the National Defense Fund (General Ledger Acc. No. 4278), the Buddha Sasana Fund A/C (General Ledger Acc. No. 4279), and the Road Maintenance Trust Fund (General Ledger 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 by the extent of the shortfall in compliance.
  - Formula for change in reserve money when required reserve regulations change:
    - ∆MM = ∆rB0 + r0 ∆B + ∆r ∆B
    - where ∆MM = change in reserve money; r0 = reserve requirement ratio prior to change; B0 = reservable base prior to change; ∆r = change in reserve requirement ratio; ∆B = immediate change in reservable base due to definition changes.
- Indicative target on cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers):
  - Definition: obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery levels.
  - Target set on cost of fuel and electricity NCOs net of government transfers (costs not compensated by central government budget).

*Source: Technical Memorandum of Understanding and attached program tables (1lkaea2019003 - 2017. A comprehensive).*

### 19.      The cost of NCOs for fuel during each quarter is measured as the cost of sales (including

### 1lkaea2019003 - 19.      The cost of NCOs for fuel during each quarter is measured as the cost of sales (including

### Measurement of cost of NCOs for fuel
- Cost of NCOs for fuel during each quarter is measured as:
  - 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) with regard to fuel supplies by CPC for transport, power generation, aviation, industries, kerosene and LPG, and agrochemicals.
- If the revenues (net of taxes) exceed the cost of sales, the cost of NCOs for fuel is zero.
- Government transfers to cover the cost of fuel NCOs are measured as central government current transfers disbursed to CPC.

### Measurement of cost of NCOs for electricity
- Cost of NCOs for electricity during each quarter is measured as:
  - total expenditures (including energy purchases and allowed revenue for transmission)
  - minus total sales revenues from 5 distribution licensees under CEB, as shown in the statement of the Bulk Supply Transaction Account managed by CEB.
- If the total sales revenues exceed the total expenditures, the cost of NCOs for electricity is zero.
- Government transfers to cover the cost of electricity NCOs are measured as central government current transfers disbursed to CEB.

### Program monitoring: cost of fuel and electricity NCOs net of government transfers
- The cost of fuel and electricity NCOs net of government transfers is calculated to take account of a time lag in estimating costs.
- Formulas for monitoring on specified test dates (where NCO(q) = cost of NCOs for fuel and electricity during quarter “q”; G(q) = central government current transfers to CPC and CEB disbursed during quarter “q”):
  - For the test date of end-June 2018:
    - { NCO(2017Q4) + NCO(2018Q1) } – { G(2018Q1) + G(2018Q2) }
  - For the test date of end-September 2018:
    - { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) }
  - For the test date of end-December 2018:
    - { NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) + NCO(2018Q3) } – { G(2018Q1) + G(2018Q2) + G(2018Q3) + G(2018Q4) }
  - For the test date of end-June 2019:
    - { NCO(2018Q4) + NCO(2019Q1) } – { G(2019Q1) + G(2019Q2) }
  - For the test date of end-September 2019:
    - { NCO(2018Q4) + NCO(2019Q1) + NCO(2019Q2) } – { G(2019Q1) + G(2019Q2) + G(2019Q3) }
  - For the test date of end-December 2019:
    - { NCO(2018Q4) + NCO(2019Q1) + NCO(2019Q2) + NCO(2019Q3) } – { G(2019Q1) + G(2019Q2) + G(2019Q3) + G(2019Q4) }
  - For the test date of end-March 2020:
    - NCO(2019Q4) – G(2020Q1)
- Definitions:
  - NCO(q) = NCO_fuel(q) + NCO_electricity(q)
  - NCO_fuel(q) = cost of NCOs for fuel during quarter “q”
  - NCO_electricity(q) = cost of NCOs for electricity during quarter “q”
  - G(q) = G_fuel(q) + G_electricity(q)
  - G_fuel(q) = central government current transfers to CPC disbursed during quarter “q”
  - G_electricity(q) = central government current transfers to CEB disbursed during quarter “q”

### Indicative target on Treasury Guarantees
- Treasury guarantees are defined as outstanding debt guarantees issued by the central government; a guarantee of a debt refers to any explicit legal obligation of the central government to service such a debt in the event of nonpayment by the recipient.
- Treasury guarantees exclude letters of credit.
- Outstanding guarantees are defined as the drawn amounts of guaranteed debts; they differ from issued guarantees, which include amounts for debts not yet disbursed.
- Treasury guarantees include:
  - outstanding treasury guarantees published in the Statement of Contingent Liabilities contained in the Annual Report of the Ministry of Finance
  - the guarantee issued for the SriLankan Airlines’ $175 million Eurobond.
- Rupee values for guarantees issued in other currencies will be calculated using the exchange rate for the last day of the calendar year as it appears in the Statement of Contingent Liabilities in the Annual Report of the Ministry of Finance.
- As of end-2017, the outstanding treasury guarantees were valued at Rs 591 billion (including the guarantee issued for the SriLankan Airlines’ Eurobond amounting to Rs. 27 billion).

### Data reporting requirements and timelines
- 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 program monitoring data will be provided by the Ministry of Finance and the CBSL.
- Data formats are specified for monitoring fiscal performance (Tables 3 and 4), monetary targets (Table 5), external sector performance (Tables 6 and 7), financial performance of CEB, CPC, and SriLankan Airlines (Tables 8, 9, and 10), cost of fuel and electricity NCOs net of government transfers (Tables 11 and 12), and treasury guarantees (Table 13).
- Reporting deadlines:
  - Data relating to the fiscal targets (Table 3 and Table 4) 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.
  - Data relating to the external and monetary targets (Tables 5, Table 6, and Table 7) will be furnished within no more than three weeks after the end of each month.
  - Data relating to the three state-owned enterprises (Tables 8–10) will be furnished within no more than 2 months after the end of each quarter.
  - Data relating to the indicative target on the cost of fuel and electricity NCOs (net of government transfers) (Table 11 and Table 12) will be furnished within no more than 5 weeks after the end of each quarter.
  - Data relating to the indicative target on treasury guarantees (Table 13) will be furnished within no more than two months after the end of each quarter.

*Source: 1lkaea2019003 (IMF chapter/section).*

### 8.00 percent, respectively.

### 1lkaea2019003 - 8.00 percent, respectively.

### Monetary policy and interest rate measures
- Temporary deposit caps were imposed in April 2019 because of high real interest rates on deposits and lending products, despite reductions in policy interest rates.
- Deposit caps were removed in September 2019 after a "more than 280 basis points decline in deposit rates."
- Temporary caps on lending rates were imposed in September 2019 to reduce excessively high nominal and real interest rates; these lending caps are "expected to be reviewed in March 2020."
- Private sector credit growth remained "sluggish at 7.2 percent by end August 2019."
- The CBSL will continue a data-dependent monetary policy and "stands committed to adjust policy rates as warranted."
- Institutional reforms are underway to transition to a "full-fledged flexible inflation targeting framework by 2020 to maintain inflation at mid-single digit levels."
- Exchange rate regime: "flexible and market oriented" within the envisaged flexible inflation targeting regime; foreign exchange sales will be limited to stem disorderly volatility and build reserves.

### Financial sector stability and reforms
- The financial sector "remains sound with high levels of capital and adequate liquidity buffers" despite some increase in non-performing loans (NPLs).
- Recent stresses attributed to subdued economic activity, macroeconomic stabilization measures, and high nominal and real interest rates; non-bank sector experienced added stress.
- Temporary measures were implemented to support tourism and ease credit conditions after the Easter Sunday attacks.
- Reforms and regulatory upgrades implemented or in progress:
  - Introduction of new capital requirements in line with Basel III standards.
  - Implementation of a new capital adequacy framework and IFRS9 accounting standards.
  - Strengthening of regulatory and supervisory regime for banks and non-bank financial institutions.
  - Enhancement of macroprudential policy framework and stress testing capabilities under the new Central Bank Act.
  - Upgrading the contingency framework for financial institutions in line with FSSR recommendations; Banking Act amendments being prepared with World Bank assistance.
  - "Roadmap for Sustainable Finance in Sri Lanka" launched on 10 April 2019, with IFC support.
  - Progress on a National Financial Inclusion Strategy.
  - Resolution of longstanding issues with weak non-bank financial institutions via stronger resolution and enforcement framework.
- AML/CFT: Sri Lanka was "removed from the improving global AML/CFT compliance lists of the Financial Action Task Force (FATF) in mid-October 2019" and will no longer be subject to FATF monitoring under its ongoing global compliance process; authorities will continue to strengthen AML/CFT measures.

### Fiscal policy, public finances, and social protection
- Authorities are committed to "revenue-based fiscal consolidation" to reduce relatively high government debt while meeting high debt service obligations and resource needs for social and capital spending.
- Fiscal performance in 2019 was adversely affected by the Easter Sunday attacks, political uncertainties, and subdued economic activity, resulting in lower than expected government revenue, clearance of unpaid bills, execution of externally financed capital projects, a lower primary surplus and an expansion of the budget deficit.
- Authorities took corrective measures to meet a "revised primary surplus target of 0.2 percent of GDP in 2019" and aim to return to fiscal consolidation in the medium term.
- Revenue-enhancement measures include the Inland Revenue Act (enacted in 2018) and revenue administration reforms; fiscal rules and public financial management reforms are being strengthened.
- Social safety nets are being enhanced with World Bank assistance and through the newly established Welfare Benefits Board (WBB) to ensure better targeting of social welfare schemes.
- Budget process: In the absence of a budget for 2020 due to Presidential elections, a "Vote on Account was approved by the Parliament in October 2019 to incur government expenditure during the first four months of 2020," which "could be extended further by the President for a period of three months, if required." A full 2020 budget is expected after the ending of the general elections in 2020.
- Fiscal management improvements being progressed:
  - Revisions to the Fiscal Management (Responsibility) Act with TA from the Fund.
  - Work on a PFM Act with World Bank support.
  - Finalizing new PPP guidelines to strengthen project selection and appraisal.

### State-owned enterprises (SOEs) and energy pricing reforms
- Measures to mitigate fiscal risks from SOE contingent liabilities continued.
- Introduction of an "automatic fuel pricing formula" and establishment of the bulk supply transaction account (BSTA).
- An "automatic electricity pricing mechanism" is expected to be completed in 2020, with measures to minimize distributional impacts on lower segments of society; intended to reduce Ceylon Electricity Board (CEB) losses and enhance energy consumption efficiency.
- Statements of Corporate Intent (SCIs) framework to monitor SOE performance under KPIs:
  - SCIs initially signed with "key 5 SOEs in March 2017."
  - Extended to "another 8 in 2019" and "further 10 SOEs are being selected to have SCIs."
- Comprehensive restructuring of SriLankan Airlines (SLA) has "been commenced towards ensuring its commercial viability."

### Debt management and public debt strategy
- Active Liability Management Act (ALMA) introduced in 2018 to address rollover risks and permit pre-financing beyond financial years covered under the Annual Appropriation Act.
- Medium-Term Debt Management Strategy (MTDS) developed with TA from the Fund and World Bank and "launched in April 2019" to make public debt more sustainable while allowing fiscal space for infrastructure and social programs.
- Progress on a multi-year plan to establish an independent debt management agency in line with international best practices.
- Alignment of medium-term debt levels with the MTDS and fiscal rules expected to help manage "relatively high debt service obligations in the next several years."

### External sector, reserves, and trade
- External sector strengthened in 2019 after measures to address 2018 vulnerabilities.
- Trade deficit contracted significantly in the first half of 2019 due to reduced import expenditure and growth in export earnings.
- Tourism earnings were negatively impacted by the Easter attacks: reduction from "US dollars 5 billion to US dollars 3.7 billion in 2019."
- Moderation of workers’ remittances and tourism shocks resulted in a marginal current account deficit in the first half of 2019 despite trade improvements.
- Authorities expect the current account deficit to reach a "sustainable level of around 2 percent of GDP over the medium-term" with improvements in the trade account, services inflows and a recovery of workers’ remittances.
- Gross official reserves stood at "US$ 7.6 billion by end-September 2019," sufficient to cover "over 4.6 months of imports." The Central Bank is committed to strengthen reserves further in the medium-term.

### Trade, investment, and structural reforms
- Priority to boost trade and investment through greater integration with regional and global value chains.
- Free Trade Agreement (FTA) with Singapore entered in January 2018; ongoing trade negotiations with China, India and Thailand; a new trade policy and trade adjustment package initiated.
- Para tariffs are being phased out.
- Anti-corruption and governance reforms:
  - A comprehensive draft law consolidating laws related to bribery and corruption to comply with the United Nations Convention against Corruption (UNCAC).
  - National Action Plan (NAP) for combating Bribery and Corruption launched in March 2019 with a roadmap for 2019-23.
- Measures to increase female labor force participation by removing barriers restricting participation.

### Conclusion and policy orientation
- The authorities’ policy reform agenda, supported by the ongoing EFF arrangement and TA from the Fund, World Bank and other IFIs, has helped gradually restore macroeconomic stability and strengthen investor confidence.
- Authorities are committed to continue structural reforms to ensure greater macroeconomic stability, "gradually return to a high growth trajectory and build buffers to improve resilience."

*Source: 1lkaea2019003*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1lkaea2019003.pdf_