## 1lkaea2023003

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### Executive summary — context and program status
- IMF Executive Board approved a 48-month Extended Arrangement under the Extended Fund Facility (EFF) in March 2023 with access of SDR 2.286 billion (395 percent of quota or about US$3 billion) and a first disbursement of SDR 254 million (about US$333 million). On completion of the first review, Sri Lanka would have access to an additional SDR 254 million.
- Program objectives:
  - restore sustainability through an ambitious revenue-based fiscal consolidation and debt restructuring;
  - maintain price stability and rebuild reserves under greater exchange flexibility;
  - safeguard financial sector stability;
  - address corruption vulnerabilities.
- Recent performance:
  - All end-June quantitative performance criteria (QPCs) were met except on expenditure arrears; all continuous QPCs met; most end-June indicative targets (ITs) met except on tax revenue. Headline inflation nonobservance of the end-June lower outer MPCC band triggered consultation.
  - Based on available data, all end-September ITs were met except for the tax revenue floor.
  - Most structural benchmarks due by end-October 2023 were met or implemented with delay.
- Debt treatments and negotiations:
  - Authorities reached agreements in principle (AIPs) with official creditors on debt treatments consistent with program parameters and are in good faith discussions with private creditors.

### Recent macroeconomic developments (selected)
- Real sector and inflation:
  - GDP contracted by 7.9 percent in H1-2023.
  - Headline inflation y-o-y fell from a peak of 70 percent in September 2022 to 1.5 percent in October 2023 (Colombo CPI).
- External sector and reserves:
  - H1-2023 current account surplus around US$1 billion due to lower imports (-19 percent y-o-y) and strong remittances (75 percent y-o-y).
  - Financial outflows estimated at US$950 million at end-June from banks closing net open FX positions and paydowns.
  - Gross International Reserves (GIR) projected to reach US$3.8 billion at end-2023 (US$600 million less than at program request).
  - CBSL direct sales intervention US$150 million and support for state-owned bank FX NOP reduction US$225 million on a net basis; immediate negative US$450 million impact on program NIR due to forward transactions to be unwound later.
  - CBSL and RBI agreed to settle ACU arrears by turning liabilities and penalty interest into a special swap (US$2.2 billion) combined with RBI SAARC swap (US$400 million); liabilities US$2.6 billion to be paid during 2023-26.
- Fiscal:
  - Total revenue projected to increase by 2 percentage points of GDP from last year.
  - Tax revenue for 2023 expected at 9.2 percent of GDP (shortfall of 0.8 ppt of GDP relative to program request).
  - Primary deficit target of 0.7 percent of GDP expected to be met through under-execution of capital spending.
  - Large interest payments were 6.3 percent of GDP at end-October.
  - Budget financing in 2023 mostly expected to come from domestic sources (6.6 percent of GDP).
- Financial sector:
  - Liquidity stress subsided; depositor confidence maintained.
  - Private credit contracted by -7.6 percent y-o-y in July 2023.
  - AQR and CBSL recapitalization roadmap confirmed capital shortfalls at two largest state-owned commercial banks (about 40 percent of bank assets) at end-2022.

### Outlook and key macro projections
- Growth and inflation:
  - Growth projected to pick up from -3.6 percent in 2023 to 1.8 percent in 2024, supported by accommodative monetary conditions and relaxation of import restrictions.
  - Inflation expected to edge up to 4.8 percent by end-2023 following the October electricity tariff hike and to 6.6 percent by end-2024 following VAT measures.
- External and reserve outlook:
  - Current account expected to post a deficit of 0.8 percent of GDP in 2024 due to strong import growth despite higher tourism and remittances.
  - GIR projected to reach US$5.35 billion at end-2024 under program and project financing and FDI.
- Debt outlook:
  - Macroeconomic framework reflects authorities’ indicative debt treatment scenario.

### Program risks and contingency planning
- Overall risk level: high and increased since program approval.
- Key sources of risk:
  - Delays in debt restructuring.
  - Weakened banking sector and exchange rate pressure.
  - Loss of market confidence and challenging political and social situation.
- Staff recommendations:
  - Contingency plans critical; policies should remain agile.
  - Staff recommends completing the required MPCC consultation.

### Program modifications, conditionality, and monitoring highlights
- Waiver requested for non-observance of end-June QPC on arrears given temporary breach and arrears cleared by end-September 2023.
- Proposed modifications to end-December 2023 targets:
  - NCG QPC revised marginally upward from Rs. 2,740 billion to Rs. 2,800 billion for end-December 2023.
  - MPCC midpoint set at 5 percent (relative to 15 percent at program approval).
  - IT on central government tax revenue revised downwards by about 13 percent to Rs. 2,550 billion.
  - New continuous QPC proposed on new CBSL purchases of government securities in the primary market as of December 2023.
  - Upgrade existing IT on the tax revenue floor to QPC as of June 2024.
- Prior actions completed for first review: (i) adoption of revenue package for 2024 budget; (ii) cabinet approval of quarterly electricity tariff revisions; (iii) formulation of recapitalization plan for five largest banks.

### Fiscal policy, revenue measures, and expenditure priorities
- 2024 budget targets and allocations:
  - 2024 Appropriation Bill targets a primary surplus of 0.8 percent of GDP in 2024 (QPC), up from projected deficit of 0.7 percent of GDP in 2023.
  - Tax revenue in the AB forecast to increase to 12.1 percent of GDP in 2024.
  - Wage bill planned to rise from 3.5 percent of GDP in 2023 to 3.6 percent in 2024.
  - Appropriation of Rs. 450 billion (1.4 percent of GDP) for recapitalization of banks.
  - Domestic financing for the budget expected to decline but still accounts for 5 percent of GDP.
  - Program continues to target a central government primary surplus of 2.3 percent of GDP starting 2025.
- Revenue package expected yields:
  - Expected yield from agreed tax policy measures estimated at 2.9 percent of GDP; adopted measures estimated at 2.7 percent of GDP.
  - VAT reforms include abolishing many exemptions, increasing rate from 15 to 18 percent, harmonizing VAT and SSCL thresholds to Rs. 60 million per annum.
  - Tax administration reforms expected to support an additional 0.2 percent of GDP in compliance gains in 2024.
- Expenditure priorities:
  - Interest bill expected at 8.1 percent of GDP in 2024.
  - Capital expenditure to increase to 4.1 percent of GDP in 2024.
  - Commitment to protect social spending and avoid regressive expenditure measures.

### Social safety nets and electricity pricing
- Social safety nets:
  - SSN spending floor set at Rs. 205 billion (0.7 percent of GDP) in 2024 (indicative target).
  - Payments under new Aswesuma scheme started July 2023; authorities to complete grievance procedures and pay previous beneficiaries pending reviews.
- Electricity tariffs:
  - Frequency of cost-recovery tariff adjustments increased from semi-annual to quarterly.
  - Average electricity tariff increased by 18 percent effective October 20, 2023 to allow CEB to break even in 2023.
  - Cabinet-approved quarterly tariff revisions to commence January 2024 (prior action).
  - Continuous SB on setting electricity tariffs at cost recovery adjusted accordingly.

### Domestic Debt Operation (DDO) and debt restructuring
- DDO executed July-September 2023:
  - Restructuring of CBSL holdings of T-bills and provisional advances into Treasury Bonds.
  - Conversion of superannuation funds’ holdings of T-bonds into longer-term maturities.
  - Conversion of commercial banks’ selected local law FX-denominated claims on the government (including SLDBs) into rupee debt instruments.
- CPC FX loan restructuring yet to be finalized.
- AIPs reached with official creditors; preliminary AIP with China EXIM Bank; negotiations with ISB bondholders ongoing.

### Banking sector recapitalization and supervision
- Recapitalization plan for five largest banks (prior action) developed by Financial Crisis Management Committee; state-owned banks presumed to receive government capital; private banks to submit capital plans with public support as backstop.
- Recapitalization needs expected within contingency amounts in the DSA at program approval (about 6 percent of 2022 GDP).
- Banking Act amendments: parliamentary approval of amendments expected by end-January 2024 and implementation by end-March 2024 (new SBs).
- AQR findings: collateral valuation issues and underprovisioning for domestic law FX exposures to the public sector.

### CBSL balance sheet, NCG, monetary financing, and reserves
- CBSL actions and commitments:
  - CBSL to objectively assess negative impact of DDO on its balance sheet by January 2024 in consultation with IMF staff and external auditors.
  - Government committed to boost CBSL equity to reach positive level by 2025 and to increase to 2 percent of GDP by 2031.
  - CBSL committed to not making additional primary market purchases of government securities; new continuous PC proposed with deviations permissible to account for external financing shortfalls within six months of first review.
- Net Credit to Government (NCG):
  - NCG fell from Rs. 3,020 billion at end-March to Rs. 2,800 billion at end-June, exceeding performance criterion by Rs. 90 billion.
  - End-September outturn for NCG was Rs. 2,838 billion (end-September IT was Rs. 2,840 billion).
  - Proposed NCG ceiling for end-2023 (QPC): Rs. 2,800 billion.
- Reserves and FX operations:
  - Program NIR estimated at US$-1.9 billion at end-June; exceeded adjusted target of US$-2.9 billion.
  - GIR forecasted at U$5.35 billion at end-2024, around US$800 million below program approval projections.
  - Program will include caps on adjustors for project financing and FX payments on restructured CPC loans.
  - FX interventions should be limited to disorderly market conditions and consistent with meeting NIR targets.

### Monetary policy stance and MPCC
- Policy rate reduced by 550 bps between June and October 2023; band of policy rates at 9-11 percent at various points.
- SRR cut in August 2023 from 4 to 2 percent to boost liquidity.
- Temporary interest rate caps imposed on pawning, overdrafts, and credit card lending categories; CBSL committed to eliminating interest rate caps as soon as possible.
- MPCC bands revised downward with midpoint set at 5 percent from December 2023 onwards; nonobservance earlier led to MPCC consultation recommendation.

### Tax revenue shortfall: drivers and implications (Annex I)
- Tax revenue projected at about 9.2 percent of GDP in 2023, about 2 percentage points above 2022 but 0.8 percentage points of GDP below program request.
- Carryover shortfall into 2024: about 0.3 percentage points of GDP.
- Staff estimate of shortfall without compensating measures: about 1.5 ppt of GDP on average between 2023 and 2024.
- Drivers:
  - Economic factors (larger contraction, more appreciated exchange rate, lower inflation and imports) estimated to contribute almost 40 percent of the shortfall in 2023 and about 30 percent in 2024.
  - Delay in lifting import restrictions on motor vehicles accounts for about 8 percent of the shortfall.
  - Weak revenue administration accounts for about 50 percent of the shortfall (low filing compliance and inadequate detection tools).
- Tax administration indicators:
  - Number of registered taxpayers at end-2022 about 438,000 compared to about 1.7 million before 2019 tax measures.
  - Without compensating measures, revenue administration shortcomings could contribute to additional 10 percent revenue loss in 2023 relative to program request projections.

### Debt sustainability, PDMA, and public debt management
- Public debt remains unsustainable pending resolution; external debt restructuring negotiations focused on four creditor groups representing 97 percent of restructurable external claims.
- As of November 2023:
  - AIP with Official Creditors Committee (OCC) aligned with program parameters.
  - Preliminary AIP with China EXIM Bank in October 2023 on comparable terms.
- PDMA:
  - Authorities plan to increase borrowing limit from 13.9 to 23.4 percent of GDP in 2024 to accommodate long-term debt issuance for bank recapitalization and external restructuring operations.
  - Complete legislative requirements to establish PDMA by March 2024; complete establishment by December 2024.
  - Ministry of Finance began publishing a quarterly public debt bulletin in February 2023.

### Debt consolidation and DSA baseline (selected numerical projections)
- Public debt (Percent of GDP) baseline path:
  - Prel. 2022: 125.8
  - 2023: 114.1
  - 2024: 115.9
  - 2025: 116.3
  - 2026: 115.1
  - 2027: 111.7
  - 2033: 90.8
- Gross financing needs (Percent of GDP):
  - 2022: 33.9
  - 2023: 27.8
  - 2024: 25.3
  - 2025: 23.0
  - 2026: 19.8
  - 2027: 17.1
  - 2033: 13.7
- Memo indicators:
  - Real GDP growth (percent): 2022: -7.8; 2023: -3.6; 2024: 1.8; 2025: 2.7; 2026: 3.0.
  - Inflation (GDP deflator; percent): 2022: 48.8; 2023: 20.4; 2024: 10.1; 2025: 6.3.
- Program financing schedule (original availability, millions of SDR):
  - Availability at arrangement approval: 254.4; repeated semiannual disbursements to March 1, 2027; Total 2,286.0 (millions of SDR); Percent of Quota 395.0.

### Governance, anticorruption, and PFM commitments
- Governance Diagnostic report published September 30, 2023; Government Action Plan to be developed and published by February 2024 (new SB).
- Anticorruption and institutional measures:
  - Constitutional Council to publish rules for appointing CIABOC commissioners in the Gazette by end-December 2023 (new SB).
  - Comprehensive asset recovery law to be enacted by April 2024 (new SB).
  - CIABOC to publish asset declarations for senior officials by July 2024 (new SB).
- PFM and transparency:
  - Complete rollout of ITMIS by March 2024; MOF’s Department of State Accounts to report monthly cash flows by third business day of subsequent month thereafter.
  - Submission of new PFM law to Parliament by end-February 2024 (revised SB).
  - Semi-annual publication of procurement contracts above Rs. 1 billion and lists of tax-exempt firms by end-December 2023 (new SB).

### Key policy recommendations (staff appraisal)
- Promptly implement banks’ recapitalization strategy and recapitalization plans for remaining AQR-covered banks by end-February.
- Expedite amendment and implementation of the Banking Act with parliamentary approval by end-January 2024 and implementation by end-March 2024.
- Strengthen deposit insurance fund (with WB support) and crisis management capacity.
- Preserve revenue-based fiscal consolidation and continue revenue administration reforms, including boosting compliance by large taxpayers and curbing corruption vulnerabilities.
- Avoid faster-than-warranted monetary loosening; CBSL should continue offloading government securities and cease primary market purchases.
- Expedite efforts to recapitalize the CBSL.

*Source: IMF staff report excerpt (1lkaea2023003).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Context
- As part of the IMF-supported arrangement Sri Lanka has undertaken significant reforms to pave the way out of a deep economic and debt crisis.
- The economy is showing tentative signs of stabilization, supported by rapid disinflation and a significant fiscal adjustment.
- Tax revenues have increased but not as much as initially projected, and reserves accumulation has slowed, including due to slow progress on debt restructuring.
- Continued ownership of reforms is essential to rebuild fiscal credibility and to improve governance and reduce corruption vulnerabilities.
- The authorities reached agreements in principle (AIPs) with official creditors on debt treatments consistent with program parameters and are in good faith discussions with their private creditors.

### Program Status
- In March 2023, the IMF’s Executive Board approved a 48-month Extended Arrangement under the Extended Fund Facility (EFF), with access to Fund resources of SDR 2.286 billion (395 percent of quota or about US$3 billion), and a first disbursement of SDR 254 million (about US$333 million).
- On completion of the first review, Sri Lanka would have access to an additional SDR 254 million.
- The program supports:
  - restore sustainability through an ambitious revenue-based fiscal consolidation and debt restructuring;
  - maintain price stability as well as rebuild reserves under greater exchange flexibility;
  - safeguard financial sector stability; and
  - address corruption vulnerabilities.

### Program Performance (end-June / end-September 2023)
- End-June performance:
  - All end-June quantitative performance criteria (QPCs) were met, except on expenditure arrears.
  - All continuous QPCs were met.
  - All end-June indicative targets (IT) were met, except on tax revenue.
  - Headline inflation led to the nonobservance of the end-June lower outer MPCC band, triggering consultation with the Executive Board.
- End-September performance:
  - Based on available data, all end-September ITs were met except for the tax revenue floor.
- Structural benchmarks:
  - Most structural benchmarks (SBs) due by end-October 2023 were either met or implemented with delay.

### Recent Macroeconomic Developments
- Real sector and inflation:
  - GDP contracted by 7.9 percent in H1-2023.
  - Headline inflation y-o-y fell from a peak of 70 percent in September 2022 to 1.5 percent in October 2023 (Colombo CPI).
  - Rapid disinflation driven by responsive monetary policy, strong base effects, weak demand, an appreciating Rupee (between December 2022 and September 2023) and muted second-round effects.
- External sector and reserves:
  - In H1-2023, lower imports (-19 percent y-o-y) and strong remittances (75 percent y-o-y) contributed to a current account surplus (around US$1 billion).
  - Financial outflows estimated at US$950 million at end-June due to banks closing net open FX positions and paydowns of external liabilities.
  - Gross International Reserves (GIR) projected to reach US$3.8 billion at end-2023 (US$600 million less than at program request).
  - The nominal exchange rate appreciated by 22.6 percent between March and May and depreciated by 10 percent during June-September.
  - Central Bank intervention through direct sales was US$150 million and support for a state-owned bank to reduce its FX NOP was US$225 million on a net basis.
  - This intervention had an immediate negative US$450 million impact on program NIR because of underlying forward transactions that will be unwound in later years of the program.
  - The CBSL and the Reserve Bank of India (RBI) agreed to settle ACU arrears by turning liabilities and associated penalty interest into a special swap (US$2.2 billion) and combining it with the RBI SAARC swap (US$400 million); these liabilities (US$2.6 billion) will be paid during 2023-26.
- Fiscal developments and budget:
  - Total revenue is projected to increase by 2 percentage points of GDP from last year.
  - Tax revenue for 2023 is expected to increase to 9.2 percent of GDP.
  - A shortfall of 0.8 ppt of GDP relative to the projection at program request is attributed to unanticipated economic developments and weaknesses in revenue administration.
  - The primary deficit target of 0.7 percent of GDP is expected to be met through under-execution of capital spending.
  - Budget liquidity remained tight despite budgetary support disbursements by ADB (US$350 million) and WB (US$250 million) in May and June.
  - Large interest payments were 6.3 percent of GDP at end-October, reflecting elevated T-bills rates and external debt service.
  - Budget financing in 2023 is mostly expected to come from domestic sources (6.6 percent of GDP).
- Financial sector:
  - Liquidity stress has subsided somewhat; depositor confidence maintained.
  - Post-DDO, local currency debt market conditions eased but T-bills yields remain significantly above the policy rate.
  - Asset Quality Review (AQR) and the CBSL recapitalization roadmap confirmed that the two largest state-owned commercial banks (about 40 percent of bank assets) had a capital shortfall at end-2022 to be addressed through the banks recapitalization plan.
  - Other challenges: worsening credit quality, shrinking profitability and large unhedged FX exposure to the public sector.
  - Private credit contracted by -7.6 percent y-o-y in July 2023.

### Debt Restructuring and Domestic Debt Operation (DDO)
- The DDO executed in July-September 2023 includes:
  - restructuring of CBSL holdings of T-bills and provisional advances into Treasury Bonds;
  - conversion of superannuation funds’ holdings of T-bonds into longer-term maturities;
  - conversion of commercial banks’ selected local law FX-denominated claims on the government (including SLDBs) into rupee debt instruments.
- The Ceylon Petroleum Corporation (CPC) FX loan restructuring is yet to be finalized.
- Negotiations with external private creditors have advanced, and agreements in principle (AIPs) with official creditors have been reached.

### Program Risks
- Overall risk level: high and has increased since program approval.
- Sources of implementation risks:
  - Sri Lanka’s track record of reform implementation.
  - Challenging political and social situation.
- Potential triggers for deeper crisis:
  - Delays in implementing the debt restructuring.
  - A weakened banking sector.
  - Exchange rate pressure.
  - Loss of market confidence.
- Staff recommendation:
  - Contingency plans are crucial, and policies should remain agile to adjust to evolving circumstances.
  - Staff recommends that the Board completes the required MPCC consultation.

### Program Modalities and Reviews
- All three prior actions for the first review have been met.
- Proposed modifications of end-December 2023 program targets for:
  - Net Credit to Government (NCG) QPC;
  - the Monetary Policy Consultation Clause (MPCC);
  - ITs on central government tax revenue and treasury guarantees.
- New and modified structural benchmarks proposed.
- Staff support authorities’ request to rephase access by adjusting the disbursement availability schedule to better align with data availability for test dates.
- A waiver is requested for the non-observance of the end-June QPC on arrears given that this nonobservance was temporary.

*Source: EXECUTIVE SUMMARY, 1lkaea2023003 - EXECUTIVE SUMMARY.*

### 4.     The outlook is for a moderate recovery in 2024. Growth is projected to pick up

### 1lkaea2023003 - 4.     The outlook is for a moderate recovery in 2024. Growth is projected to pick up

### Outlook and key macro projections
- Growth is projected to pick up from -3.6 percent in 2023 to 1.8 percent in 2024, supported by accommodative monetary conditions and the relaxation of import restrictions.
- Inflation is expected to edge up to 4.8 percent by end-2023 following the October electricity tariff hike and further to 6.6 percent by end-2024 following the introduction of the Value-Added Tax (VAT) measures.
- The current account (CA) is expected to post a deficit of 0.8 percent of GDP due to strong import growth as restrictions are relaxed, despite higher tourism earnings and remittances inflows.
- New program and project financing along with Foreign Direct Investment (FDI) would bring gross international reserves (GIR) up to US$5.35 billion at end-2024.
- The macroeconomic framework reflects the authorities’ indicative debt treatment scenario.

### Risks to the program and financing
- Program financing risks:
  - Reserves are being accumulated at a slower pace due to uncertainties from the debt restructuring and upcoming large outflows.
  - Higher gross financing needs projected for 2024-27—due in part to shorter maturities—and less certain financing, including for projects.
  - Recapitalization needs of CBSL and banks could be higher than expected.
  - Potential effects from restructuring of domestic FX debt.
  - Revenue is being raised at a slower pace and revenue administration remains inadequate.
- External risks:
  - Intensified regional conflicts (including Russia’s prolonged war in Ukraine and the conflict in the Middle East) could produce commodity price volatility and a sharp global slowdown, reducing capital flows and reserve accumulation and leading to sharp exchange rate depreciation.
  - Slow progress in debt restructuring would worsen the balance of payments and create wider financing gaps.
- Domestic risks:
  - Incomplete program implementation against a weak track record, delays in addressing banking sector vulnerabilities including from rising dollarization, some upside inflation risks, and reform fatigue ahead of presidential elections in 2024.
  - Social unrest risks from falling real incomes, tax rate hikes, cost-recovery pricing in energy, insufficient anti-corruption efforts, and delayed local elections.
  - Delays in debt restructuring could weaken confidence and tighten financing conditions.

### Program management, contingency measures, and policy adjustments
- Program responses and contingency measures:
  - Policy slippages to be corrected by compensating actions where possible; overperformance to be locked in.
  - Revenue shortfalls to be mitigated by stronger ex-ante conditionality on revenue performance and a stronger focus on revenue administration reforms.
  - Authorities engaging closely with creditors to minimize debt restructuring delays.
  - Commitments to immediate remedial actions if downside risks materialize, e.g., more frequent electricity tariff revisions and emergency tariff revisions when needed, emergency policy rate hikes if inflation risks appear, and consultation with staff on adopting measures and revisions to the MEFP.
  - Authorities commit to refrain from policies inconsistent with program objectives.
- Modifications to program modalities:
  - Waiver of non-observance for the end-June QPC on arrears.
  - MPCC consultation recommended due to headline inflation nonobservance of the lower outer band of end-June MPCC; authorities lowered the policy rate by 550 bps between June and October.
  - End-December 2023 QPC for Net Credit to Government (NCG) revised upward marginally from Rs. 2,740 billion to Rs. 2,800 billion.
  - MPCC clause midpoint set at 5 percent (relative to 15 percent at program approval) to account for faster disinflation.
  - Indicative Target (IT) on central government tax revenue revised downwards by about 13 percent to Rs. 2,550 billion.
  - New continuous QPC proposed on new CBSL purchases of government securities in the primary market as of December 2023.
  - Existing IT on the tax revenue floor upgraded to QPC as of June 2024.
  - Prior actions completed: (i) adoption of a revenue package for the 2024 budget; (ii) cabinet approval of quarterly electricity tariff revisions; (iii) formulation of a recapitalization plan for the five largest banks.
  - Structural Benchmarks (SBs) modified: continuous SB on end-user electricity tariffs to quarterly revisions; postponement of submission of new PFM law to Parliament from December 2023 to February 2024; new SBs proposed across sectors.
  - Support for rephasing of access to align disbursement availability with data availability for test dates.

### Program performance and compliance (quantitative and structural)
- Quantitative conditionality:
  - All continuous QPCs were observed.
  - End-June quantitative targets were met except for the QPC on arrears, the IT on tax revenue, and inflation leading to nonobservance of the end-June lower outer MPCC band.
  - Based on available data, all end-September ITs were met except for the tax revenue floor.
- Fiscal outcomes:
  - Primary balance posted a surplus of Rs. 31 billion at end-June and Rs. 123.7 billion at end-September, surpassing quantitative targets of a deficit of Rs. 113 billion and 160 billion respectively.
  - Tax revenues fell short of the IT by about 8 percent (and an average of 0.3 percent of GDP) for both June and September.
  - Expenditure arrears accumulated to Rs. 34.5 billion by June (missed June QPC) but were cleared by end-September.
- Monetary and reserves:
  - Inflation fell below the lower outer band of the MPCC in Q2-2023 by 4.6 percentage points and fell further to 3.8 percent in Q3-2023, within the MPCC inner band.
  - Net Credit to Government (NCG) fell from Rs. 3,020 billion at end-March to Rs. 2,800 billion at end-June, exceeding the performance criterion by Rs. 90 billion.
  - End-September outturn for NCG was Rs. 2,838 billion (end-September IT was Rs. 2,840 billion).
  - Program Net International Reserves (NIR), estimated at US$-1.9 billion at end-June, exceeded the adjusted target of US$-2.9 billion; the September IT was met.
- Structural benchmarks:
  - Majority of SBs due by end-October 2023 were met despite some delays.
  - Continuous SBs on setting fuel and electricity prices at cost recovery levels were met ex-ante; Ceylon Electricity Board (CEB) losses in July and August followed a 14 percent cut in the average tariff in July; corrective action: average electricity tariff increased by 18 percent in October.
  - Cabinet approved in June a comprehensive strategy to restructure balance sheets of four key SOEs.
  - 2024 Appropriation Bill submitted in October broadly in line with program parameters.
  - Parliament passed the new welfare benefit payment scheme (WBPS) known as Aswesuma in May.
  - SBs not met: cabinet approval of revenue measures to support fiscal consolidation in 2024 (end-July) and ITMIS rollout (end-September) due to insufficient trainers.
  - Central Bank Act (CBA) approved on July 20 (instead of end-April), removing government representation from governing boards but allowing an 18-month transitory period for monetary financing; staff assesses the SB as not met.
  - SBs on AQR rounds and Banking Act revision experienced delays; roadmap for banks’ recapitalization due end-July implemented with delay (October); end-October SB on determining recapitalization strategy of viable banks was met.
  - Anti-Corruption SB to publish governance diagnostic report was met; Parliament approved Anti-Corruption Bill on July 19 but SB assessed as not met due to lack of transparent selection provision; alternative SB proposed to reinforce Constitutional Council processes.

### Fiscal policy, revenue measures, and expenditure priorities
- 2024 budget and fiscal targets:
  - 2024 Appropriation Bill targets a primary surplus of 0.8 percent of GDP in 2024 (QPC), up from a projected deficit of 0.7 percent of GDP in 2023.
  - Tax revenue in the AB forecast to increase to 12.1 percent of GDP in 2024, supported by a package of further revenue measures.
  - Draft AB plans a small increase in the wage bill from 3.5 percent of GDP in 2023 to 3.6 percent in 2024.
  - Appropriation of Rs. 450 billion (1.4 percent of GDP) for recapitalization of banks.
  - Domestic financing for the budget expected to decline from 2023 but still accounts for 5 percent of GDP.
  - Program continues to target a central government primary surplus of 2.3 percent of GDP starting 2025.
  - Authorities agreed to refrain from tax policy or administrative measures that may erode tax revenue throughout the program and to maintain stock of budget expenditure arrears at zero throughout the program (QPC).
- Revenue package and expected yields:
  - Expected yield from agreed tax policy measures estimated at 2.9 percent of GDP and would raise tax revenue (new QPC) to 12.1 percent of GDP under staff’s baseline.
  - Expected yield from agreed tax policy measures adopted so far is estimated at 2.7 percent of GDP and includes further VAT reforms: (i) abolishing many exemptions including on fuel, Liquefied Petroleum Gas and selected food and agriculture items; (ii) increasing the rate from 15 to 18 percent; (iii) harmonizing the liable registration thresholds for the VAT and Social Security Contribution levy (SSCL) to Rs. 60 million per annum.
  - Package also includes expected gains from relaxing import restrictions and other measures.
  - Tax administration reforms expected to support an additional 0.2 percent of GDP in compliance gains in 2024.
  - By March 2024, authorities will introduce, track, and report quarterly on 7 Key Performance Indicators related to four core tax administration functions (payment; filing; reporting; registration) (new SB).
  - By December 2023, the Inland Revenue Department to create within the LTU a new High Net Worth Individuals (HNWI) unit, a design and monitoring unit, and a strengthened Risk Management Unit (new SB).
  - Strategy to build a valid VAT refund system and fully repeal SVAT by April 2025 to be adopted by end-December 2023 (new SB).
  - Medium-term IRD Modernization Strategy and Implementation Plan to be adopted by January 2024 with FAD CD assistance.
- Expenditure rationalization:
  - Interest bill expected to remain large at 8.1 percent of GDP in 2024 as domestic rates remain elevated, before gradually declining over the medium-term.
  - Capital expenditure expected to increase to 4.1 percent of GDP in 2024 to mitigate adverse effects on growth from recent compression.
  - Avoiding revenue shortfalls will help minimize further cuts to capital expenditure.
  - A public expenditure review with World Bank assistance would help identify possible savings in current spending.
  - Important to ensure expenditure measures are not regressive and complement revenue-based consolidation.

*Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1lkaea2023003.pdf*

### 13.      To ensure adequate support for the poor and vulnerable, the program will continue to

### 13.      To ensure adequate support for the poor and vulnerable, the program will continue to

### Social safety nets (SSN)
- Floor on SSN spending set at Rs. 205 billion (0.7 percent of GDP) in 2024 (indicative target), preserving the real value of cash transfers per household.
- Payments under the new scheme (Aswesuma), using the new Social Registry developed with World Bank support, started in July 2023.
- Staff recommended completing the proper grievance procedure related to appeals and objections on beneficiary selection.
- Authorities committed to paying cash transfers to previous beneficiaries who applied but were not selected under the new criteria until grievance reviews are completed during the transition period.

### Electricity tariffs and CEB financial sustainability
- Frequency of formula-based adjustment of cost-recovery electricity tariffs increased from semi-annual to quarterly to address losses more quickly.
- Average electricity tariff increased by 18 percent with effect from October 20, 2023 to allow CEB to break even in 2023.
- Cabinet-approved quarterly tariff revisions to commence from January 2024 (prior action).
- Continuous structural benchmark (SB) on setting electricity tariffs at cost-recovery levels adjusted accordingly.
- Conservative assumptions needed in setting tariffs to prevent further losses.
- Improvements in the Bulk Supply Transaction Account (BSTA) expected to lead to more frequent automatic tariff adjustments in-between revisions (end-December SB).
- Authorities to continue working with the WB and ADB on options for lowering CEB administrative, generation and distribution costs.
- Fuel price-setting mechanism to remain unchanged; authorities committed to adjust the formula if the built-in margin of 4 percent proves insufficient, including to cover potential losses from the transfer of supply contracts of about 25 percent of CPC fuel stations to other producers (Annex II).

### Public Financial Management (PFM) reforms and fiscal risks
- Proposed postponement of the SB on the new PFM law from end-December 2023 to end-February 2024 to allow further consultations with TA experts.
- Two new SBs proposed involving cabinet approval of:
  - (i) reduction in the limit on government guarantees from 15 to 7.5 percent of GDP by end-December 2023; and
  - (ii) a fiscal strategy statement including a medium-term fiscal framework (MTFF) by end-June 2024.
- Authorities developing guidelines for issuance and management of loan guarantees and on-lending with assistance from FAD and the WB.
- SOE strategy (Annex II) expected to be implemented by end-December 2023; further SOE reforms focus on restructuring, including divestment, and enhancing financial transparency with WB and IFC assistance.
- Measures to contain PFM corruption risks referenced (¶28).

### Restoring public debt sustainability and restructuring progress
- Sri Lanka’s debt remains unsustainable pending resolution (Annex III).
- External debt restructuring negotiations focused on four major creditor groups representing 97 percent of total restructurable external claims.
- As of November 2023:
  - An AIP reached with the Official Creditors Committee (OCC) with terms in line with program parameters.
  - A preliminary AIP reached with China EXIM Bank in October 2023 on terms comparable to the OCC AIP.
- Work on codifying the OCC agreement in a Memorandum of Understanding advancing with good prospects for finalization in coming months.
- Authorities assessed to be engaging in good faith negotiations with ISB bondholders, aiming to reach an AIP no later than the second review of the EFF; negotiations with China Development Bank (CDB) are at an advanced stage.
- Debt relief agreed and being negotiated expected to be consistent with program debt targets, though with minimal buffers, highlighting implementation risks (Annexes III and IV).
- Active public debt management strategy critical to mitigate medium-term refinancing risks given elevated Gross Financing Needs (GFNs) in the near-term (¶17).

### Centralized Public Debt Management Agency (PDMA) and domestic debt strategy
- Authorities plan to increase the borrowing limit from 13.9 to 23.4 percent of GDP in 2024 to accommodate issuance of long-term debt instruments for bank recapitalization schemes and external debt restructuring operations.
- IMF and WB TA supported PDMA setup to centralize debt management and better manage FX, rollover and interest rate risks.
- Authorities committed to:
  - Complete legislative requirements to establish the PDMA in line with international best practices by March 2024; and
  - Complete establishment of the PDMA by December 2024.
- Ministry of Finance started publishing a quarterly public debt bulletin in February 2023; next bulletin to include more granular domestic debt information, including debt service cost and creditor types.
- Normalization of local currency debt markets following the DDO is welcome; going forward active public debt management should focus on lengthening domestic debt maturities and mitigating medium-term refinancing risks.
- Large GFNs in part due to a large stock of T-bills maturing in next 12 months (roughly 13 percent of GDP) held by banks and nonbank financial institutions; these T-bills need refinancing with longer-term securities.

### Maintaining price stability and monetary policy stance
- Between June and October 2023, policy rate (lending facility) reduced by 550 bps to 11 percent.
- In August 2023, interest rate caps on pawning, overdrafts, and credit card lending categories were imposed to loosen financial conditions.
- Based on latest inflation projections and Taylor rule analysis, CBSL stance considered appropriate accounting for rapid disinflation, re-anchored inflation expectations, credit contraction, and high forward-looking real policy rate (4 percent).
- An additional policy rate cut of 100 bps in November to 10 percent has raised inflation risks.
- MPCC bands revised downward relative to program request and now set with a mid-point target at 5 percent from December 2023 onwards to ensure a prudent monetary stance.
- Monetary policy should be implemented through the policy rate, avoiding interest rate caps which increase pressure on the banking system; CBSL committed to eliminating interest rate caps as soon as possible.

### Net credit to government, Treasury cash buffer, and monetary financing
- NCG has declined since August 2023 despite a temporary increase in July.
- Taking into account planned repayment by end-2023 by Treasury of Rs. 4,283 billion of T-bills and T-bonds (including those held by CBSL) and other repayments within the DDO, the NCG ceiling is proposed at Rs. 2,800 billion for end-2023 (QPC), slightly higher than at program request to alleviate money market structural liquidity shortages.
- In 2024 CBSL expected to continue offloading government securities as domestic borrowing markets normalize and external financing resumes.
- To compensate for extended transition period permitting monetary financing under the CBA, CBSL committed to not making additional primary market purchases of government securities, with deviations permissible to account for external financing shortfalls within six months of the first review (new continuous PC).
- Staff recommend T-bill auctions aim to raise adequate amounts including a buffer to allow Treasury to meet cashflow needs without relying on monetary financing.

### CBSL recapitalization
- Swap of CBSL T-bill holdings for long-term T-bonds reduces government near-term GFNs and refinancing risks but reduces CBSL capital.
- Staff cautioned against valuing T-bonds using discount rates disconnected from current market yield curve.
- Urgency of recapitalizing CBSL emphasized to avoid weaker demand for CBSL liabilities, higher inflation risk premia, and rising dollarization risks.
- Government should stand ready to inject capital into CBSL as fiscal buffers allow so as to reach positive equity from 2025, increasing to 2 percent of GDP by 2031.
- A buffer of 0.5 percent GDP reserved for CBSL recapitalization in 2024; staff assesses this as sufficient to bring CBSL equity to positive levels based on IMF staff’s estimate of CBSL’s NPV loss from DDO and its equity position at time of bond exchange in September 2023.
- Recapitalization needs of banks and CBSL are incorporated in the DSA.

### Bank liquidity framework and monetary transmission
- Statutory Reserve Ratio (SRR) cut in August 2023 from 4 to 2 percent to boost banking sector liquidity.
- SRR framework could be expanded to cover more deposit-taking institutions (e.g., national savings bank) and FX deposits to reduce regulatory arbitrage, discourage dollarization and safeguard settlement risk.
- Liquidity framework should be applied equally to all banks.
- Current restrictions limiting licensed commercial banks’ access to CBSL deposit facilities (e.g., 5 times per month) weaken monetary policy transmission and should be removed.

### Reserves, external buffers, and FX operations
- Reserve levels projected to rise in 2024 until adequacy is achieved at end of program, though subject to risks from recent and upcoming outflows.
- End-2023 NIR target kept unchanged, but adjusted target (QPC) forecasted to be lower given lower-than-expected project financing.
- CBSL committed to accumulate more reserves once banks’ NOPs rebalance in 2024; GIR forecasted at U$5.35 billion at end-2024, around US$800 million below program approval projections.
- Significant expected net drains on gross reserves over program period, largest from repayments on restructured debt and payments on central bank credit lines including US$2.6 billion for the ACU repayments and the RBI SAARC swap.
- Reserve adequacy (IMF’s ARA metric) expected to be reached by 2027, albeit with greater uncertainty.
- Program will include caps on adjustors for project financing and FX payments on restructured CPC loans to drive proactive reserve accumulation.
- Staff warned against repeated CBSL interventions through direct sales; FX interventions should be limited to disorderly market conditions and consistent with meeting NIR targets.
- Authorities committed to restructure remaining FX local law debt of government and SOEs to state banks in a way minimizing adverse impact on banks’ capital and FX NOPs (MEFP ¶27).
- In case FX sales threaten NIR targets, program conditionality such as FX intervention budgets could be considered in future reviews.

### Exchange rate regime, FX market depth, and import restrictions
- Exchange rate regime is flexible; FX market remains shallow and displayed relative stability recently.
- Beyond periods in June and August, central bank engaged only in FX accumulation to build reserves; market settled into relative stability without large direct central bank FX sales.
- Banks managed their FX positions after the DDO internally, reducing interbank FX market usage and leading to a shallow market with low turnover and small exchange rate movements.
- Authorities have relaxed import restrictions apart from vehicles and eliminated some measures inconsistent with Article VIII obligations:
  - Most import restrictions relaxed in phases: 286 items in June, 325 in July, and 299 in October.
  - Removing remaining vehicle import restrictions to be considered after completion of debt restructuring to avoid undue current account pressures.
- Since program approval, authorities eliminated three out of six existing multiple currency practices and three out of eight existing exchange restrictions.
- Some Capital Flow Management Measures (CFMs) relaxed, including increasing limits on certain outflows (Annex VII).
- Authorities working on a plan (initially envisaged for end-June 2023) on phased removal of import restrictions, exchange restrictions, MCPs, and CFMs during the program period.

*Source: 1lkaea2023003 - 13.      To ensure adequate support for the poor and vulnerable, the program will continue to (PDF).*

### 26.      A prompt implementation of the banks’ recapitalization strategy is crucial to

### 26.      A prompt implementation of the banks’ recapitalization strategy is crucial to

### Recapitalization of the banking sector
- A recapitalization plan for the five largest banks (prior action) has been developed by the Financial Crisis Management Committee (comprising CBSL and MoF) to support compliance with the CBSL roadmap and minimize implementation delays.
- The plan:
  - Assesses size of capital and FX shortfalls taking into account the restructuring terms for the CPC FX loans and the locally held portion of the ISBs, the impact on banks’ NOPs, additional provisions recommended by the AQR, and a forward-looking assessment of NPLs based on stress testing.
  - Sets out high-level terms, conditions and format for government support.
- State-owned banks are presumed to raise capital from the government.
- Private banks will submit capital plans for review by the CBSL; public capital support would be available only as a backstop and its design would consider avoiding increased state role in governance of private banks.
- A similar plan will be developed for the remaining four banks covered by the AQR by end-February (new SB).
- Main issues identified by the AQRs: collateral valuation and underprovisioning for domestic law FX exposures to the public sector.
- Recapitalization needs are expected to remain within the contingency amounts incorporated in the DSA at program approval (about 6 percent of 2022 GDP).
- Assumption for DSA purposes: recapitalization operation takes place in mid-2024, and provides participating banks with long-term LKR bonds, in exchange for common equity or Additional Tier 1 capital instruments (with no coupon or dividend payments in the first three years).

### Banking Act amendments, supervision, and crisis management
- Authorities need to move swiftly to amend the Banking Act (BA) to restore investor confidence and improve governance of state-owned banks.
- Cabinet approved instructions to amend the BA to strengthen requirements for:
  - bank capital,
  - large exposures,
  - related party lending,
  - governance and fit-and-proper standards,
  - audit standards for state-owned banks.
- Timeline changes:
  - End-December 2023 SB related to Parliamentary approval of a full revision of the BA is proposed to be replaced by a new SB requiring parliamentary approval by end-January 2024 of the amendments of the BA (new SB).
  - Implementation of the amendments to the Banking Act is proposed for end-March 2024 (new SB).
- Significant reforms to the resolution regime were passed earlier and further work is needed to strengthen the deposit insurance fund with WB financial support and TA.

### Reducing corruption vulnerabilities and strengthening governance
- Authorities committed to governance reforms based on the Governance Diagnostic (GD) report; a government action plan (new SB) will inform next steps.
- Anticorruption legal frameworks and institutions:
  - Constitutional Council to develop rules for appointing CIABOC commissioners; rules to be published in the Gazette by end-December 2023 (new SB).
  - A more comprehensive asset recovery law will be enacted by April 2024 in compliance with FATF standards in consultation with the IMF (new SB).
  - Staff recommended appointing commissioners and publishing implementation plans for the AC Bill by December 2023.
  - Operationalized Anti-Corruption commission should publish asset declarations for senior officials by July 2024 (new SB).
- Tax policy and revenue administration:
  - Authorities will no longer approve new projects under the SDP Act by December 2023 and will amend the law to include explicit and transparent selection and evaluation processes for new investment projects.
  - Authorities agreed not to extend new tax incentives schemes without prior consultations with the IMF.
- PFM and procurement transparency:
  - By end-December 2023 (new SB), publish on a designated website on a semi-annual basis:
    - all public procurement contracts above LKR 1 billion with comprehensive searchable information on contract award winners;
    - a list of all firms receiving tax exemptions through the Board of Investment and the SDP and an estimation of the value of the tax exemption;
    - a list of firms receiving tax exemptions on luxury vehicle imports.
- Financial sector oversight:
  - Cabinet to adopt and publish, in consultation with IMF and WB/IFC, a framework to strengthen governance of State-Owned Banks requiring boards to have a majority of independent members, and nominations made by banks’ nomination committees following open search procedures with clear requirements for independence and professional experience by end-June 2024 (new SB).
- AML/CFT:
  - National ML/FT Risk Assessment (NRA) updated and published on September 14, 2023.
  - AML/CFT National Policy for 2023-2028 approved by the Cabinet of Ministers on August 7, 2023.
  - Authorities committed to continue strengthening AML/CFT regime, including amendments to legal framework and strengthened cooperation between FIU, law enforcement, and CIABOC.

### Raising potential growth
- Growth-enhancing reforms to be incorporated into the EFF-supported program after stabilization.
- Trade and FDI:
  - Authorities rationalized para-tariffs as commitments under the WB’s Development Policy Operation.
  - More trade reforms underway: implementing a National Export Strategy, expediting bilateral and regional trade agreements, participating in global value chains, promoting tourism.
  - Investment regime needs streamlining, e.g., fully implementing a national single window for investors.
- Labor productivity, participation, and gender gaps:
  - Authorities committed to developing a comprehensive strategy to improve:
    - (i) labor market flexibility through ongoing reforms to the Labor Act,
    - (ii) labor skills through education reforms,
    - (iii) financial inclusion including supporting female entrepreneurs’ access to credit guarantee schemes,
    - (iv) public transportation infrastructure,
    - (v) availability, quality and affordability of child and elderly care.
- Other reforms:
  - Continue public sector efficiency reforms including digitalization of public services, and address investment needs in electricity generation and transmission.
  - Reduce government and SOEs’ role to improve resource allocation and productivity, facilitating private sector access to land and digital platforms.
  - Strengthen adaptation to climate change, including contingency budgeting and insurance schemes for natural disasters.

### Program modalities, financing, and arrears
- LOI and MEFP describe progress and set out policy commitments; TMU clarifies program definitions and quarterly targets.
- Program financing and gap figures (2022–2027; in millions of USD) reported by staff:
  - Financing Gap (A): -2,834; -5,674; -4,654; -4,708; -3,291; -3,949; -25,110 (Total 2022-27)
  - Program Financing (B): 2,834; 5,674; 4,654; 4,708; 3,291; 3,949; 25,110 (Total 2022-27)
  - IMF EFF: 0; 682; 268; 268; 568; 934; 6,30?84 (text shows "IMF EFF06826826856893463084" — preserve as presented)
  - IFI program financing support: 0; 1,220; 780; 524; 524; 524; 3,572
  - World Bank*: 0; 570; 330; 0; 0; 900; 0 (presented as "World Bank*0570330000900")
  - ADB: 0; 650; 450; 300; 300; 300; 2,000
  - Other Financing**: 0; 0; 0; 224; 224; 224; 672
  - Debt moratorium: external arrears accumulation: 2,834; 0; 0; 0; 0; 0; 2,834
  - Debt relief: 0; 3,772; 3,192; 3,499; 2,078; 1,579; 14,120
  - Sovereign bonds (market access): 0; 0; 0; 0; 0; 1,500; 1,500
  - Shortfall (A+B): 0; 0; 0; 0; 0; 0; 0
  - Memorandum items:
    - Gross International Reserves: 1,898; 3,806; 5,346; 7,477; 9,894; 13,525
    - Project loans: 1,473; 680; 1,200; 1,556; 1,603; 1,651
- An additional US$135 million disbursement from the WB on deposit insurance is not included in program financing, as it will be ringfenced.
- Staff supports waiver of non-observance of one PC at end-June given the breach was temporary and the September IT was met; all outstanding arrears were cleared by end-September 2023.
- New program conditionality agreed: revised targets for end-December 2023—QPC on the NCG, the MPCC bands, the IT on tax revenue, and IT on the limit on treasury guarantees due to the new guarantee of the special swap between the CBSL and the RBI; new quantitative targets proposed for end-March (ITs), end-June (QPCs), and end-September 2024 (ITs); new continuous QPC on new CBSL purchases of government securities in the primary market as of December 2023; upgrade the IT on tax revenue to a QPC as of June 2024; new structural benchmarks proposed.

### Risks, safeguards, and capacity to repay
- Enterprise risks identified:
  - Financial risks from capacity to repay and prolonged debt risks; credit risks to the Fund extend beyond the program until final repurchase.
  - Business and reputational risks from waning public support for reforms after debt restructuring.
  - Security risks from socio-political tensions.
- Mitigation measures:
  - Authorities’ firm commitment to conclude public debt restructuring.
  - Upfront implementation of reform measures including on anti-corruption.
  - Adjust program conditionality to evolving circumstances.
  - Extensive Capacity Development (CD) support.
  - Steadfast implementation of structural reforms to boost confidence and growth.
- Safeguards:
  - Effective implementation of the new CBA is key to improve CBSL’s institutional framework, mandate, governance arrangements, and autonomy.
  - CBSL received TA on assessing its balance sheet and monetary operations and has initiated implementation of recommendations of the 2023 safeguards assessment; performed an internal audit verification of program monetary data submitted to the Fund.
- Capacity to repay the Fund (Table 7 highlights):
  - Fund outstanding credit would peak at 3.7 percent of GDP in 2027, corresponding to 14.4 percent of exports of goods and services and 24 percent of gross reserves.
  - EFF repurchases and charges would peak in 2031, at 2.5 percent of exports of goods and services and 4.0 percent of gross reserves.
  - Capacity to repay is adequate under the program scenario but contingent on successful implementation of program measures and a debt restructuring that restores debt sustainability.

### Staff appraisal and policy recommendations
- Progress noted: rapid disinflation, rebuilding reserves, and significant fiscal adjustment; steps to relax import restrictions and remove administrative BOP measures; progress in debt negotiations; publication of the governance diagnostic report.
- Remaining vulnerabilities: subdued growth momentum, banking sector vulnerabilities, and slowed reserves accumulation.
- Key policy recommendations:
  - Promptly implement banks’ recapitalization strategy and recapitalization plans for remaining AQR-covered banks by end-February.
  - Expedite amendment and implementation of the Banking Act to strengthen supervision, governance, capital and related-party rules with parliamentary approval by end-January 2024 and implementation by end-March 2024.
  - Strengthen deposit insurance fund (with WB support) and crisis management capacity.
  - Preserve revenue-based fiscal consolidation and continue revenue administration reforms, including boosting compliance by large taxpayers and curbing corruption vulnerabilities in the tax system.
  - Avoid faster-than-warranted monetary policy loosening; CBSL should continue offloading government securities and no longer make purchases in the primary market.
  - Expedite efforts to recapitalize the CBSL.

*Source: IMF staff report excerpt (1lkaea2023003).*

### 41.      Despite the near-term challenges, the authorities should continue accumulating

### Despite the near-term challenges, the authorities should continue accumulating reserves

### Reserve policy and exchange rate flexibility
- Rebuilding external buffers and restoring reserve adequacy are critical to meet program targets, including to restore debt sustainability.
- A slower pace for reserve accumulation during the remainder of 2023 is justified amid FX scarcity given the financial system’s need for FX and lower project financing.
- A faster pace of accumulation would be needed in 2024 and beyond to ensure reserve adequacy is achieved by 2027.
- Selling FX should be limited to disorderly market conditions and not prevent the exchange rate from moving in line with economic fundamentals.

### Financial stability and banking sector reforms
- Financial stability hinges on a well-recapitalized banking system and strengthened legal framework.
- Despite recent improvements, financial system vulnerabilities remain and need to be addressed promptly.
- The prompt implementation for financial sector recapitalization is key to safeguarding financial stability.
- Efforts to strengthen financial supervision and crisis management framework are crucial to enhance resilience and prepare the financial system for times of stress.

### Governance, anti-corruption, and public financial management
- Reforms to tackle corruption and strengthen governance are critical to unleash Sri Lanka’s growth potential.
- Enacting the anti-corruption bill is an important milestone in eradicating corruption in Sri Lanka.
- The next step is to ensure a transparent and merit-based selection process for the Anti-corruption Commission members.
- A timely implementation of key recommendations from the Governance Diagnostic exercise to tackle corruption vulnerabilities in revenue administration, tax policies, public procurement, and PFM as well as financial oversight will be critical.

### Reform ownership, implementation, and risks
- More visible ownership of program reforms is key for credibility.
- Reform momentum should be strengthened with enhanced ownership, building on the progress made so far.
- Accelerating implementation of structural reforms especially for fiscal, banking and governance reforms is critical and will increase confidence in Sri Lanka’s recovery.
- Risks to program implementation and financing are high and have increased since program approval.
- Risks stem from slower-than-envisaged reserve accumulation amid debt restructuring uncertainties, less certain project financing, potential delays in implementing the debt restructuring, a weakened banking sector, exchange rate pressure, and loss of market confidence.
- Implementation risks also arise from Sri Lanka’s weak track record of reform implementation, and the challenging political and social situation.
- Contingency plans are crucial and policies should remain agile to adjust to the evolving circumstances.

*SRI LANKA INTERNATIONAL MONETARY FUND 29*

### 46.      Staff supports the completion of the first review under the EFF arrangement, in light of

### 46.      Staff supports the completion of the first review under the EFF arrangement, in light of

### Program endorsement and conditionality actions
- Staff supports the completion of the first review under the EFF arrangement, in light of recent progress, corrective actions and the authorities’ commitment to maintaining the reform momentum.
- Staff supports the authorities’ request for:
  - modification of quantitative conditionality;
  - completion of the MPCC consultation with the Executive Board and modification of the MPCC;
  - rephasing of access;
  - waiver for the non-observance of the PC on arrears.
- Staff also supports the completion of the financing assurances review.

### Real sector findings
- Following a large contraction in 2022, the economy continued to contract in the first half of 2023, reflecting weak industrial activity.
- Consumption remained suppressed by the interest rate environment.
- PMIs and industrial production suggest some stabilization, but growth momentum remains weak.
- Trade balance improved due to large import compression.
- Headline and core inflation have fallen significantly in recent months, reflecting:
  - passthrough of tight monetary conditions;
  - easing commodity inflation;
  - weak demand;
  - stronger rupee.

### Fiscal sector findings and dynamics
- Amid the recession, tax revenue increases and primary spending restraint delivered a primary surplus.
- Public debt and gross financing needs remain elevated.
- Tax collections were driven by improved income taxes and other indirect domestic taxes.
- Interest payments weigh on the budget.
- Local currency yields have declined but remain much higher than historic levels.
- Sri Lanka’s EMBI spreads have declined but remain at high levels.

### Financial market and monetary developments
- T-bill and T-bond yields have moderated slightly, reflecting a policy rate cut, disinflation, and resolution of uncertainty regarding debt restructuring.
- The central bank’s net credit to government has peaked, while the gap narrowed between budget financing costs and the call market rate.
- Lending rates moderated while deposit rates remained elevated due to high share of time deposits.
- Equities market showed first signs of recovery following its collapse in 2022.

### Foreign exchange and reserves
- The rupee remains above its post-devaluation level after reversing some earlier appreciation, and has clawed back some but not all the gap with regional peers.
- Inflation and recent nominal appreciation have offset some earlier REER depreciation.
- CBSL purchased significant FX in H1 2023 to build reserves.
- There has been some entry of foreign investors into the T-bills market in 2023.
- Both GIR and NIR bounced back by June 2023 from their lows in 2022 but remained flat since June.

### Monetary and financial sector health
- Monetary aggregates fell sharply, and private credit continued to contract.
- Despite recovery of Net Foreign Assets, declining T-bill holdings contributed to negative reserve money growth.
- Banks’ reported capital adequacy still appeared above regulatory requirements, but this does not include adjustments recommended by the AQR.
- Reported NPLs have continued to rise, likely reflecting high real interest rates and economic contraction.
- Net interest rate margin compressed and profitability shrank.
- The banking sector overall remains liquid.

### Balance of payments and external financing
- Goods exports dropped in the first half of 2023; imports declined due to import compression and restrictions.
- Current account moved to a surplus in H1 2023.
- External financing was dependent on program partners.
- GIR grew significantly in H1 2023 as net purchases were large.
- Savings-investment balance includes net savings by private sector and net investment by the public sector.

### Key projections and numerical indicators (selected, as reported)
- Real GDP growth: -0.2 (2019 Prel.), -4.6 (2022 Act.), 3.5 (2023 Prog. Req.), -7.8 (2023 Proj.), -3.0 (2024 Prog. Req.), -3.6 (2024 Proj.), 1.5 (2025 Prog. Req.), 1.8 (2025 Proj.), 2.7 (2026 Prog. Req.), 3.0 (2026 Proj.), 3.1 (2027 Prog. Req.), 3.1 (2027 Proj.), 3.1 (2028 Prog./Proj. entries vary).
- Inflation (average, Colombo CPI): 4.3 (2019), 4.6 (2020), 6.0 (2021), 45.2 (2022), 28.5 (2023 Prog. Req.), 17.9 (2023 Proj.), 8.7 (2024 Prog. Req.), 7.9 (2024 Proj.), 5.6 (2025 Prog. Req.), 5.4 (2025 Proj.), 5.3 (2026 Prog. Req.), 5.2 (2026 Proj.).
- Public debt (percent of GDP, public debt): 89.0 (2019 Prel.), 105.1 (2020 Act.), 114.9 (2021 Act.), 125.8 (2022 Act.), 111.2 (2023 Prog. Req.), 114.1 (2023 Proj.), 108.5 (2024 Prog. Req.), 115.9 (2024 Proj.), 116.3 (2025 Prog. Req.), 115.1 (2025 Proj.), 111.7 (2026 Prog. Req.), 107.9 (2026 Proj.).
- Gross official reserves (end of period, in millions of U.S. dollars): 7,642 (2019), 5,664 (2020), 3,139 (2021), 1,898 (2022), 4,431 (2023 Prog. Req.), 3,806 (2023 Proj.), 6,128 (2024 Prog. Req.), 5,346 (2024 Proj.), 7,477 (2025 Prog. Req.), 9,894 (2025 Proj.), 13,525 (2026 Prog. Req.), 15,320 (2026 Proj.).
- Current account balance (in millions of U.S. dollars): -1,844 (2019), -1,187 (2020), -3,285 (2021), -744 (2022), -1,184 (2023 Prog. Req.), 1,232 (2023 Proj.), -1,092 (2024 Prog. Req.), -634 (2024 Proj.), -908 (2025 Prog. Req.), -879 (2025 Proj.), -846 (2026 Prog. Req.), -764 (2026 Proj.).
- Central government gross financing needs (percent of GDP): 21.7 (2019), 26.1 (2020), 31.0 (2021), 33.9 (2022), 26.6 (2023 Prog. Req.), 27.8 (2023 Proj.), 17.9 (2024 Prog. Req.), 25.3 (2024 Proj.), 23.0 (2025 Prog. Req.), 19.8 (2025 Proj.), 17.1 (2026 Prog. Req.), 12.3 (2026 Proj.).
- Tabled program financing schedule under the Extended Arrangement (original): Availability at arrangement approval 254.4 (millions of SDR), September 1, 2023 254.4, March 1, 2024 254.4, September 1, 2024 254.4, March 1, 2025 254.4, September 1, 2025 254.4, March 1, 2026 254.4, September 1, 2026 254.4, March 1, 2027 254.4; Total 2,286.0 (millions of SDR), Percent of Quota 395.0.

### Program implementation implications and monitoring
- Completion of the first review and related modifications (conditionality, MPCC changes, rephasing of access, arrears waiver) are supported by staff given recent corrective actions and authorities’ commitments.
- Financing assurances review completion is supported by staff, indicating continued reliance on program partner financing and monitoring of GIR and usable reserves.
- Continued monitoring of:
  - inflation trends and monetary transmission;
  - fiscal interest burden and public debt trajectories;
  - banking sector asset quality and adequacy adjustments from the AQR;
  - external financing flows, GIR, and contingent exceptional financing needs.

*Sources: CBSL; Ministry of Finance; Bloomberg Data L.P.; CEIC; and IMF staff estimates.*

### Annex I. Drivers of the Tax Revenue Shortfall in 2023

### Annex I. Drivers of the Tax Revenue Shortfall in 2023

### Overview
- Tax revenue is projected at about 9.2 percent of GDP in 2023, about 2 percentage points above 2022, driven mainly by improvements in income tax collections and other indirect domestic taxes following tax policy measures adopted since September 2022.
- Despite the improvement relative to 2022, revenue is projected to fall short of program request projections by 0.8 percentage points of GDP in 2023, with a carryover shortfall of about 0.3 percentage points of GDP into 2024.

### Magnitude and persistence of the shortfall
- Shortfall in 2023: 0.8 percentage points of GDP relative to program request projections.
- Carryover shortfall into 2024: about 0.3 percentage points of GDP.
- Staff estimate of shortfall without additional compensating measures: about 1.5 ppt of GDP on average between 2023 and 2024.
- In the absence of new measures, staff projects tax revenue to be almost 20 percent lower on average in 2023 and 2024 than at the program request.

### Drivers of the revenue shortfall
- Economic factors (combined effects of a larger economic contraction, less depreciated exchange rate, lower inflation, and lower imports):
  - Estimated to contribute almost 40 percent to the tax revenue shortfall in 2023 and about 30 percent in 2024.
  - The exchange rate is more appreciated relative to the program request and, together with lower commodity prices, is expected to reduce the value of imports.
  - Imports account for about one third of tax revenue and are projected to be lower by more than 25 percent in local currency terms in 2023 relative to the program request.
  - This economic underperformance would result in tax revenue that is about 7 percent lower in 2023 than projected at the time of the program request.
- Policy/administrative constraints:
  - A delay in the lifting of import restrictions on motor vehicles accounts for about 8 percent of the shortfall.
  - Weak revenue administration is assumed to account for the balance of the shortfall—about 50 percent of the shortfall—reflecting low filing compliance and inadequate tools to detect and deter inaccurate reporting.

### Tax administration, taxpayer registration, and compliance
- January Tax Administration Diagnostic Tool (TADAT) assessment and follow-up discussions highlighted weaknesses in tax administration, including low filing compliance and inadequate audit/detection tools.
- Despite tax policy reforms (notably lowering registration thresholds for income taxes and VAT), the number of registered taxpayers at end-2022 was about 438,000 compared to about 1.7 million before the 2019 tax measures.
- Staff assessment: without compensating measures, revenue administration shortcomings could contribute to an additional revenue loss of 10 percent in 2023 relative to program request projections.
- Efforts to increase taxpayer compliance have not yet translated into increased revenue; the lowered registration thresholds have not materially increased registered taxpayers.

*Source: IMF staff analysis in "Annex I. Drivers of the Tax Revenue Shortfall in 2023."*

### 5. Debt consolidation across sectors:

### 5. Debt consolidation across sectors:

### Perimeter and intra-government holdings
- DSA perimeter includes:
  - central government debt;
  - SOE debt guaranteed by the central government;
  - liabilities of the central bank arising from the 2016-20 EFF and bilateral swap arrangements.
- Other public financial corporation holdings of CG debt include holdings by state-owned banks (estimated based on end-September information) but exclude retirement funds.
- Provincial and local governments do not carry debt as they are not authorized to borrow.
- Table entries (holders/issuers): Budget. central govt 283442287062; Nonfin pub. corp. 702702; other entries 0. Total shown: 000000283449307764.

### Public debt structure and drivers
- Commentary highlights:
  - Accelerating inflation reduced the real value of domestic debt in 2022.
  - Exchange rate depreciation led to a large increase in external and foreign-currency debt.
  - Foreign-law debt accounts for more than half of Sri Lanka's debt.
  - The debt operation is assumed to rebalance the maturity profile.
- Maturity and instrument notes:
  - Residual maturity: 6. years.
  - Marketable vs nonmarketable, domestic vs foreign currency and governing law breakdowns are shown for central government (figures and charts in source).

### Baseline scenario projections (Table 4)
- Public debt (Percent of GDP) by year:
  - Prel. 2022: 125.8
  - 2023: 114.1
  - 2024: 115.9
  - 2025: 116.3
  - 2026: 115.1
  - 2027: 111.7
  - 2028: 107.9
  - 2029: 104.2
  - 2030: 100.7
  - 2031: 97.3
  - 2032: 94.0
  - 2033: 90.8
- Change in public debt (Percent of GDP) by year:
  - 2022: 11.5
  - 2023: -11.7
  - 2024: 1.8
  - 2025: 0.5
  - 2026: -1.3
  - 2027: -3.4
  - 2028: -3.8
  - 2029: -3.6
  - 2030: -3.5
  - 2031: -3.4
  - 2032: -3.3
  - 2033: -3.1
- Contribution of identified flows (Percent of GDP) by year:
  - 2022: 6.6
  - 2023: 1.8
  - 2024: 0.9
  - 2025: -1.3
  - 2026: -2.2
  - 2027: -2.7
  - 2028: -3.2
  - 2029: -3.0
  - 2030: -3.0
  - 2031: -2.9
  - 2032: -2.9
  - 2033: -2.7
- Primary deficit (Percent of GDP) by year:
  - 2022: 3.7
  - 2023: 0.7
  - 2024: -0.8
  - 2025: -2.3
  - 2026: -2.3
  - 2027: -2.3
  - 2028: -2.3
  - 2029: -2.3
  - 2030: -2.3
  - 2031: -2.3
  - 2032: -2.3
  - 2033: -2.3
- Noninterest revenues and expenditures (Percent of GDP):
  - Noninterest revenues: 2022: 8.2; 2023: 10.1; 2024: 12.9; 2025–2033: 14.9, 15.0, 15.1, 15.1, 15.1, 15.1, 15.1, 15.1, 15.1
  - Noninterest expenditures: 2022: 11.9; 2023: 10.8; 2024: 12.1; 2025–2033: 12.6, 12.7, 12.8, 12.8, 12.8, 12.8, 12.8, 12.8, 12.8
- Automatic debt dynamics and components (Percent of GDP / rates):
  - Automatic debt dynamics: 2022: 2.9; 2023: 1.1; 2024: -0.4; 2025: 0.0; 2026: -0.4; 2027: -0.8; 2028: -0.9; 2029: -0.7; 2030: -0.7; 2031: -0.6; 2032: -0.6; 2033: -0.4
  - Real interest rate and relative inflation:
    - Real interest rate and relative inflation: 2022: -15.7; 2023: -3.6; 2024: 1.6; 2025: 3.0; 2026: 2.9; 2027: 2.6; 2028: 2.4; 2029: 2.5; 2030: 2.4; 2031: 2.4; 2032: 2.3; 2033: 2.4
    - Real interest rate: 2022: -32.9; 2023: -14.0; 2024: -2.2; 2025: 1.0; 2026: 1.2; 2027: 0.8; 2028: 0.8; 2029: 0.9; 2030: 0.9; 2031: 0.9; 2032: 0.9; 2033: 1.1
    - Relative inflation: 2022: 17.2; 2023: 10.4; 2024: 3.8; 2025: 2.1; 2026: 1.7; 2027: 1.7; 2028: 1.6; 2029: 1.6; 2030: 1.5; 2031: 1.4; 2032: 1.4; 2033: 1.3
  - Real growth rate (selected entries): 2022: 9.7; 2023: 4.7; 2024: -2.0; 2025: -3.1; 2026: -3.4; 2027: -3.4; 2028: -3.3; 2029: -3.2; 2030: -3.1; 2031: -3.0; 2032: -2.9; 2033: -2.8
  - Other identified flows: 2022: 0.0; 2023: 0.0; 2024: 2.1; 2025: 1.0; 2026: 0.5; 2027: 0.5; thereafter 0.0
  - Contribution of residual (Percent of GDP) by year:
    - 2022: 4.9
    - 2023: -13.5
    - 2024: 0.9
    - 2025: 1.8
    - 2026: 1.0
    - 2027: -0.7
    - 2028: -0.6
    - 2029: -0.6
    - 2030: -0.5
    - 2031: -0.5
    - 2032: -0.5
    - 2033: -0.4
- Gross financing needs and composition (Percent of GDP):
  - Gross financing needs: 2022: 33.9; 2023: 27.8; 2024: 25.3; 2025: 23.0; 2026: 19.8; 2027: 17.1; 2028: 12.3; 2029: 11.9; 2030: 11.6; 2031: 12.3; 2032: 12.8; 2033: 13.7
  - of which: debt service: 2022: 30.2; 2023: 27.1; 2024: 26.1; 2025: 25.3; 2026: 22.1; 2027: 19.4; 2028: 14.6; 2029: 14.2; 2030: 13.9; 2031: 14.6; 2032: 15.1; 2033: 16.0
  - Local currency GFN: 2022: 21.1; 2023: 25.3; 2024: 23.3; 2025: 21.9; 2026: 18.8; 2027: 15.4; 2028: 10.3; 2029: 9.8; 2030: 9.6; 2031: 10.3; 2032: 10.9; 2033: 11.7
  - Foreign currency GFN: 2022: 9.1; 2023: 1.7; 2024: 2.8; 2025: 3.4; 2026: 3.3; 2027: 4.0; 2028: 4.4; 2029: 4.4; 2030: 4.3; 2031: 4.3; 2032: 4.2; 2033: 4.2
- Memo indicators:
  - Real GDP growth (percent): 2022: -7.8; 2023: -3.6; 2024: 1.8; 2025: 2.7; 2026: 3.0; 2027: 3.1; 2028: 3.1; 2029: 3.1; 2030: 3.1; 2031: 3.1; 2032: 3.1; 2033: 3.1
  - Inflation (GDP deflator; percent): 2022: 48.8; 2023: 20.4; 2024: 10.1; 2025: 6.3; 2026: 5.4; 2027: 5.3; 2028: 5.2; 2029: 5.2; 2030: 5.2; 2031: 5.2; 2032: 5.2; 2033: 5.2
  - Nominal GDP growth (percent): 2022: 36.5; 2023: 16.1; 2024: 12.1; 2025: 9.1; 2026: 8.6; 2027: 8.5; 2028: 8.5; 2029: 8.5; 2030: 8.5; 2031: 8.5; 2032: 8.5; 2033: 8.5
  - Effective interest rate (percent): 2022: 9.4; 2023: 7.5; 2024: 8.0; 2025: 7.2; 2026: 6.5; 2027: 6.1; 2028: 6.0; 2029: 6.1; 2030: 6.2; 2031: 6.2; 2032: 6.3; 2033: 6.5

### Realism of baseline assumptions and medium-term risks
- Staff commentary:
  - Public debt increased drastically in 2020-22 due to exchange rate depreciation, large fiscal deficits, SOE borrowing, and external borrowing by the Central Bank.
  - Near-term debt decline is driven by inflation and contributions from creditors (assumed in 2023 and shown in residuals).
  - Longer-term debt reduction depends on continued fiscal discipline.
- Realism and risk indicators (selected):
  - Fanchart width: 76.0 1.1
  - Probability of debt not stabilizing (pct): 8.9 0.1
  - Terminal debt level x institutions index: 68.2 1.5
  - Average GFN in baseline: 18.2 6.2
  - Bank claims on government (pct bank assets): 36.2 11.7
  - Change in claims on govt. in stress (pct bank assets): 4.7 1.6
  - GFN financeability index: ... 19.5
  - Prob. of missed crisis, 2023-2028 (if stress not predicted): 54.5 pct.
  - Prob. of false alarm, 2023-2028 (if stress predicted): 3.4 pct.
- Commentary: MT tools point to high levels of risk associated with relatively high debt and GFNs, a strong sovereign-bank nexus, and vulnerability to large shocks (including natural disasters that could push debt and GFNs to very high levels).

### Debt restructuring negotiations (Annex IV developments)
- Official sector involvement (OSI):
  - OCC co-chaired by France, India and Japan; four OCC meetings held on May 9, June 8, July 24, and September 22.
  - OCC provisionally agreed on a cutoff date of March 18, 2022.
  - In November 2023, an agreement in principle was agreed between the authorities and the OCC to restructure its claims on Sri Lanka.
  - China ExIm participated as observer; in October announced a tentative agreement with authorities.
- Private Sector Involvement (PSI):
  - Initial restructuring proposal from foreign bondholders’ advisors received on April 11.
  - On October 13, foreign bondholders group presented a revised proposal featuring a macro-linked bond with state-contingent debt service; authorities have not accepted it.
  - Litigation by Hamilton Reserve Bank ongoing; US court granted Sri Lanka’s motion for a stay until February 29, 2024.
  - Technical exchanges with CDB, including Colombo in May 2023 and Beijing in October 2023, occurred to reconcile DSA modeling.
- Domestic Debt Exchange (DDO) launched in July 2023; key aspects concluded in September 2023:
  - DDO perimeter aligned with indicative scenario and covers:
    - CBSL’s holdings of Treasury Bills from outright primary market purchases and provisional advances to the government;
    - a voluntary exchange of Treasury Bonds with a minimum participation requirement for superannuation funds to avoid an increase in investment income tax rate from 14 percent to 30 percent;
    - Sri Lankan Development Bonds (SLDBs) and domestic banks’ FX loans extended to the central government.
  - Outcomes of exchanges:
    - CBSL’s short-term claims restructured into a new 15-year instrument with a gliding interest rate path matching projected disinflation.
    - Treasury Bonds exchange lengthened average maturity at a 12 percent initial coupon rate stepping down to 9 percent in 2026.
    - Holders of SLDBs and FX bank loans opted for local currency payments: floating rate indexed to the Standing Lending Facility Rate plus 1 percent, 10-year amortizing T-bond with no haircut.
  - Restructuring terms for FX local law claims taken over from the CPC are being contemplated in the context of a holistic bank recapitalization plan.
- IMF staff role:
  - Facilitated debtor-creditor engagement, shared macro and financing assumptions, provided DSA modeling support, participated in OCC meetings, and assessed consistency of proposals with program parameters.

### Consultation on missed inflation target under the MPCC (Annex V)
- Context:
  - Headline inflation declined to 23.4 percent in Q2 2023, 4.6 percentage points lower than the outer MPCC band as agreed under the EFF.
- Key drivers of faster-than-expected disinflation:
  - Limited Exchange Rate Passthrough: Rupee appreciated by 18 percent between February and May 2023 rather than depreciating.
  - Muted Second Round Effects: Despite electricity tariff hikes of 66 percent, nominal wage growth remained moderate; private credit and real GDP growth contracted by 4.5 and 7.9 percent in the first half of 2023, respectively.
  - Global food and energy deflation and strong base effects also contributed.
- Policy response:
  - CBSL lowered the policy rate (lending facility) by 550 basis points between June and October.
  - Broader monetary conditions eased: 3-month T-bills rate and prime lending rate declined from peak 30-33 percent to 16.6 and 14 percent respectively in October 2023.
  - Contemporary real policy rate: 9.6 percent; forward-looking real policy rate: 4 percent; neutral rate cited as 2.5 percent.

*Source: IMF staff report chapter titled "5. Debt consolidation across sectors:"*

### 3.      Inflation Outlook.

### 3.      Inflation Outlook.

### Near-term projection
- Inflation is expected to increase to 4.8 precent in Q4 2023 due to the 18 percent increase in the electricity tariff in October.

### Medium-term projection
- Further increases are projected in 2024 due to tax policy measures (e.g., VAT rate increases and removal of several exemptions).

### Longer-term path
- Gradual convergence to inflation target 5 percent in the outer years.

*Source: IMF staff (content unit: 3.      Inflation Outlook.)*

### 7.      Restricting outward transfer of funds for emigrants etc.

### 7.      Restricting outward transfer of funds for emigrants etc.

### Summary of measures and timeline
- On April 2, 2020, measures introduced for a period of 3 months:
  - the eligible migration allowance for the emigrants who are claiming the migration allowance for the first time has been limited up to a maximum of US$30,000.
  - the repatriation of funds under the migration allowance through Capital Transactions Rupee Accounts (CTRAs) by the emigrants who have already claimed migration allowance under the general permission was suspended.
- On July 2, 2020, measures introduced for a period of 6 months:
  - the eligible migration allowance for the emigrants who are claiming the migration allowance for the first time continue to be limited up to a maximum of US$30,000,
  - the repatriation of funds under the migration allowance through CTRAs by the emigrants who have already claimed migration allowance, was limited up to a maximum of US$20,000.
- On December 18, 2020, the period of validity of the above measures were extended for further 6 months from January 2, 2021. (time extension)
- On July 02, 2021, measures implemented for a period of 6 months:
  - Suspended the repatriation of funds under the migration allowance out of funds received as monetary gifts by an emigrant from an immediate family member, being funds realized from any asset in Sri Lanka (including movable, immovable, tangible and intangible assets);
  - Limited the repatriation of funds under the migration allowance through CTRAs by the emigrants who have already claimed migration allowance, up to a maximum of US$10,000.
  - Continued to limit the eligible migration allowance for the emigrants who are claiming the migration allowance for the first time, up to a maximum of US$30,000.
  - Limited the outward remittances or issuance of FX for any Sri Lankan individual who resides in or outside Sri Lanka and has obtained Temporary Residence Visa of another country, up to a maximum of US$20,000 per person.
  - Limited the issuance of FX for any person resident in Sri Lanka who intends to leave Sri Lanka under the Temporary Residence Visa of another country up to a maximum of US$10,000 per person. (tightening)
- On December 15, 2021, the period of validity of the above measures were extended for further 6 months from January 2, 2022. (time extension)
- On June 30, 2022, the suspension/limitations above were extended for further 6 months. (time extension)
- On December 22, 2022, the above suspension/limitations were extended for further 6 months from December 30, 2022. (time extension)
- On June 28, 2023, measures implemented for a period of 6 months (easing):
  - Limit the eligible migration allowance for the emigrants who are claiming the migration allowance for the first time, up to a maximum of US$50,000.
  - Limit the repatriation of funds under the migration allowance through CTRAs by the emigrants who have already claimed migration allowance, by the date of this Order, up to a maximum of US$20,000;
  - Limit the outward remittances or issuance of FX for any Sri Lankan individual who resides in or outside Sri Lanka and has obtained Temporary Residence Visa of another country, up to a maximum of US$20,000 per person.
  - Limit the issuance of FX for any person resident in Sri Lanka who intends to leave Sri Lanka under the Temporary Residence Visa of another country up to a maximum of US$10,000 per person.

### Specific quantitative limits (as stated)
- Eligible migration allowance for first-time claimants:
  - April 2, 2020: up to a maximum of US$30,000.
  - July 2, 2020: continue up to a maximum of US$30,000.
  - July 02, 2021: continued limit up to a maximum of US$30,000.
  - June 28, 2023: up to a maximum of US$50,000.
- Repatriation through CTRAs for emigrants who have already claimed migration allowance:
  - April 2, 2020: repatriation suspended (general permission).
  - July 2, 2020: limited up to a maximum of US$20,000.
  - July 02, 2021: limited up to a maximum of US$10,000.
  - June 28, 2023: limited by date of Order up to a maximum of US$20,000.
- Outward remittances / issuance of FX for Sri Lankans with Temporary Residence Visa (residing in or outside Sri Lanka):
  - July 02, 2021: up to a maximum of US$20,000 per person.
  - June 28, 2023: up to a maximum of US$20,000 per person.
- Issuance of FX for persons resident in Sri Lanka intending to leave under Temporary Residence Visa:
  - July 02, 2021: up to a maximum of US$10,000 per person.
  - June 28, 2023: up to a maximum of US$10,000 per person.

### Policy direction and characterizations in the record
- Measures described as "suspended" (April 2, 2020) and later as "limited" with specific caps.
- Notations in the text describing phases as "tightening", "easing", and multiple instances labeled "time extension" for successive 6-month extensions.
- Use of Capital Transactions Rupee Accounts (CTRAs) is central to repatriation restrictions.

*Source: 1lkaea2023003 - 7.      Restricting outward transfer of funds for emigrants etc.*

### 5.      Tax revenue underperformance will require capital spending cuts in the short-term to

### 5.      Tax revenue underperformance will require capital spending cuts in the short-term to preserve the fiscal consolidation path

### Fiscal shortfall and immediate response
- Tax revenues fell short of the June IT by about 8 percent and is projected at about 9.2 percent of GDP in 2023, about 0.8 percentage point of GDP lower than projected at the time of the program request.
- Primary drivers of the shortfall:
  - (i) unanticipated economic developments: a larger decline in growth, a less depreciated exchange rate, declining inflation, and lower imports;
  - (ii) implementation delays in the lifting of import restrictions which was supposed to partly come into effect in 2023;
  - (iii) existing shortcomings in revenue administration—in particular to broaden the taxbase and to enhance enforcement.
- Given limited time and scope to compensate for the revenue shortfall by year end, a downward adjustment of the tax revenue floor for end-2023 (indicative target) is requested.
- To meet overriding objectives of restoring debt sustainability and regaining creditor confidence, the authorities intend to meet the primary balance target (end-December 2023 QPC) by reducing the execution of both current and capital expenditure relative to approved allocations in the budget.

### Medium-term fiscal framework and quantitative targets
- Central government primary surplus target: a central government primary surplus of 2.3 percent of GDP by 2025 and in subsequent years.
- Path for primary balance (quantitative performance criterion):
  - 2022: -3.7 percent of GDP
  - 2023: -0.7 percent of GDP
  - 2024: 0.8 percent of GDP
- Additional commitments and targets:
  - Convert the existing IT to a QPC to increase tax revenue collection.
  - Reduce the stock of budget expenditure arrears to zero (quantitative performance criterion).
  - Maintain a ceiling on the issuance of treasury guarantees (indicative target); a request to increase the limit was made to accommodate issuance of a new guarantee of US$2.6 billion for the Special Swap Agreement signed between the CBSL and the Reserve Bank of India (RBI).

### 2024 draft Budget and near-term spending allocations
- The 2024 draft Budget aims to raise the tax-to-GDP ratio to 12.1 percent of GDP in 2024 (Prior Action).
- Key spending parameters in the draft budget (based on the November 13th Budget Speech):
  - Wage bill: planned increase from 3.5 percent of GDP in 2023 to 3.6 percent of GDP.
  - Social Safety Nets cash transfers: Rs. 205 billion (increased from Rs. 200 in the Appropriation Bill).
  - Capital expenditure: Rs. 1,260 billion (4 percent of GDP).
  - Recapitalization of banks: Rs. 450 billion (1.4 percent of GDP).
  - Draft budget targets a primary surplus of Rs. 250 billion (0.8 percent of GDP).
- Parliamentary approval for the 2024 Appropriation Act consistent with program targets is planned for December 2023 (structural benchmark).

### Revenue measures and tax policy reforms
- Tax policy outcomes and targets:
  - Tax policy measures adopted since 2022 are expected to raise tax revenue from 7.3 percent of GDP in 2022 to 9.2 percent in 2023.
  - Commitment to raise tax revenue ratio to at least 14 percent by 2026 through a sequenced package of tax measures.
- Recent and planned tax measures:
  - Increased excise taxes on alcohol and tobacco products by an additional 20 percent in July 2023.
  - Introduced a second increase in fuel taxes in June 2023.
  - Lifted import restrictions as of October 10 on items other than motor vehicles for personal use.
- Prior Action measures expected to take effect by January 2024 at the latest:
  - VAT reforms: submitted amendment to remove exemptions on 87 main items (decision to come into effect in December 2023); plan to submit another amendment to remove additional exemptions on petroleum, diesel, LPG, motor vehicles and other identified items; increase VAT tax rate from 15 to 18 percent; reduce VAT registration threshold from Rs. 80 million per annum to Rs. 60 million per annum.
  - Reduce the liable registration threshold of the Social Security Contribution Levy from Rs. 120 million per annum to Rs. 60 million per annum.
  - Gazette notification to increase the Special Commodity Levy on sugar from 25cts/Kg to Rs. 50/Kg in November 2023.
  - Expand the 5 percent withholding tax on service fee payments made to all service providers and expect gains in import-related taxation from relaxing import restrictions on several items.

### Revenue administration and compliance reforms
- Registration and compliance expansion:
  - Mandated registration of several groups of potential taxpayers such as professionals.
  - Expanded tax registration to the entire adult population, to be implemented as of January 2024.
- Performance measurement:
  - By March 2024, introduce, track and report 7 Key Performance Indicators related to the four core tax administration functions: (1) payment; (2) filing; (3) reporting; and (4) registration (new Structural Benchmark). Quarterly targets for each KPI have been agreed between IMF staff, the IRD and the Ministry of Finance.
- Large taxpayer and risk management measures:
  - Prioritize assessment of VAT and CIT returns for the current tax period subject to higher taxation over older returns.
  - Create and implement by December 2023 within the Large Taxpayers Unit (LTU) of IRD a new High Net Worth Individuals (HNWI) unit, a design and monitoring unit, and a strengthened Risk Management Unit (new structural benchmark).
  - Introduce modern risk-based audits for large taxpayers.
- IRD modernization milestones:
  - Streamline the online portal for simplified individual income tax filing by June 2024.
  - Accelerate outreach to re-register VAT taxpayers who dropped out.
  - Enhance the electronic Revenue Administration Management Information System (RAMIS) to support assessment of 2022/23 income tax returns and to administer and assess the Social Security Contribution Levy (SSCL) by end March 2024.
  - Ensure processing tax collections is only carried out through RAMIS as of June 2024.
  - Adopt by January 2024 a medium-term IRD Modernization Strategy and Implementation Plan with IMF FAD CD assistance.

### VAT refund system and institutional considerations
- VAT refund reform and SVAT repeal:
  - Begin work to fix the VAT refund system; objective to ensure the full repeal of the SVAT system by April 2025.
  - By December 2023, adopt a Cabinet-approved strategy laying out a gradual multi-step process to fully repeal the SVAT by April 2025 (new Structural Benchmark).
  - Tighten controls of the SVAT system in the interim, verify registered identified purchasers (RIPs) meet eligibility criteria and deregister noncompliant entities; ensure sufficient funds available to pay approved refunds.
  - Work with the CBSL to ensure foreign exchange repatriation requirements do not create unnecessary delays in refunds.
- Consideration of a semi-autonomous Revenue Authority:
  - Consider creation of a Revenue Authority incorporating initially the Inland Revenue Department and later Customs and Excises; will consult IMF experts before further steps.

### Expenditure priorities and protections for growth
- Capital expenditure execution and approach:
  - Under-executed capital expenditure by more than 1 percent of GDP relative to approved allocations in the 2023 budget due to shortfalls in foreign project financing and more stringent approval criteria.
  - Going forward, avoid having the full adjustment fall on capital spending.
  - Further capital spending cuts, if needed, will rely on transparent criteria to guide project cancellation decisions to mitigate adverse effects on growth and not discourage revenue mobilization efforts.
  - Measures to raise public investment efficiency as recommended by the 2018 IMF Public Investment Management Assessment, strengthen prioritization of capital projects, and undertake a public expenditure review with World Bank assistance to find possible savings in current spending.

### Social Safety Nets (SSN) adjustments and targets
- Institutional and program changes:
  - Parliamentary approval of the welfare benefit payment scheme (WBPS) and new eligibility criteria in May 2023 (Structural Benchmark); payments under the new WBPS (Aswesuma) began July 2023.
  - Welfare Benefits Board (WBB) to complete grievance reviews and ensure transition to Aswesuma is complete by end-December 2023.
  - From January 2024, cash transfers under Samurdhi will cease and no ineligible beneficiaries will receive Aswesuma cash transfers.
  - Use survey data to assess targeting and adequacy of Aswesuma; seek Cabinet approval of updated graduation strategy for four household categories receiving Aswesuma benefits by end-March 2024.
- SSN spending floors and allocations:
  - Program spending floor on SSN spending of Rs. 187 billion in 2023 (Indicative Target); met up to June 2023.
  - Commitment to pay previous Samurdhi beneficiaries who applied but were not selected under Aswesuma until grievances are resolved and ensure retroactive payments by end-December 2023.
  - Raise SSN budget allocation to Rs. 205 billion (or 0.7 percent of GDP) in 2024 (Indicative Target) to maintain the real value of cash transfers per household.
  - Raise and protect social spending related to nutrition and education (school nutrition program and nutrition for expectant mothers) over the medium-term.

### Energy SOEs and pricing mechanisms to mitigate fiscal risks
- Automatic pricing and tariff adjustments:
  - Cabinet approval (November 2022) to automate monthly retail fuel price adjustment per the 2018 formula and automate quarterly cost-recovery based electricity price adjustment.
  - Retail fuel prices adjusted monthly in line with cost-recovery; retail electricity prices increased to cost-recovery level in February 2023.
  - Following a 14 percent decrease in the average electricity tariff as of July 1, a severe drought and global energy price fluctuations resulted in CEB losses in August and September 2023.
  - Revised the average end-user electricity tariff by 18 percent effective from October 20, 2023 to recoup CEB losses and ensure CEB breaks even for 2023.
- New procedural and institutional arrangements:
  - Adopted a Cabinet memo changing electricity tariff revision frequency to quarterly starting in January 2024 (prior action).
  - Maintain electricity tariff at cost-recovery level with quarterly formula-based adjustments effective from January 1, April 1, July 1, and October 1; CEB to submit tariff revision requests by end-October, end-January, end-April, and end-July respectively (revised continuous structural benchmark).
  - Improve the Bulk Supply Transaction Account (BSTA) to accurately measure the electricity subsidy and start using it to determine cost-recovery based electricity tariff and government transfer requirement by December 2023 (structural benchmark).
  - Set a zero ceiling on the cost of non-commercial obligations for fuel and electricity (net of government transfers) under the program (indicative target).
  - Explore mechanisms for more frequent automatic adjustments between revisions; once BSTA is operational it will trigger automatic surcharge or discount when exceeding a specified threshold for two consecutive weeks.
  - By June 2024, introduce legislative reforms making the Minister of Power and Energy responsible for implementing cost-recovery based fuel and electricity price adjustments.

*Source: 1lkaea2023003 - 5.      Tax revenue underperformance will require capital spending cuts in the short-term to preserve the fiscal consolidation path*

### 18.      We will further improve the timeliness, accuracy, and coverage of fiscal data. After

### 1lkaea2023003 - 18.      We will further improve the timeliness, accuracy, and coverage of fiscal data. After

### Fiscal data timeliness, accuracy, and coverage
- Complete rollout of the ITMIS by March 2024; thereafter the MOF’s Department of State Accounts will begin to report monthly cash flows from revenues, expenditures, and financing by the third business day of the subsequent month.
- Preliminary steps to update fiscal reporting framework to the GFSM 2014 standard by end-2024.
- Form a committee to hold bi-weekly meetings to address issues regarding timeliness, accuracy, and coverage of fiscal data.

### Public Financial Management (PFM) strengthening and budget discipline
- Continue sequenced reforms across macro-fiscal analysis and forecasting, fiscal data collection and reporting, fiscal management, budget formulation and execution, and public debt management.
- Identified recurrent shortcomings: systematic overestimation of revenues, underestimation of interest payments, weak expenditure management leading to budget overruns and spending arrears.
- New PFM law:
  - Plan to submit new legislation to Parliament by end-February 2024 (revised structural benchmark).
- Macro-Fiscal Unit:
  - Continue integrating MOF’s recently established Macro-Fiscal Unit into fiscal policy decision making and strengthen its analytical, forecasting, and reporting capacity.
- ITMIS and commitment-based spending controls:
  - Complete rollout of ITMIS; introduce a more rigorous IT-based commitment control framework such as an e-procurement system for public investment.
  - End-September 2023 structural benchmark on completing ITMIS rollout was missed.
  - Expect ITMIS to cover 168 budget heads (98 percent of the total) by end-December 2023, and the remaining 3 budget heads by end-March 2024.
- Medium-term fiscal framework (MTFF) and Fiscal Strategy Statement (FSS):
  - Begun developing multi-year baseline fiscal projections in 2023.
  - By end-June 2024, obtain Cabinet approval of the fiscal strategy statement (FSS) that would include the MTFF (new structural benchmark).
- Government guarantees:
  - Obtain Cabinet approval of a reduction in the limit on government guarantees to 7.5 percent of GDP by end-December 2023 (new structural benchmark).

### State-owned enterprises (SOEs): governance, restructuring, and transparency
- CPC downstream petroleum sector reform:
  - Implement Cabinet decision of June 2022 allowing entry of additional private sector firms into downstream petroleum.
  - Contracts with about 25 percent of fuel stations transferred from CPC to other companies.
  - Fuel pricing formula includes a small margin; CPC began repaying some old financial obligations in August 2023.
- Balance-sheet restructuring:
  - Obtained Cabinet approval of a comprehensive strategy to restructure balance sheets of the CEB, CPC, SriLankan Airlines (SLA), and the Road Development Authority in June 2023.
  - Plan to settle mutual debts in a budget-neutral way by end-December 2023.
  - By February 2024, develop and adopt a credible divestment strategy for SLA with IFC assistance.
- CEB restructuring roadmap:
  - With World Bank assistance, develop a road map for restructuring CEB, including legacy debts, by end-February 2024.
  - Ensure restructuring of old CEB debts does not create additional burden for the central government budget.
- SLA restructuring and guarantees:
  - Implement draft strategy by SOE restructuring unit to reform SLA business model; divestment strategy approved by Cabinet in November 2022.
  - Following balance-sheet restructuring with IFC assistance, any residual government-guaranteed FX loans will be transferred to the government’s balance sheet; at that point there will be no more government guarantees for the SLA’s FX loans.
- SOE governance and financial transparency measures:
  - Clarify mandates through Statements of Corporate Intent and hold management accountable via key performance indicators.
  - Review framework for selecting SOE board members to ensure qualifications and independence.
  - Ensure all 52 major SOEs publish their audited financial statements.
  - Financial statements of all 52 major SOEs were made available on the dedicated website by end-June.
  - Auditing all statements is taking longer than anticipated; anticipate audited statements of all but five small SOEs would be available by end-December 2023.
  - The remaining five SOEs require auditing statements going back to 2018; expect to complete that process during 2024.

### SOE borrowing framework
- New borrowing limited to financing commercially viable activities (e.g., investment projects); subsidies and quasi-fiscal activities to be remunerated through government transfers.
- Restriction: except for project loans on-lent by the Treasury and short-term trade financing, no new borrowing in foreign currency for non-financial SOEs with less than 20 percent of revenues denominated in foreign currency.
- New PDM law (¶23) will:
  - Prohibit new Treasury guarantees to SOEs with negative equity.
  - Prohibit new Treasury guarantees on SOE liabilities in foreign currency.
- Strengthen governance and oversight of state-owned banks to ensure lending to SOEs is guided solely by commercial considerations (¶34).

### Restoring public debt sustainability — targets and restructuring progress
- EFF program debt sustainability targets:
  - Reduce the ratio of public debt to GDP to below 95 percent by 2032.
  - Reduce the central government’s annual gross financing needs below 13 percent of GDP, on average, in 2027-32.
  - Reduce the central government’s annual debt service in foreign currency below 4.5 percent of GDP in every year in 2027-32.
  - Close the balance of payments financing gaps of $17 billion over the EFF program period.
- Domestic Debt Optimization (DDO) progress:
  - Parliament adapted resolution on DDO implementation in June.
  - Concluded a major part of DDO with debt treatments for outstanding Provisional Advances from the CBSL to the Government, outstanding Treasury bills purchased by the CBSL in the primary market, superannuation funds’ holdings of T-bonds, and holdings of Sri Lanka Development Bonds by resident and non-resident investors.
  - Finalizing strategies to restructure remaining FX local law debt of the government and SOEs to state banks, aiming to minimize adverse impact on banks’ capital and FX net open positions within program debt targets.
- External creditor engagement:
  - In May 2023, shared an indicative debt treatment scenario with external creditors consistent with debt sustainability targets.
  - Proposed restructuring perimeter includes all FX foreign law debt except debt to international financing institutions, bilateral currency swaps, and emergency financing credit lines extended in 2022.
  - Restructuring discussions ongoing via the official creditors committee (OCC), direct discussions with Chinese creditors, and contacts with two ISB bondholder committees.
  - Preliminary agreement reached with the EXIM Bank of China and an agreement in principle with the OCC.
  - Significant progress with China Development Bank; hopeful for debt treatment agreements in the coming weeks and months.
  - Commitment: refrain from resuming debt service payments to any external commercial or bilateral creditor unless it agrees to a comprehensive debt treatment in line with IMF program parameters, debt sustainability targets, and comparability of treatment principle.
  - Commitment to transparent creditor communications and regular reporting of indebtedness.

### Debt management and transparency reforms
- Current public debt management bodies: CBSL’s Public Debt Department, MOF’s External Resources Department and Treasury Operation Department.
- Public Debt Management Agency (PDMA):
  - Complete necessary legislative requirements by passing the public debt management law to establish a PDMA by February 2024.
  - Complete establishment of the PDMA by December 2024.
  - PDMA features:
    - Will report to and be accountable to the Ministry of Finance but have significant operational autonomy.
    - Assume overall policy responsibility for debt management by formulating medium-term debt strategies and annual borrowing plans.
    - Direct implementation of annual borrowing plans, including decisions on auction cut-offs.
    - Oversee all domestic and international market-based financing decisions and participate in evaluation of all debt, derivatives, and guarantees.
- Debt transparency:
  - MOF commenced publishing a quarterly bulletin of public debt and debt service in February 2023 covering the debt profile as of end-September 2022.
  - Latest bulletin published in August 2023 reflecting outstanding debt as of June 2023.
  - Commit to gradually broaden the quarterly bulletin’s coverage to stock and debt service flows of all liabilities and contingent liabilities of the budgetary central government and extrabudgetary central government units.
  - Will issue guidelines regarding statistical treatment of guaranteed debt of distressed corporations and transfer of government liabilities to SOEs, to be approved by Cabinet.

### Monetary policy, inflation, and price stability
- Inflation objective and MPCC:
  - Key objective: maintain inflation around target level of 5 percent (YoY).
  - Monitored through Monetary Policy Consultation Clause (MPCC) with a mid-point at 5 percent (reset at a lower level compared to program request) and inner and outer bands of ±1.5 and 3 percentage points on December 2023 and onwards (Quantitative Performance Criterion).
  - Policy consultation with IMF staff ahead of each Monetary Policy Board meeting; nonobservance of inner/outer bands requires policy consultation with IMF staff and IMF Board respectively (see Technical Memorandum of Understanding).
- Inflation developments:
  - Headline and core inflation fell from peaks of 70 and 50 percent in September 2022 to 12 and 10 percent in June 2023 respectively—outside of the MPCC band—and further down to less than 2 percent since September 2023.
  - Inflation expectations re-anchored to single digit levels.
- Monetary policy rate and market rates:
  - Monetary tightening cycle raised policy rate by 11 percent from August 2021 (5.5 percent) to March 2023 (16.5 percent).
  - CBSL reduced policy rates by 650 bps since June 2023, currently standing at 9-10 percent.
  - Treasury yields (3 months) and the prime lending rate fell from peak of 30-33 percent to 15.3 and 13.0 percent, respectively.
  - Statutory Reserve Requirement (SRR) reduced from 4 percent to 2 percent in August 2023.
- Temporary interest rate caps and future removal:
  - Caps imposed: pawning facilities at 18 percent, pre-arranged temporary overdrafts at 23 percent, credit cards at 28 percent, per annum.
  - Penal interest rate capped at 2 percent over and above regular interest rates for all licensed banks.
  - Banks directed to reduce lending rates in line with monetary policy.
  - These regulations will be eliminated as soon as possible due to distortionary impacts on credit provisions.
- Inflation risks and monitoring:
  - Inflation expected to edge up due to electricity price hike in October 2023 (¶17) and new tax measures in 2024 (¶8).
  - Will monitor risks from: (i) second-round effect of newly proposed tax measures, (ii) potential exchange rate passthrough from financial outflows, (iii) banks’ NOP as result of debt restructuring, and (iv) relaxing import restrictions.
- Flexible inflation targeting and legal framework:
  - New Central Bank Act (CBA) No. 16 of 2023 enacted on September 15, 2023; CBSL to operate under a flexible inflation targeting framework.
  - CBSL committed to sustain forward-looking real policy rates close to the neutral rate and adjust policy stance guided by inflation forecasts and MPCC performance.

### Monetary financing, CBSL net credit to government (NCG) ceilings, and domestic borrowing
- Commitment to refrain from monetary financing.
- Monitor reduction in CBSL holdings of Treasury securities and discontinuation of monetary financing via:
  1. Quantitative performance criterion on ceiling of the CBSL’s net credit to the government (NCG) (excluding CBSL’s temporary holdings of treasury securities for short-term monetary operations; see TMU).
  2. Continuous performance criterion to ensure no more purchases of Treasury securities from the primary market.
- NCG ceiling targets:
  - Rs. 2,800 billion for end-December 2023.
  - Rs. 2,720 billion by end-June 2024.
  - Rs. 2,560 billion by end-September 2024.
- Ceiling for continuous performance criterion on new primary purchases of Treasury securities: zero.
- Both targets subject to an adjustor in the amount of program financing shortfall in the first six months after the first review.
- Will raise domestic borrowing amounts aiming to maintain an adequate cash balance – including a buffer – to meet cashflow needs while reducing reliance on monetary financing.

*Italic: Source — Excerpt from the content unit 1lkaea2023003 (PDF chapter/section).*

### 26.      The CBSL remains committed to objectively assess the negative impact of the DDO on

### 26.      The CBSL remains committed to objectively assess the negative impact of the DDO on

### Assessment of DDO impact and balance sheet
- The CBSL will objectively assess the negative impact of the DDO on its balance sheet by January 2024, in close consultation with IMF staff and external auditors.
- MOF is committed to boost the equity of the CBSL through a capital injection to reach a positive level by 2025, as soon as the fiscal buffer is available.
- The CBSL will follow good accounting standard to evaluate and confirm the discount rates applicable for the DDO and the resultant accounting entries in consultation with External Auditors.
- The authorities will consult with IMF staff on the design and implementation of these steps.

### Exchange rate flexibility and rebuilding international reserves
- Commitment to maintain a market-determined and flexible exchange rate to serve as a buffer against external shocks.
- In March 2023, market guidance confining daily exchange rate movements within a pre-defined band around the weighted average spot interbank rate of the previous trading day was eliminated; since then the rupee has been allowed to move in line with fundamentals.
- Plan to gradually rebuild gross international reserves through:
  - outright FX purchases in the market,
  - support from a non-interest current account surplus,
  - new external financing and other non-debt creating inflows,
  - sovereign debt relief.
- Commitment to meet program targets on Net Official International Reserves (NIR) (quantitative performance criterion); for 2024 these targets are predicated on the CBSL’s outright FX purchases on a net basis of $2 billion in 2024.
- Intention to save any overperformance in accumulating the NIR going forward.
- Inclusion of a cap on the adjustor for the NIR target throughout the EFF program as a signal of proactive reserve accumulation in case of project financing shortfalls.
- Inclusion of a cap on the adjustor for FX payments (amortization and interest) on restructured CPC loans.
- Encouragement for banks to close any potential net open position issues in a planned and orderly fashion to avoid disorderly market conditions in the FX market.
- FX interventions will be limited to truly disorderly market conditions that could lead to destabilizing inflation and/or balance sheet effects; interventions will be transparently disclosed to guide market expectations.
- Intervention decisions will be rationalized based on objective criteria and subordinated to the CBSL’s price stability mandate, while ensuring the FX intervention budget is consistent with meeting the NIR targets.

### Institutional reforms to support flexible inflation targeting and exchange rate flexibility
- The new CBA strengthens the CBSL’s independence and modernizes its policy framework to enable credible inflation targeting, including provisions to:
  - establish price stability as the CBSL’s primary objective and financial stability as the other objective,
  - buttress the CBSL’s operational autonomy by removing government representation from the Governing Board and Monetary Policy Board.
- The new CBA included an 18-month transitory period to allow monetary financing as a last resort, which is not fully in line with the program objective of prohibiting monetary financing; the authorities commit to discontinue monetary financing governed by program conditionality (¶26).
- Commitment to foster a deeper and more liquid foreign exchange market and develop adequate systems for managing exchange rate risks, including with IMF technical assistance.

### Phasing out administrative measures (import, exchange, MCPs, CFMs)
- Started phasing out administrative measures imposed to support the balance of payments; measures include import restrictions, exchange restrictions, multiple currency practices (MCPs), and capital flow management (CFM) measures.
- Import restrictions:
  - Over 2020-22 many non-priority non-critical goods imports were suspended.
  - Removal of temporary suspension began in September 2022 with removal of 707 items, continued with relaxation on 286 goods in June 2023, 325 goods in July 2023, and 299 goods in October 2023.
  - With the October relaxation, import restrictions removed on all items apart from motor vehicles.
  - A time-bound plan will be provided for relaxing restrictions on motor vehicles after completion of the debt restructuring process; this plan will be tied to removing tax exemptions on imports of motor vehicles granted to specific groups including civil servants.
- Exchange restrictions present at IMF EFF program approval in March 2023 included (i)–(viii); eliminated thus far: (i), (iii), and (viii); remaining restrictions will be eliminated when conditions allow.
  - The listed exchange restrictions include prioritization and rationing of FX by CBSL, prohibitions on converting Sri Lanka Rupees into FX for certain current international transactions, unremunerated cash margin deposit requirements on imports under LC/DP/DA, 2.5 percent stamp duty on credit card transactions abroad, 14 percent remittance tax on nonresidents’ profits, limits on repatriation by nonresidents, requirement for a tax clearance certificate for certain transfers, and Sri Lanka’s net debtor position under the Asian Clearing Union pending settlement for longer than 90 days.
- Multiple currency practices (MCPs) present at program approval included (i)–(vi); eliminated thus far: (i), (iii), and (vi); remaining MCPs will be eliminated when conditions allow.
  - MCPs listed include unremunerated cash margin deposit requirements on certain imports, official exchange rate based on previous day’s interbank transactions used for CBSL FX transactions with the government, use of weekly volume weighted average rate for CBSL’s FX sales in certain bilateral transactions, 2.5 percent stamp duty on credit card transactions abroad, 14 percent remittance tax on nonresidents’ profits, and MCP from incentives on inward worker remittances.
- Capital flow management (CFM) measures introduced or tightened since 2020 included a set of measures (i)–(vii); reforms removed the surrender requirement for banks on purchases of export proceeds and inward worker remittances and relaxed CFMs related to outward remittances on capital transactions and outward transfers for emigrants since program approval.
  - CFMs introduced or tightened since 2020 include: (i) repatriation requirement for exports of goods and services; (ii) surrender requirement for exporters on proceeds from exports of goods; (iii) surrender requirement for banks on purchases of export proceeds; (iv) surrender requirement for banks on purchases of inward worker remittances; (v) suspension of outward remittances on capital transactions; (vi) restrictions on purchases of Sri Lankan ISBs by local banks; (vii) restrictions on outward transfers of funds for emigrants.
- Commitment that these measures should not substitute for comprehensive macroeconomic adjustment; committed to phasing them out as macroeconomic conditions stabilize and program objectives are met (exchange rate, debt sustainability, financial stability, improved market access prospects, accumulation of reserves above critical levels).
- Continuous performance criteria during the program period: will not (i) introduce or intensify exchange restrictions or MCPs; (ii) impose or intensify import restrictions for balance of payments purposes; (iii) conclude any bilateral payment agreements inconsistent with Article VIII.

### Ensuring financial stability: diagnostics, recapitalization, and crisis management
- Recognition of increased credit risk in private sector loan books, large exposures to the public sector, and impact of debt restructuring (including on banks’ foreign exchange /Net Open Positions).
- CBSL actions:
  - Hired two internationally reputable independent specialist firms without conflicts of interest to perform asset quality reviews (AQRs) based on Terms of Reference agreed with IMF staff.
  - AQRs assessed impact on banks’ capital from asset quality deterioration, FX exposure and the sovereign default.
  - First round of AQRs completed for five banks accounting for more than 70 percent of domestically-owned bank assets in May 2023 (two largest state-owned banks and three largest private sector banks).
  - Second round covering four smaller domestically-owned banks accounting for 20 percent of domestically-owned bank assets completed in August 2023.
  - CBSL provided assessors guidance on expected impact of debt restructuring on impairment and stepped up supervision of valuation, classification, and impairment practices for sovereign and public sector exposures, monitoring liquidity positions, and regulatory compliance of loans under moratoria and forbearance.
  - Successful completion of AQRs lays the foundation for designing a recapitalization plan for the banking sector.
- Responses for banks unable to ensure viability:
  - Intensify supervision and impose prompt corrective actions as appropriate.
  - In October 2023, CBSL developed a roadmap for restructuring and recapitalization of the five large banks to address capital and FX liquidity shortfalls identified through diagnostics, forward-looking stress testing, and domestic debt restructuring and to intervene in non-viable banks.
  - MOF will complete restructuring related to SOE FX debt mainly comprising former CPC debt to support roadmap compliance.
  - Authorities developed a banks’ recapitalization plan that includes size, timing, instruments, and terms and conditions for government recapitalization of viable banks unable to close capital shortfalls from private sources (Prior Action).
  - The five banks will submit time-bound plans for capital restoration and closure of their FX net open positions; CBSL will define content, review credibility, and oversee implementation.
  - Similar process for the remaining four banks to be completed by end-February 2024 (new SB).
  - CBSL to develop a roadmap by December 2023 and authorities to develop the detailed recapitalization plan by February 2024.
- Financial Sector Crisis Management Committee established:
  - Chaired by the Governor with the Secretary to the Treasury functioning as Deputy Chairperson.
  - Includes senior representatives from the MoF and the CBSL.
  - Responsibilities: crisis preparedness and management, in-crisis coordination, information-sharing and communication among the authorities.

### Strengthening supervision, legal framework, and crisis management powers
- Banking (Special Provisions) Act approved by Parliament in July 2023 to strengthen CBSL crisis management powers.
- Amendments to the Banking Act consistent with IMF recommendations were approved in principle by Cabinet in June 2023; final approval by Cabinet expected in November 2023.
- Amendments to the Banking Act expected to be approved by Parliament by January 2024 (new SB) with a view to implementing them by March 2024 (new SB).
- Expected strengthening via the Banking (Special Provisions) Act and Banking Act amendments to:
  - strengthen the resolution authority mandate of the CBSL and provide powers, tools, and appropriate funding mechanisms for resolution of distressed financial institutions;
  - strengthen the deposit insurance framework, including appropriate backstop funding arrangements from the government, and the regime for liquidation of banks;
  - raise regulatory standards in bank licensing, bank ownership, consolidated supervision, capital and liquidity framework, large exposures and related party transactions, governance requirements, recovery planning and early intervention powers;
  - strengthen regulation and supervision of state-owned banks (¶33).
- For non-bank deposit-takers, CBSL has reduced regulatory arbitrage on non-performing loan classification and capital requirements; review of the Banking Act and the Finance Business Act will take further steps to minimize regulatory arbitrage.
- Staffing and structure:
  - Staffing of the Bank Supervision Department and the structure, staffing, and funding of the Resolution and Enforcement Directorate in the CBSL will be strengthened to carry out expanded responsibilities.
- CBSL updated framework for provision of Emergency Loans and Advances (ELA) for banks in November 2022; new CBSL Act (effected on September 15, 2023) enables a similar framework to be extended to other financial institutions regulated and supervised by CBSL.
- Liquidity provision to Non-Bank Finance companies by the deposit insurance fund will be ended.
- Initiatives to follow international best practices and be developed in consultation with IMF staff.

### Strengthening resilience and governance of state-owned banks
- Amendments to the Banking Act will ensure state-owned banks meet the same regulatory requirements as private banks, including on large exposures, related party lending, appointment of directors and key management personnel and governance, and binding time-bound transition periods for reduction of existing large exposures.
- Cabinet will, by end-June 2024, adopt and publish a framework prepared in consultation with IMF and WB staff to strengthen governance of public banks, requiring:
  - boards to have a majority of independent members,
  - nominations for board and senior management to be made by banks’ nomination committees following open search procedures with clear requirements for independence and professional experience (new structural benchmark).
- Clear mandates will be defined to ensure state-owned banks are run at arm’s length from the government, lend to SOEs on a commercial basis and within standard prudential limits on concentration risk and foreign currency lending, with CBSL supervision equivalent to that of private banks.

*Source: Excerpt from IMF staff document (paragraphs 26–32).*

### 33.      We are committed to advance governance and anti-corruption reforms as a central

### 33.      We are committed to advance governance and anti-corruption reforms as a central

### Governance and anti-corruption reform commitments
- Develop and publish a Government Action Plan by February 2024 (new structural benchmark) to implement all priority recommendations from the Governance Diagnostic report (published on September 30).
- Focus areas to set the stage for a broader reform agenda include anticorruption legal frameworks and institutions, tax policy, revenue administration, public financial management (PFM), financial sector oversight, and AML/CFT strengthening.

### Anticorruption legal frameworks and institutions
- The new AC Act:
  - Significantly strengthens the asset declaration system and CIABOC’s investigative power.
  - Lacks adequate provision for transparent and merit-based selection of Commission members.
- Actions and benchmarks:
  - Constitutional Council to develop rules for appointing CIABOC Commissioners that establish an open and transparent process; these rules will be published in the Gazette by end-December (new Structural Benchmark).
  - A more comprehensive asset recovery law will be enacted by April 2024 in compliance with FATF standards and in consultation with the IMF (new structural benchmark).
  - Commitments:
    - Appoint commissioners to the CIABOC and publish implementation plans for the AC Act by December 2023.
    - CIABOC will publish asset declarations for senior officials in line with AC Act by July 2024 (new structural benchmark).
- Rationale:
  - Rapid operationalization of the AC Act is critical to address vulnerabilities from the lack of mechanism to review and publish asset declarations and to investigate and prosecute corruption cases.

### Tax policy reforms
- Concerns:
  - SDP, BoI, and Port City Acts grant wide-ranging tax exemptions with no specific or transparent criteria, causing revenue losses and corruption risks.
- Commitments and measures:
  - No longer provide tax exemptions or incentives and evaluate all tax incentives weighing benefits against costs.
  - No longer approve new projects under the SDP Act as of December 2023; law to be amended only to accept new investment proposals upon promulgation of explicit and transparent evaluation processes.
  - Evaluate all existing SDP contracts and publish a report detailing exemptions and the value of all tax, regulatory, and other exemptions.
  - Publish a list of all tax exemptions and tax benefits granted by the BoI or other government agencies, with an estimation of the cost to the state.
  - Consult with IMF prior to implementing any new tax proposals to attract investments.
  - Amend tax legislation (in particular, the Special Commodity Levy) to impose further discipline on ministerial authority to introduce tax policy changes without prior parliamentary approval by end-June 2024 and ensure permitted modifications do not result in tax revenue losses.

### Revenue administration
- Identified vulnerabilities:
  - Decentralized and discretionary tax policies favoring prioritized sectors and commodities.
  - Lack of effective information sharing and performance monitoring to detect and sanction corrupt behavior.
  - Limited digitization in tax and customs leading to high levels of direct interaction with officials and reduced capacity for data-analytics detection.
- Commitments and measures:
  - Each revenue department will develop and launch a program of anti-corruption measures to strengthen internal oversight and sanctioning processes.
  - IRD will fully implement a staff Code of Conduct by December 2023, followed by a public report on steps taken and results obtained by December 2024.
  - IRD will strengthen information sharing between IRD and CIABOC.
  - IRD will develop and implement a simplified PIT return that can be filed via mobile phone technology by end-June 2024.

### Public Financial Management (PFM)
- Corruption drivers to be addressed:
  - Political engagement in public procurement selection.
  - Limited oversight and transparency around SOE operations.
- Commitments and measures:
  - Publish on a semi-annual basis on a designated website by December 2023 (new SB):
    - All public procurement contracts above Rs. 1 billion, with comprehensive searchable information on contract award winners.
    - A list of all beneficiaries receiving tax exemptions through the Board of Investment and the SDP, and an estimation of the value of the tax exemption.
    - A list of firms receiving tax exemptions on luxury vehicle import.
  - Enact a Public Procurement Law by December 2024 reflecting international good practice (coordination with the WB for technical support).
  - Implement the State-Owned Enterprise Policy, including an explicit policy on management of state financial assets and ensure officers and directors of the State Holding Company and individual SOEs are appointed in a rigorous, transparent, and merit-based process.
  - Strengthen accountability by vesting the Auditor General with the authority to levy surcharges on officers, including Chief Accounting Officers, for failure to properly discharge responsibility for oversight and accountability of public resources.

### Financial sector oversight
- With amendments to the Banking Act (¶32), commitments include:
  - Enhance regulation and supervision of financial institutions’ corporate governance, especially assessment of board and senior management fitness, propriety, and effectiveness in line with international standards.
  - Cabinet will adopt and publish a framework (prepared in consultation with IMF and WB staff) to strengthen governance of public banks by end-June 2024 (new SB), requiring:
    - Boards of public banks to have a majority of independent members.
    - Nominations for board and senior management to be made by banks’ nomination committees following open search procedures with clear requirements for independence and professional experience.

### AML/CFT strengthening
- Actions taken and planned:
  - Final report of the updated National ML/FT Risk Assessment (NRA) published on September 14, 2023.
  - AML/CFT National Policy for 2023-2028 approved by the Cabinet of Ministers on August 7, 2023, and published.
  - Amendments being finalized to:
    - The Companies Act to strengthen beneficial ownership provisions relating to legal persons (the only remaining non-compliant aspect of the FATF 40 Recommendations).
    - The Prevention of Money Laundering Act.
    - The Convention on Suppression of Terrorist Financing Act.
    - The Financial Transactions Reporting Act.
    - The Voluntary Social Service (Registration and Supervision) Act.
  - Strengthen risk-based AML/CFT supervision through regular supervision of financial institutions and DNFBPs and joint supervisory activities via BSD, SNBFI, SEC & IRCSL.
  - Conduct AML/CFT risk-based supervision focusing on compliance by reporting entities with beneficial ownership requirements and enhanced due diligence for politically exposed persons.
  - Strengthen use of financial intelligence to identify potential corruption activities and cooperation between FIU, law enforcement, and CIABOC to facilitate parallel investigations and prosecutions.
  - Strengthen the institutional framework of the FIU by providing adequate resources.
  - Leverage development partner support in key reform areas.

### Advancing growth-enhancing structural reforms
- Near-term focus:
  - Stabilize the macro economy and restore debt sustainability.
- Later program development:
  - Develop structural reforms to unlock Sri Lanka’s growth potential across trade liberalization, exports, public sector reform, labor market reforms, climate resilience, and sectoral competitiveness.
- Commitments and initiatives:
  - Trade liberalization: Adopted regulations to rationalize para-tariffs; implementation will consider revenue implications and include measures to support local business competitiveness; pursue further trade reforms with development partner assistance.
  - External sector resilience: Implement a National Export Strategy, expedite Free Trade Agreement negotiations and entry into regional trade blocs, improve competitiveness and Global Value Chain positioning, develop industry sector for domestic and global markets, transform IT/BPO and Tourism sectors into key service exports.
  - Public sector reforms: Digitalization of government services; upskilling and reskilling public sector workers; auditing government institutions; commitment to create a public sector free of corruption, fraud and malpractices.
  - Labor market reforms to address low labor productivity and large gender gap in employment by developing a comprehensive strategy including possible reforms to:
    - (i) labor laws to improve labor market flexibility;
    - (ii) the education sector to improve labor productivity and close gender gaps;
    - (iii) promote financial inclusion including through credit guarantee schemes supporting female entrepreneurs;
    - (iv) upgrade public transport infrastructure;
    - (v) increase quantity, quality and affordability of child and elderly care facilities.
  - Climate resilience and energy:
    - Urgent action to address climate-related vulnerabilities, especially impacts on agriculture, livelihoods and food security.
    - Enhance electricity generation from renewable energy led by annual additions of solar and wind capacity.
    - Rely on private sector financing and multilateral financing to help meet envisaged annual investment.
    - Engage multilateral partners to build technical capacity for rapid implementation of climate mitigation and adaptation.
  - Broader reforms with development partners to address impediments to private investment, reduce the large role of the public sector, improve the electricity sector, and strengthen climate adaptation, including contingency budgeting and insurance for natural disasters.

### Program risks and contingency planning
- Overall assessment:
  - Risks to program implementation are high due to adverse initial conditions, a complex debt restructuring with potential delays, and large downside risks to the program baseline scenario.
- Specific risks and responses:
  - Debt restructuring delays:
    - A delay could suspend access to IFI financial support and deepen the BOP crisis.
    - Commitment to intensify creditor engagement and stay current on payments to the IMF and Multilateral Development Banks.
  - Macroeconomic policy space constraints:
    - Sustained increases in inflation and de-anchored inflation expectations would require a tighter monetary policy stance than in the baseline.
    - Commitment to ensure monetary policy remains prudent and tuned to inflation risks.
  - Banking sector stresses:
    - Banks’ net open positions may affect solvency and create FX market pressure.
    - Plan to develop a banking sector roadmap for orderly resolution of bank capital and NOP issues after debt restructuring.
  - Program underperformance:
    - Remedial measures include enhanced revenue administration and enforcement and targeted spending cuts as a last resort rather than depending solely on capital expenditure reductions.
    - Slippages in reserves buildup would require introduction of explicit FX intervention rules to avoid hindering needed exchange rate adjustment.
    - Delays in key structural reforms should be avoided to allow program reviews to conclude as scheduled.
    - Program overperformance should be locked in where possible to achieve program objectives.

### Program monitoring, safeguards, and conditionality
- Reviews and testing:
  - Program subject to semiannual reviews with performance criteria, MPCC bands, and indicative targets set out in Table 1 attached to this MEFP and the TMU.
  - Completion of second and third reviews requires observance of quantitative performance criteria for end-December 2023 and end-June 2024, respectively, and continuous performance criteria as specified in Table 1.
  - Reviews will assess progress on structural benchmarks in Table 2 attached to this MEFP.
  - The second and third reviews will take place on or after April 1 and October 1, 2024, respectively.
- Safeguards:
  - Recognize importance of safeguards assessment of the Central Bank finalized in February 2023.
  - The recently passed CBA would address some identified safeguards issues, and CBSL has initiated steps to implement other recommendations.
- Specific conditionality and requests to the Executive Board:
  - Waiver of nonobservance of the PC on arrears (temporary); arrears cleared by end-September 2023.
  - MPCC Consultation: request Board completes required consultation after inflation breached the end-June lower outer MPCC band.
  - Modification of End-2023 Quantitative Targets:
    - Request (i) upward revision in the QPC for NCG from Rs. 2,740 bn to Rs. 2,800 billion (¶25) to address structural liquidity shortages.
    - Request (ii) resetting of the MPCC clause at a lower mid-point of 5 percent relative to 15 percent at program approval to account for faster disinflation (¶24).
    - Request (iii) downward revision of the IT on central government tax revenue from Rs. 2,940 billion to Rs. 2,550 billion to account for slower-than-envisaged revenue mobilization (¶5).
    - Request (iv) increase in the IT on the limits on treasury guarantees from Rs. 1,700 billion to Rs. 2,100 billion to account for the guarantee of the Special Swap Agreement of about US$2.6 billion between the CBSL and the Reserve Bank of India (to be repaid through monthly installments over the next 3 years) (¶6).
  - New proposed quantitative targets:
    - Agree to a new continuous QPC on new CBSL purchases of government securities in the primary market as of December 2023 to reinforce commitment to refrain from monetary financing.
    - Agree to upgrade the existing IT on the tax revenue floor to QPC as of June 2024 to underline commitment to revenue mobilization.
  - Rephasing of access:
    - Request revising availability dates by one month to October 1 and April 1 to better align schedule with data availability for end-June and end--December test dates.
  - Request completion of the financing assurances review.

### Selected quantitative performance indicators and targets (as presented)
- Central government primary balance (floor, in billion rupees):
  - end-Dec. Actual: -895
  - end-Mar IT/Adj. IT/Act/Prel.: -56 / -56 / 48 (Met)
  - end-June IT/Adj. IT/Act/Prel.: -113 / -113 / 31 (Met)
  - end-Sep IT/Adj. IT/Act/Prel.: -160 / -160 / 124 (Met)
  - Proposed end-period ITs: -209 / -209 / 70 / 140 / 220
- Program net official international reserves (Program NIR, floor, end of period stock, in million US$) 1/ 2/:
  - end-Dec. Actual: -3,540
  - end-Mar IT/Adj. IT/Act/Prel.: -3,188 / -3,424 / -2,956 (Met)
  - end-June IT/Adj. IT/Act/Prel.: -2,830 / -2,901 / -1,918 (Met)
  - end-Sep IT/Adj. IT/Act/Prel.: -2,068 / -2,772 / -2,492 (Met)
  - Proposed end-period ITs: -1,592 / -1,592 / -2,035 / -1,810 / -1,524
- Net credit to the government of the CBSL (ceiling, end of period stock, in billion rupees) 3/:
  - end-Dec. Actual: 2,834
  - end-Mar IT/Adj. IT/Act/Prel.: 2,890 / 2,890 / 3,020 (Not Met)
  - end-June IT/Adj. IT/Act/Prel.: 2,890 / 2,890 / 2,800 (Met)
  - end-Sep IT/Adj. IT/Act/Prel.: 2,840 / 2,840 / 2,838 (Met)
  - Proposed end-period ITs: 2,740 / 2,800 / 2,800 / 2,720 / 2,560
- Stock of expenditure arrears of the central government (ceiling, in billion rupees):
  - end-Dec. Actual: 60
  - end-Mar IT/Adj. IT/Act/Prel.: 30 / 30 / 0 (Met)
  - end-June IT/Adj. IT/Act/Prel.: 0 / 0 / 1) [table truncated in source]
  - Note: Table 1 continues in the source with additional cells and explanatory footnotes.

*Source: 1lkaea2023003 - 33.      We are committed to advance governance and anti-corruption reforms as a central*

### 34.5  Not met

### 1lkaea2023003 - 34.5  Not met

### Quantitative Performance Criteria and Indicative Targets (selected figures)
- Proposed central government tax revenue (floor, in billion rupees): 750; 1,500; 2,400.
- Continuous performance criteria (cumulative from beginning of the program):
  - New external payment arrears by the nonfinancial public sector and the CBSL (ceiling, in million US$): 0; 0; 0; 0; 0; 0; 0.
  - Proposed CBSL purchases of government securities in the primary market: values shown as "..." across reporting dates; test outcomes include multiple "0" entries.
- Monetary policy consultation clause — Year-on-year inflation in Colombo Consumers Price Index (in percent) 4/:
  - Outer band (upper limit): 55.0; 55.0; 34.0; 34.0; 20.0; 8.0; 18.0; 8.0; 8.0; 8.0; 8.0.
  - Inner band (upper limit): 53.5; 53.5; 32.5; 32.5; 18.5; 6.5; 16.5; 6.5; 6.5; 6.5; 6.5.
  - Actual / Center point (selected test dates): 58.6; 52.0; 52.0; 50.9 (Met); 31.0; 31.0; 23.4 Not met; 17.0; 5.0; 3.8 (Met); 15.0; 5.0; 5.0; 5.0; 5.0.
  - Inner band (lower limit): 50.5; 50.5; 29.5; 29.5; 15.5; 3.5; 13.5; 3.5; 3.5; 3.5; 3.5.
  - Outer band (lower limit): 49.0; 49.0; 28.0; 28.0; 14.0; 2.0; 12.0; 2.0; 2.0; 2.0; 2.0.

### Indicative targets and test outcomes (fiscal and social)
- Central government tax revenue (floor, in billion rupees) — reported sequence and status:
  - 1,751; 650; 650; 578 Not met; 1,300; 1,300; 1,199 Not met; 2,100; 2,100; 1,934 Not met; 2,940; 2,550.
- Social spending by the central government (floor, in billion rupees) — reported:
  - 142; 35; 35; 48 Met; 70; 70; 96 Met; 120; 120; 126.5 Met; 187; 187; 50; 100; 150.
- Cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers) (ceiling, in billion rupees) 5/:
  - Repeated "0" entries across test dates, with "Met" annotations for several dates.
- Treasury guarantees (ceiling, in billion rupees):
  - 1,181; 1,700; 1,700; 1,074 Met; 1,700; 1,700; 1,024 Met; 1,700; 1,700; 1,050 Met; 1,700; 2,100; 2,100; 2,100; 2,100.

### Structural Benchmarks — status highlights (dates and outcomes)
- Fiscal, SOE, and Social Safety Net Reforms:
  - Set retail fuel prices to cost-recovery with monthly formula-based adjustments and compensate CPC with on-budget transfers — Continuous: Met.
  - Adjust end-user electricity tariff schedule to cost-recovery with semi-annual formula-based adjustments (Jan and July) and compensate residual subsidies with on-budget transfers — Continuous: Met.
  - Parliamentary approval of the welfare benefit payment scheme and application of new eligibility criteria — End-May 2023: Met (Parliament approved on May 12).
  - Cabinet approval of a comprehensive strategy to restructure balance sheets of CEB, CPC, Sri Lankan Airlines, and Road Development Authority (in consultation with IMF staff) — End-June 2023: Met.
  - Cabinet approval of revenue measures to support fiscal consolidation during 2024, in line with program parameters — End-July 2023: Not met (To be adopted as a prior action).
  - Completion of rollout of the ITMIS to all 220 heads — End-September 2023: Not met (Expected to be met by end-March 2024).
  - Submission to Parliament for first reading of the 2024 Appropriation Bill in line with program parameters — End-October 2023: Met.
  - Submission to Parliament of a new PFM law (in consultation with IMF staff) — End-December 2023: Postponed.
  - Parliamentary approval of the 2024 Appropriation Act and spending allocations in line with program parameters — End-December 2023: (status blank in table).
  - Improve the BSTA to accurately measure electricity subsidy and start using it to determine cost-recovery tariff and government transfer requirement — End-December 2023: (status blank).
- Newly Proposed and Reformulated Prior Actions / SBs:
  - Cabinet approval of quarterly revisions of electricity tariffs starting in 2024 — Met.
  - Cabinet approval of the package of revenue measures (paragraph 8) — Met.
  - Maintain cost-recovery level of end-user electricity tariff with quarterly formula-based adjustments (Jan, Apr, July, Oct); CEB to submit tariff revision requests by specified end-of-month deadlines; compensate residual subsidies with on-budget transfers; use tariff surcharges in interim if CEB making losses — Continuous.
  - Create and implement within the LTU a HNWI unit and a design and monitoring unit including a strengthened Risk Management Unit — End-December 2023.
  - Obtain Cabinet approval of a reduction in the limit on government guarantees to 7.5 percent of GDP — End-December 2023.
  - Submission to Parliament of a new PFM law, based on IMF TA — End February 2024.
  - Obtain Cabinet approval of the fiscal strategy statement (FSS) containing a medium-term fiscal framework (MTFF) — End-June 2024.
  - Cabinet approval of revenue measures requiring legislative amendments to support fiscal consolidation during 2025 — End-September 2024.
  - Obtain Cabinet approval of a strategy to build a VAT refund system and achieve a full repeal of SVAT, with timeline and intermediate steps — End-December 2023.
  - Introduction, tracking and reporting quarterly KPIs of tax compliance — End-March 2024.

### Financial sector and governance benchmarks (selected)
- Monetary, exchange rate and external sector:
  - Parliamentary approval of the new CBA prepared in consultation with IMF staff — End-April 2023: Not met (Implemented with delay on July 21, 2023, long transitory arrangement remedied with a new continuous PC).
- Financial sector:
  - Completion of the AQR component of bank diagnostic exercise for two largest state-owned banks and three largest private banks — End-April 2023: Not met (Implemented with delay in mid-May).
  - Cabinet approval of a full revision of the Banking Act in consultation with IMF staff — End-June 2023: Not met (In progress, reformulated and merged with SB on parliamentary approval by end-January 2024).
  - Development by the CBSL of a roadmap for addressing banking system capital and FX liquidity shortfalls and intervening in banks assessed to be non-viable — End-July 2023: Not met (Met with delay on October 10).
  - Determination by the government of size, instruments, and terms for potential government recapitalization of viable banks unable to close capital shortfalls from private sources — End-October 2023: Met on October 31, 2023.
  - Newly proposed: Determination by the authorities of size, instruments, and terms for potential government recapitalization of viable banks among five large banks unable to close capital shortfalls — Met on October 31, 2023.
  - Parliamentary approval for amendments to the Banking Act consistent with IMF recommendations in MEFP in March 2023 — End-January 2024.
  - Government and CBSL to develop a detailed recapitalization plan for the remaining four banks — End-February 2024.
  - Implementation of the amendments to the Banking Act — End-March 2024.
- Governance:
  - Enact new anti-corruption legislation harmonized with the United Nations Convention Against Corruption — End-June 2023: Not met (Implemented with delay on July 19, lacks transparent and merit-based selection process, remedied by new SB in ¶33).
  - Publication of the Governance Diagnostic report — End-September 2023: Met.
  - Constitutional Council to develop rules for appointing CIABOC Commissioners with open and transparent process; publish rules in Gazette — End-December 2023.
  - Publish on a semi-annual basis on a designated website: (i) all public procurement contracts above Rs. 1 billion with searchable information on contract award winners; (ii) list of all firms receiving tax exemptions through Board of Investment and the SDP, and estimated value of tax exemption; (iii) list of firms receiving tax exemptions on luxury vehicle import — End-December 2023.
  - Publication of a government action plan for implementing Governance Diagnostic recommendations — End-February 2024.
  - Enact a comprehensive Asset Recovery Law harmonized with UNCAC — End-April 2024.
  - Cabinet approval and publication of a framework to strengthen governance of public banks requiring majority independent boards and open search procedures — End-June 2024.
  - Operationalized Anticorruption commission to publish asset declarations for senior officials in line with Anticorruption Act — End-July 2024.

### Appendix I — Tax Reforms to be Implemented for 2023-25 (selected items and effective dates)
- Remove CIT exemptions on exports of IT services — April 1, 2025.
- Start estimating and publishing the direct costs imposed by tax incentives granted under the Strategic Development Projects and Board of Investment Acts — January 1, 2024.
- Introduce automatic indexation of all excises to inflation — January 1, 2024.
- Introduce a nationwide real property tax including a review of related fiscal transfers (request TA as needed) — January 1, 2025.
- Introduce a gift and inheritance tax with a tax-free allowance and minimal exemptions — January 1, 2025.

### Appendix II — KPIs for Inland Revenue (Quarterly Targets under EFF) — select KPIs and targets
- KPI-1.1: Risk Based Audit — baseline: "No cases are currently selected on a systematic, data-driven, risk basis."
  - March 2024 Target: 10 LTU cases selected in Q1.
  - June 2024 Target: 20 new LTU cases selected in Q2.
  - September 2024 Target: 30 new LTU cases selected in Q3, & 2 percent of new non-LTU cases selected during Q3.
  - December 2024 Target: 40 new LTU cases selected in Q4, & 5 percent of new non-LTU cases in Q4.
- KPI-1.2: Audit Effectiveness — baseline: "Baselines currently unknown and must be determined using historic data for different taxpayer segments: large, upper corporate, medium corporate."
  - No Target for March 2024 and June 2024; "TBD after EFF Second Review" for September 2024 and December 2024.
- KPI-2.1: Tax Return Filing Compliance of Large Taxpayers — baseline (From 2023 TADAT Assessment (P4.12)):
  - On-Time CIT Filing: 93.4 percent.
  - On-Time VAT Filing: 82.6 percent.
  - Targets: March 2024 — 85 percent of VAT returns on-time; June 2024 — 87 percent of VAT returns on-time & 90 percent of PAYE returns on-time; September 2024 — 89 percent of VAT returns on-time; December 2024 — 91 percent of VAT returns on-time & 95 percent of CIT returns on-time.
- KPI-2.2: Tax Return Filing Compliance of Non-Large Taxpayers — baseline (From 2023 TADAT Assessment (P4.12)):
  - On-Time CIT Filing: 32 percent.
  - On-Time VAT Filing: 45.5 percent.
  - PAYE Filing: 23.6 percent.
  - Targets: March 2024 — 48 percent of VAT returns on-time; June 2024 — 52 percent of VAT returns on-time & 60 % of PAYE returns on-time; September 2024 — 56 percent of VAT returns on-time; December 2024 — 60 percent of VAT returns on-time & 50 percent of CIT returns on-time.
- KPI-2.3: Electronic Filing of Individual Income Tax (IIT) Returns — baseline (From 2023 TADAT assessment (P4.14)): 23 percent of IIT returns filed electronically in 2021.
  - March 2024 Target: 30 percent filed electronically.
  - June 2024 Target: 35 percent filed electronically.
  - September 2024 Target: 40 percent filed electronically.
  - December 2024 Target: 50 percent filed electronically.
- KPI-3.1: Management of Collectible debt — baseline (From 2023 TADAT assessment (P5.18)):
  - At end of 2021, ratio of collectible debt to annual collections was 13.75 percent, deteriorated to 15.4 percent by end-2022.
  - Targets: collectible debt is not above 15 percent of 2024 revenue target (March 2024); not above 14 percent (June 2024); not above 13 percent (September 2024); not above 12 percent (December 2024).
- KPI-4.1: VAT Registration — baseline: Registered VAT population nearly 29,000 before 2019 changes and fell to 12,000. IRD seeks to rebuild VAT and SSCL taxpayer base to 20,000 by end-2024.
  - Targets: March 2024 — 14,000 active VAT and SSCL registered taxpayers; June 2024 — 16,000; September 2024 — 18,000; December 2024 — 20,000.

### Technical Memorandum of Understanding (TMU) — monitoring framework highlights
- The TMU sets the framework for monitoring performance under the program supported by the Extended Arrangement under the EFF, specifying performance criteria and indicative targets for semiannual reviews, and detailing monitoring procedures and reporting requirements.
- Quantitative performance criteria and indicative targets listed in Table 1 of the MEFP include:
  - a) a quantitative performance criterion on central government primary balance (floor);
  - b) a quantitative performance criterion on central government tax revenue (floor);
  - c) a quantitative performance criterion on the stock of expenditure arrears of the central government (ceiling);
  - d) a quantitative performance criterion on net official international reserves (floor);
  - e) a quantitative performance criterion on the CBSL’s net credit to the government (ceiling);
  - f) a continuous quantitative performance criterion on new external payment arrears of the nonfinancial public sector and the CBSL (ceiling);
  - g) performance criterion on new CBSL’s purchases of government securities in the primary market;
  - h) a monetary policy consultation clause;
  - i) an indicative target on social safety net spending (floor);
  - j) an indicative target on cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling); and
  - k) an indicative target on treasury guarantees (ceiling).
- Definitions and technical notes:
  - Central government defined to include line ministries, departments, and other public institutions; CBSL, state-owned enterprises, parastatals and other agencies that do not receive subventions from the central government are excluded.
  - Debt defined in accordance with paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements attached to Executive Board Decision No. 16919-(20/103), adopted October 28, 2020.

*Sources: Authorities; and IMF Staff.*

### 4.      Unless otherwise specified, all definitions follow the GFSM1986. The primary balance of

### 1lkaea2023003 - 4. Unless otherwise specified, all definitions follow the GFSM1986. The primary balance of

### Definitions and Measurement of the Central Government Primary Balance
- Primary balance of the central government on cash basis is defined as central government revenues and grants minus expenditures and net lending, plus interest payments.
- Proceeds from privatization or commercialization of public assets to residents or non-residents will not be recorded as part of central government revenues.
- Spending is recorded in the period during which cash disbursements are made.
- For program monitoring, the primary balance on cash basis is measured as the overall balance of the central government plus the interest payment of the central government. The overall balance is measured from the financing side as the negative of the sum of specified financing items (net borrowings, changes in deposits, CBSL advances, etc.). Net borrowings refer to gross disbursements minus principal repayments.

### 2022 Central Government Fiscal Outcomes (as measured for program monitoring)
- Primary balance (central government, cash basis, measured per paragraph 5): minus Rs 895 billion.
- Overall balance: minus Rs. 2,460 billion.
- Interest payment: Rs 1,565 billion.

Financing components for 2022 (amounts reported as totals for the year unless otherwise stated):
- a) Net borrowings from issuances of Treasury Bills, Treasury Bonds, and loans in local currency: Rs. 3,610 billion.
- b) Net decreases in the balances (deposits minus overdrafts) of the central government in the banking system: Rs. minus 814.5 billion (an increase in bank balances).
- c) Net increases in CBSL advances, net of changes in central government deposits at the CBSL: Rs. minus 85 billion.
- d) Net borrowings from Sri Lankan Development Bonds (SLDBs) and domestic loans in foreign currency: Rs minus 461 billion.
- e) Commercial borrowings issued under foreign law, including international sovereign bonds and syndicated loans: Rs 0 billion.
- f) Net borrowings from official project and program loans and trade credit lines: In 2021, Rs 535 billion.
- g) Net borrowings from all other bonds, loans, and advances contracted by the central government: Rs minus 2.9 billion.
- h) Proceeds from privatization or commercialization of public asset to residents and nonresidents: Rs 0 billion.

### Treatment of Government Equity Injections and Net Lending
- Government equity injections into banks for recapitalization purposes will not be recorded as central government expenditure for program monitoring; the primary balance per paragraph 5 will be reduced by amounts transferred to banks.
- Equity injections into other corporations (private and state-owned) are recorded as central government expenditure; the primary balance per paragraph 5 will not be reduced by such transfers.
- Net lending by the government is recorded as government expenditure, in line with GFSM1986. Example: funds lent by the government to CPC in 2022 related to fuel credit lines from India are recorded above the line (increasing the deficit). Repayments in 2023 and 2024 will be recorded above the line (reducing the deficit).

### Performance Criterion on the Stock of Expenditure Arrears
- Expenditure arrears of the central government are defined as:
  - (i) any invoice received by a spending agency for delivered and verified goods, services, and capital goods, not paid within the contractually agreed period (taking into account any contractual grace period), or absent a grace period, within 3 months after the due date; and
  - (ii) wages, pensions, or transfers expensed by the central government for which payment has been pending for longer than 3 months to domestic or foreign residents.

### Performance Criterion on Central Government Tax Revenue
- Central government tax revenue: revenues from taxes collected by the central government; excludes revenues from asset sales, grants, and non-tax revenues.
- Revenue target is calculated as the cumulative flow from the beginning of the year.
- For 2022, central government tax revenue defined in this manner was Rs 1,751 billion.

### Net Official International Reserves (Program NIR): Definition and Key Numbers
- Program NIR = (a) CBSL’s conventional NIR definition (market-value expression of gross foreign assets minus liabilities plus DSTs Special Dollar/Japanese Yen/Chinese Yuan Revolving accounts) minus (b) CBSL’s outstanding liabilities in foreign exchange swaps with domestic commercial banks (net short positions).
- On January 3, 2023:
  - Program NIR evaluated at market exchange rates: minus US$3,524 million.
  - Program NIR evaluated at program exchange rates: minus US$3,520 million.
  - CBSL conventional NIR (market exchange rates): minus US$3,222 million.
  - CBSL outstanding liabilities in foreign exchange swaps with domestic commercial banks: US$302.4 million.

- For Program NIR measurement:
  - All foreign-currency related assets and liabilities will be converted into U.S. dollar terms at the exchange rates prevailing on January 3, 2023 (Table 1).
  - Monetary gold valued at US$1,831.615 per troy ounce (price prevailing on January 3, 2023 as per CBSL).

### Program Exchange Rates (Rates as of January 3, 2023; JPY and AUD rates as of December 23, 2022)
- Sri Lanka rupee: 363.11 units per 1 US dollar
- British pound: 0.838012 units per 1 US dollar
- Japanese yen: 132.650000 units per 1 US dollar
- Canadian dollar: 1.365800 units per 1 US dollar
- Euro: 0.948317 units per 1 US dollar
- Chinese yuan: 6.892800 units per 1 US dollar
- Australian dollar: 1.497006 units per 1 US dollar
- Swiss franc: 0.939650 units per 1 US dollar
- SDR: 0.752014 units per 1 US dollar
- Memorandum: Gold price, US$/oz 1831.62

### Adjustors to the Program NIR Floor
- If any of the following items (relative to program assumptions) are higher/lower in U.S. dollar terms than assumed, the floor on the Program NIR will be adjusted upward/downward by the maximum of the cumulative differences on the test date and the caps on the adjustors as specified:
  - (i) amount of foreign program financing (exclusive of EFF disbursements) by the central government;
  - (ii) net borrowings from SLDBs and FCBUs by the central government in FX terms;
  - (iii) external commercial loans (including international sovereign bonds and syndicated loans) borrowed by the central government;
  - (iv) project loans and grants disbursed as FX cash flows to the central government;
  - (v) proceeds from commercialization of public assets to non-residents.
- Proceeds from commercialization of public assets defined as cash receipts from sale or lease of publicly held assets, including publicly held land, public holdings of infrastructure or commercial real estate, and public or quasi-public enterprises.
- Adjustors apply to NIR floor for end-December 2022 and thereafter.

- If the sum of amortization of total external debt and interest payments on total external debt owed by the central government (excluding IMF) in U.S. dollar terms (starting 2024 the interest payments adjustor will also include external interest payments by the CBSL excl. IMF), and the sum of interest payments on SLDBs and FCBUs by the central government in U.S. dollar terms, is higher/lower than assumed, the floor on the Program NIR will be adjusted downward/upward by the cumulative differences on the test date. These adjustors apply for end-December 2022 and thereafter.

- Specific adjustor caps:
  - Project loans and grants disbursed as FX cash flows to the central government: capped at US$1.15 billion in 2023, and at US$250 million in 2024.
  - 2024 adjustor on amortization and interest payments in FX for restructured CPC loans: capped at US$100 million.
  - Other adjustors will be uncapped.

### Program Assumptions (Selected entries from Table 2a and Table 2b)
- 2023 cumulative (Mar. 2023 / Jun. 2023 / Sep. 2023 / Dec. 2023) — amounts in million US$:
  - Foreign program financing of the central government: 0 / 330 / 750 / 900
  - Net borrowings from SLDBs and FCBUs by the central government in FX terms: 0 / 0 / 0 / 0
  - External commercial loans (including Eurobonds and syndicated loans) by the central government: 0 / 0 / 0 / 0
  - Proceeds from commercialization of public assets to non-residents: 0 / 0 / 0 / 0
  - Amortization of total external debt owed by the central government (excl. IMF): 239 / 778 / 877 / 989
  - Interest payments on total external debt owed by the central government (excl. IMF): 47 / 107 / 337 / 568
  - Interest payments on SLDBs and FCBUs by the central government in US dollar terms: 0 / 0 / 0 / 0
  - Project loans and grant FX cash amounts disbursed to the central government: 219 / 548 / 876 / 1,204

- 2024 cumulative (Mar. 2024 / Jun. 2024 / Sep. 2024 / Dec. 2024) — amounts in million US$:
  - Foreign program financing of the central government: 425 / 650 / 800 / 800
  - Net borrowings from SLDBs and FCBUs by the central government in FX terms: 0 / 0 / 0 / 0
  - External commercial loans (including Eurobonds and syndicated loans) by the central government: 0 / 0 / 0 / 0
  - Proceeds from commercialization of public assets to non-residents: 0 / 0 / 0 / 0
  - Amortization of total external debt owed by the central government (excl. IMF): 187 / 374 / 561 / 748
  - Interest and Amortization payments on FX restructured CPC loans by central government: 2 / 55 / 075 / 100
  - Interest payments on total external debt owed by the central government and central bank (excl. IMF): 308 / 615 / 919 / 1,226
  - Interest payments on SLDBs and FCBUs by the central government in US dollar terms: 0 / 0 / 0 / 0
  - Project loans and grant FX cash amounts disbursed to the central government: 105 / 210 / 315 / 420

- If NIR outcome outperforms its program target(s), CBSL will consult with IMF staff on raising the targets for subsequent test dates accordingly.

### CBSL Net Credit to the Government (NCG): Definition and Adjustment
- NCG = (a) CBSL’s claims on the central government minus (b) the central government’s Rupee-denominated deposits at the CBSL.
  - (a) CBSL’s claims on the central government include provisional advances, government securities acquired by the CBSL through primary market purchases, the central government’s special direct issuances to the CBSL, and long-term or outright open market operations.
  - Exclusion for program monitoring: government securities acquired through purchases solely for monetary policy purposes and emergency liquidity assistance (ELA) operations on a temporary basis with agreement to reverse in less than 90 days.
  - Stock of government securities held by the CBSL is measured in face value for program monitoring.
  - (b) Central government’s Rupee-denominated deposits at the CBSL exclude deposits related to foreign program financing (including IMF disbursements) placed at the government’s account at the CBSL.
- Adjustment: The ceiling on the CBSL’s NCG will be adjusted upward by the amount of shortfalls in foreign program financing of the central government (measured against programmed amounts in Table 2). This adjustor applies only during six months after the Board date of the First review. Foreign currency amounts converted to Sri Lankan rupees using program exchange rates defined in paragraph 9.

### Continuous Performance Criteria
- New external payment arrears:
  - Continuous performance criterion on non-accumulation of new external payments arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL.
  - Nonfinancial public sector defined per 2001 Government Finance Statistics Manual and 1993 System of National Accounts; includes central government and nonfinancial public enterprises.
  - External payments arrears = debt-service obligations (principal and interest) to nonresidents not paid when due per contractual agreements, subject to applicable grace periods.
  - Overdue debt and debt service obligations in dispute are not considered external payments arrears for program monitoring.
  - Arrears where rescheduling or restructuring is being sought are excluded.
  - Authorities will monitor continuously and immediately report any non-observance to the Fund.

- New CBSL purchases of government securities in the primary market:
  - Continuous performance criterion: ceiling of zero on new purchases by the CBSL in the primary market on a continuous basis.
  - Adjustment: ceiling will be adjusted upward by the amount of shortfalls in foreign program financing of the central government (measured against programmed amounts in Table 2). This adjustor applies only during six months after the Board date of the First review. Foreign currency amounts converted using program exchange rates.

- Other continuous criteria (prohibitions during the program period):
  - a) Not impose or intensify restrictions on payments and transfers for current international transactions.
  - b) Not introduce or modify multiple currency practices (MCPs).
  - c) Not conclude bilateral payment agreements inconsistent with Article VIII of IMF Articles of Agreement.
  - d) Not impose or intensify import restrictions for balance of payments purposes.

### Monetary Policy Consultation Clause (Inflation Measurement and Consultations)
- Inflation target bands specified in Table 1 attached to the MEFP around projected 12-month rate of inflation measured by CCPI (headline Colombo Consumers Price Index) published by the Department of Census and Statistics of Sri Lanka.
- CCPI index (2021=100) used to measure actual inflation.
- Year-on-year inflation for each test date measured as:
  - { CCPI*(t) – CCPI*(t-12) } / CCPI*(t-12)
  - where:
    - t = the month within which the test date is included
    - CCPI(t) = CCPI index (all items) for month t
    - CCPI(t-k) = CCPI index (all items) as of k months before t
    - CCPI*(t) = { CCPI(t-2) + CCPI(t-1) + CCPI(t) } / 3
    - CCPI*(t-12) = { CCPI(t-14) + CCPI(t-13) + CCPI(t-12) } / 3
- If observed year-on-year inflation for end-December 2023 and end-June 2024 falls outside the outer bands 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 traction; (ii) reasons for deviation; and (iii) proposed policy response. When 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 in Table 1 attached to the MEFP for end-December 2023, end-March 2024, end-June 2024, and end-September 2024, authorities will consult with IMF staff on reasons and proposed policy response.

### Indicative Targets (Selected)
- Social Safety Net (SSN) spending defined as central government spending on SSN programs comprising:
  - (1) Aswesuma cash transfers (transitioning from Samurdhi to Aswesuma; transition expected to be completed by end-December 2023),
  - (2) Samurdhi cash transfers (until end-December 2023),
  - (3) assistance to the elderly (over 70 years of age),
  - (4) allowance for disabled people,
  - (5) financial support for kidney patients.
- Classifications align with reporting in the Ministry of Finance Annual Report (Table 9).
- Indicative target on Cost of Non-Commercial Obligations for Fuel and Electricity (Net of Government Transfers) referenced but not numerically specified in the supplied text.

*Source: Excerpt from IMF program documentation for Sri Lanka (text provided).*

### 23.      The non-commercial obligations (NCOs) for fuel and electricity refer to the obligations of

### 23.      The non-commercial obligations (NCOs) for fuel and electricity refer to the obligations of 

### Definition and scope
- NCOs refer to the obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery levels.
- The indicative target is set on the cost of fuel and electricity NCOs net of government transfers, which corresponds to the cost of the NCOs that are not compensated by the central government budget.

### Measurement of cost of fuel NCOs
- The 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.
- The government transfers to cover the cost of fuel NCOs are measured as central government current transfers disbursed to CPC.

### Measurement of cost of electricity NCOs
- Starting on January 1, 2024, the cost of NCOs for electricity during each quarter will be 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.
- Until January 1, 2024, the cost of NCOs for electricity during each quarter will be measured by total losses as reported on the CEB’s financial statement.
- If the total sales revenues exceed the total expenditures, the cost of NCOs for electricity is zero.
- The government transfers to cover the cost of electricity NCOs are measured as central government transfers disbursed (including capital injection as specified in paragraph 6) to CEB.

### Program monitoring calculation (cost of fuel and electricity NCOs net of government transfers)
- The cost of fuel and electricity NCOs net of government transfers is calculated taking account of a time lag in estimating the cost of fuel and electricity NCOs.
- Formulas as specified:
  - For the test date of end-December 2023:
    - { NCO(2022Q4) + NCO(2023Q1) + NCO(2023Q2) + NCO(2023Q3) } – { G(2023Q1) + G(2023Q2) + G(2023Q3) + G(2023Q4) }
  - For the test date of end-March 2024:
    - NCO(2023Q4) – G(2024Q1)
  - For the test date of end-June 2024:
    - { NCO(2023Q4) + NCO(2024Q1) } – { G(2024Q1) + G(2024Q2) }
  - For the test date of end-September 2024:
    - { NCO(2023Q4) + NCO(2024Q1) + NCO(2024Q2) } – { G(2024Q1) + G(2024Q2) + G(2024Q3) }
- Definitions used:
  - NCO(q) = cost of NCOs for fuel and electricity during quarter “q”
  - NCO_fuel(q) = cost of NCOs for fuel during quarter “q”
  - NCO_electricity(q) = cost of NCOs for electricity during quarter “q”
  - NCO(q) = NCO_fuel(q) + NCO_electricity(q)
  - G(q) = central government transfers to CPC and CEB disbursed during quarter “q”
  - G_fuel(q) = central government transfers to CPC disbursed during quarter “q”
  - G_electricity(q) = central government transfers to CEB disbursed during quarter “q”
  - G(q) = G_fuel(q) + G_electricity(q)

### Treasury guarantees (indicative target)
- Treasury guarantees are defined as outstanding debt guarantees issued by the central government, i.e., 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 comfort.
- Outstanding guarantees are defined as the drawn amounts of guaranteed debts; they differ from issued guarantees, which include guaranteed 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.
- 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-2022, the outstanding treasury guarantees were valued at Rs 1,180.7 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 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.
- Specific reporting formats and frequencies (selected highlights):
  - Fiscal targets (Table 3, Table 4, Table 5): furnished within no more than five weeks after the end of each month, except salaries and wages, goods and services, subsidies and transfers (and its subcomponents) furnished within no more than seven weeks after the end of each month; total recurrent expenditure and interest payments furnished within no more than five weeks after the end of each month.
  - Monetary targets (Table 6): furnished within no more than four weeks after the end of each month.
  - External targets (Table 7 and Table 8): furnished within no more than 25 days after the end of each month.
  - Indicative target on social safety net spending (Table 9): furnished within no more than two months after the end of each quarter.
  - Financial performance of CEB, CPC, and SriLankan Airlines (Tables 10, 11, 12): furnished within no more than 2 months after the end of each quarter.
  - Indicative target on the cost of fuel NCO (net of government transfers) (Table 13): furnished within no more than 5 weeks after the end of each quarter.
  - Indicative target on treasury guarantees (Table 14): furnished within no more than two months after the end of each quarter.

### Financial sector monitoring
- For monitoring the financial sector, the authorities will provide a quarterly written update and the following information on a bank-by-bank basis:
  - Liquidity monitoring template, with breakdown by currency (daily)
  - LCR template, with breakdown by currency (monthly)
  - Net open foreign currency positions (weekly)
  - Exposures to the central government and large SOEs (CEB, CPC, SLA, RDA), with breakdown by entity, currency, and instrument (monthly)
  - Maturities of exposures to the central government and large SOEs (CEB, CPC, SLA, RDA), (monthly)
  - Arrears of state-owned banks (monthly)
  - Impairment schedule including breakdown of impairments on public sector exposures (monthly)
  - Monthly supervisory returns to CBSL including statements of financial position and comprehensive income (monthly)
  - Top 10 largest depositors (quarterly)
  - Large exposures exceeding 15 percent of capital (quarterly)
  - Capital adequacy template (quarterly)
  - Financial soundness indicators (quarterly)
- Timeliness by frequency:
  - Daily financial sector data: within one week of the end of the reporting period
  - Weekly data: within two weeks
  - Monthly data: within four weeks
  - Quarterly data: within six weeks

### Program context and selected macro-fiscal figures from authorities’ statement
- Real economy contraction: from 12.4 percent in Q4 2022 to 3.1 percent in Q2 2023 (year-on-year).
- Inflation (Colombo Consumer Price Index (CCPI) based, headline): peaked at 69.8 percent in September 2022; reached 1.3 percent by September 2023.
- CBSL net purchases from the domestic forex market: exceeding US$ 1.8 billion (trade date basis) thus far during the year.
- Sri Lanka rupee movements: depreciated by 44.8 percent against the US dollar in 2022; appreciated by 11.0 percent thus far during the year.
- Gross official reserves (GOR): improved from US$ 1.8 billion in April 2022 to US$ 3.6 billion by end November 2023.
- Tax revenue collection: increased by 55.8 percent during January-November 2023 compared to the same period of the previous year.
- Tax revenue to GDP ratio: 7.3 percent in 2022; expected to improve to 9.2 percent of GDP in 2023 and 12.1 percent in 2024.
- Social safety nets allocation: set at 0.7 percent of GDP.
- Fiscal deficit for 2024 (without bank recapitalization): projected at 7.6 percent.

*Source: IMF staff report text excerpt provided in the content unit.*

### 8.5  percent  in  2023  and  the  double-digit  deficits  recorded  during  2020-2022.  During  this  year,  the

### 1lkaea2023003 - 8.5  percent  in  2023  and  the  double-digit  deficits  recorded  during  2020-2022.  During  this  year,

### Fiscal outlook and primary balance
- 0.7 percent of GDP is expected by end 2023 with a surplus of 0.8 percent (without bank recapitalization) in 2024.
- Primary deficits were 5.7 percent in 2021 and 3.7 percent in 2022.
- With bank recapitalization, the fiscal deficit and the primary deficit for 2024 are envisaged at 9.1 percent and 0.6 percent of GDP, respectively.
- Expected revenue improvement will provide adequate space for the government to gradually increase capital expenditure on development projects.
- The proposed Public Financial Management Act will aid efforts to strengthen fiscal sustainability.

### Cashflow management and market implications
- Strictly limited foreign financing and the absence of deficit financing from the Central Bank resulted in considerable challenges to the General Treasury in terms of cashflow management.
- Authorities managed cash stresses without triggering speculative increases of yields on government securities, as evidenced in recent auctions.
- Authorities have built sufficient cash buffers to thwart adverse speculation and smooth out Treasury operations.

### State-owned enterprises (SOEs) and energy sector reforms
- Cost-reflective, formula-based, monthly pricing introduced in the petroleum sector.
- Electricity tariffs adjusted to reflect the true cost of generation.
- Due to unpredictability of hydro-power generation and resultant energy mix, authorities will implement quarterly adjustments to electricity prices from 2024 replacing semi-annual adjustments introduced in 2023.
- Private sector participation is expected to improve the performance of energy utilities.
- Several key SOEs are being restructured; a special government unit has been established for this purpose.
- Restructuring is expected to reduce over-exposure of the fiscal and financial sectors to SOEs.

### Inflation and monetary policy outcomes
- CCPI-based headline and core inflation (year-on-year) peaked at 69.8 percent and 50.2 percent, respectively, in September 2022.
- Headline and core inflation in November 2023 were recorded at 3.4 percent and 0.8 percent, respectively.
- Some upward movement of inflation is expected in 2024 due to scheduled increases in taxes and the one-off effect of recent electricity tariff adjustments.
- Beyond 2024, inflation is projected around the targeted level of 5 percent, supported by appropriate policy measures.
- Staff had projected double-digit inflation throughout 2023, requiring the CBSL to effect a prior action of a 100 basis point tightening of monetary policy in March 2023.
- CBSL eased the monetary policy stance by 650 basis points since June 2023.
- CBSL policy rates currently form a band of 9-10 percent, compared to current inflation of 3.4 percent and the targeted level of 5 percent.
- The faster-than-expected disinflation caused a breach of the lower outer band of inflation under the monetary policy consultation clause (MPCC) and required a significant downward adjustment to the MPCC from September 2023 onwards.

### Interest rates, credit, and CBSL balance-sheet actions
- Prime lending rate: around 29.7 percent at peak in November 2022; currently at 13.03 percent.
- 364-day primary market Treasury bill rate: peaked at 30.5 percent in August/September 2022; currently at 12.88 percent.
- Credit to the private sector recorded a month-on-month decline from June 2022 to May 2023; rebounded somewhat thereafter.
- Year-on-year contraction of private sector credit in October 2023 was 4.3 percent.
- Following the domestic debt operation converting the CBSL’s short term credit to the government into longer term instruments, the CBSL has commenced gradual unwinding of its government securities portfolio.
- Recent monetary policy easing, supported by sufficient market liquidity and interest rate caps on selected lending products, is expected to ease market interest rates to levels more affordable to businesses and households.

### Financial sector soundness and reforms
- Banking sector assets on a gradual upward trend; deterioration in credit quality has shown some moderation.
- Liquidity ratios maintained above minimum requirements.
- Net interest margin (NIM) of the banking industry recorded at around 3.5 percent in recent months.
- Return on equity (ROE) has remained above 10 percent during this period.
- Total capital adequacy ratio (CAR) maintained above 16 percent thus far in 2023.
- Asset Quality Review (AQR) will guide the process of recapitalization of the banking sector.
- Amendments to the Banking Act expected by end-January 2024 to further strengthen regulation and supervision.
- Measures to strengthen state-owned banks and improve governance, including appointment processes and board composition (majority independent members).
- Continued strengthening of the AML/CFT regime with several legislative amendments envisaged.

### External sector developments
- Sri Lanka is likely to record an external current account surplus in 2023.
- Import contraction, supported by import restrictions and subdued demand, contributed to a decline in the trade deficit.
- Removal of import restrictions (except motor vehicles) is unlikely to exert considerable pressure on the balance of payments.
- Export earnings declined due to growth slowdown in export markets and domestic disruptions.
- Worker remittances increased to US$ 4.9 billion during January to October 2023 from US$ 2.9 billion during the same period in the previous year.
- Cumulative tourist arrivals up to end November 2023 were 1,276,951, compared to 628,017 during the corresponding period in 2022.
- The current account deficit is expected to remain around 1.5 percent to 2.0 percent in the medium term.
- As cashflows improved, banks settled external liabilities and invested in liquid assets abroad, resulting in some financial outflows.
- Some increase in foreign portfolio and direct investments was observed during the year.
- CBSL continued to accumulate foreign exchange from the domestic market to rebuild Gross Official Reserves and intervened when necessary to prevent excessive volatility.
- The Sri Lanka rupee appreciated against the US dollar by 11.0 percent thus far during the year.

### Anti-corruption, governance, and growth-supporting reforms
- Authorities welcomed the Governance Diagnostic Assessment (GDA) conducted by the Fund and published the report as scheduled.
- The Anti-Corruption Act was unanimously approved by the Parliament in July 2023.
- The process of selection of anti-corruption commissioners by the Constitutional Council is underway.
- Measures being taken to increase merchandise and services exports.
- Planned phasing out of para-tariffs and entry into bilateral and multilateral trade agreements to bolster open trade policies.
- Planned reforms to labor, land and capital markets to improve productivity and efficiency.
- Authorities are addressing Sri Lanka’s vulnerability to climate change and seeking collective support for urgent climate action.

### Debt negotiations and creditor engagement
- Authorities engaged with official and commercial creditors transparently and in good faith.
- Agreements-in-principle reached with official bilateral creditors, including the OCC and the ExIm Bank of China, in line with program parameters.
- Authorities look forward to finalizing debt agreements in a transparent manner with all creditors early.
- Authorities acknowledge the role of the Fund management and staff in the debt negotiations process.
- Authorities have engaged closely with commercial creditors and expect to continue negotiations to reach an early agreement.

### Implementation, monitoring, and Fund engagement
- Authorities recognize implementation risks and have established a high-level implementation monitoring committee with participation of officials from the Presidential Secretariat, the Ministry of Finance, and the Central Bank of Sri Lanka.
- Meetings between IMF staff and the committee are being held on a weekly basis.
- Authorities appreciate technical assistance and capacity development support from the Fund to meet program targets and benchmarks.
- Authorities reaffirm commitment to close engagement with the Fund and timely implementation of the EFF-supported economic program, and appreciate Executive Directors’ support for the favorable conclusion of the First Review of the EFF-arrangement.

*Source: Excerpt from the provided IMF content unit (1lkaea2023003).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1lkaea2023003.pdf_