## 1lkaea2024001 ## Source details **Canonical URL:** [1lkaea2024001](https://www.imf.org/-/media/files/publications/cr/2024/english/1lkaea2024001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1lkaea2024001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1lkaea2024001.pdf.json) --- ### Executive summary: context and program status - Reform momentum: economy starting to recover; inflation low; revenue collection improving; reserves accumulating. - Key reforms: - New Central Bank Act approved July 2023; monetary financing phased out. - Revised Banking Act enhanced supervisory powers. - Exchange rate more flexible; reserves rebuilt from critically low levels; BoP measures being relaxed. - Tax policy measures and expenditure restraint underpinned a sizeable adjustment; cost-recovery energy pricing adopted. - Social safety nets enhanced. - Authorities advancing debt restructuring to restore debt sustainability. - Program approvals and access: - 48-month Extended Arrangement under the Extended Fund Facility (EFF) approved March 2023; access SDR 2.286 billion (395 percent of quota or about US$3 billion). - First disbursement SDR 254 million (about US$333 million); second disbursement SDR 254 million approved after first review on December 12, 2023; upon completion of second review, access to additional SDR 254 million. ### Program performance and structural benchmarks - Quantitative and continuous targets: - All quantitative targets for end-December 2023 met except the IT on social spending; all continuous QPCs observed. - By end-April 2024, all continuous SBs and ten out of fourteen SBs met or implemented with delay. - Prior action on parliamentary submission of the PFM bill was met. - Structural benchmarks reset or reprogrammed: - Full operationalization of Bulk Supply Transaction Account (BSTA) and enactment of Asset Recovery Bill reprogrammed to later dates. - Banking Act amendments approved April 2, 2024 after end-January deadline; full implementation expected by June 2024. - Specific monitoring and adjustments: - Authorities discussed breach of the MPCC inner band. - Staff supports: (i) completion of the second review under the EFF; (ii) reprogramming two SBs to later dates; (iii) modification of end-June 2024 performance criterion to lock in reserves overperformance and introduction of a new IT. ### Recent macroeconomic outcomes and key statistics - Growth and activity: - Real GDP: two consecutive quarters of expansion of 1.6 and 4.5 percent y-o-y in Q3 and Q4 in 2023. - Near-term growth projection: recover moderately at 2 and 2.7 percent in 2024-25 (macro framework). - Inflation and prices: - Inflation in low single digits since July 2023; April 2024 Colombo CPI cited in charts. - Headline consumer price inflation fell from 70 percent in September 2022 to 1.5 percent in April 2024 (text references varying month measures). - External sector and reserves: - Current account balance: surplus of 3.1 percent of GDP in 2023 (up from deficit of 1.0 percent in 2022). - Gross reserves: US$4.4 billion (2.4 months of prospective imports) as of end-December 2023. - CBSL net purchases: US$1.5 billion through mid-April 2024; gross official reserves increased to US$5.5 billion by end-April (2.6 months of prospective imports or 46 percent of the ARA metric). - Projected GIR: US$5.6 billion in 2024 (vs. US$5.3 billion at first review). - Fiscal outcomes: - Primary balance: from deficit of 3.7 to surplus of 0.6 percent of GDP in 2023 (surpassing targeted deficit of 0.7 percent). - Tax revenue: increased from 7.3 to 9.8 percent of GDP in 2023; number of taxpayers nearly one million. - Primary spending: declined from 12.1 to 10.5 percent of GDP in 2023. - Interest bill: 8.9 percent of GDP in 2023; overall deficit 8.3 percent of GDP. - Favorable developments reduced T-bill rates from over 30 percent to around 10 percent by end-April, 2024. - Financial sector: - NPLs ratio: declined marginally from 13.6 to 13.1 percent in January 2024. - Banks face elevated credit risk, shrinking net interest margins, large public sector exposure, and effects from debt restructuring. - Joint CBSL-MoF recapitalization plan to ensure adequate capitalization; recapitalization of Phase I banks contingent on CPC FX loan restructuring. ### Near-term outlook, projections, and risks - Projections (selected): - Real GDP growth (respective projection entries): 2024 Proj. -2.3 (table) and growth recover moderately at 2 and 2.7 percent in 2024-25 (macro framework references). - Inflation (Colombo CPI, selected): 2024 Proj. 17.4 (table) and longer-term path returning to near target by 2027 onward; alternative textual references report low single digits—source contains multiple series depending on scenario definitions. - Gross official reserves (end-period, US$mn): 2024 Proj. 4,387; 2025 5,346; 2027 7,174; 2029 13,466. - Central government debt (percent of GDP): 2024 Proj. 109.8; 2025 110.3; 2027 108.4; 2031 100.1. - Risk environment: - Downside risks remain elevated: fiscal financing risks, larger recapitalization needs, adverse effects from debt restructuring, waning reform momentum, social unrest, intensified regional conflicts, commodity price volatility, global slowdown. - Slow progress in debt restructuring would worsen BoP and widen financing gaps. - Program risk management and contingency: - Program overperformance locked in; revenue shortfalls mitigated by stronger ex-ante conditionality and revenue administration focus; capital spending under-execution as last resort. - Authorities committed to refrain from policies inconsistent with program objectives and continue creditor engagement. ### Fiscal policy: consolidation, revenue mobilization, and social protection - Fiscal targets and mechanics: - Program envisages about 6½ percent of GDP in tax revenue gains between 2022 and 2025 to bring tax revenue to about 14 percent of GDP. - 2024 Budget targeted a primary surplus of 0.8 percent of GDP; approved measures increase tax revenue by 0.3 ppts to 12.4 percent of GDP; expected primary surplus of 1 percent of GDP in 2024 (QPC). - Locking in 2023 overperformance reduces revenue-based adjustment needs by 0.4 ppts in 2025. - Stock of expenditure arrears to be maintained at zero (QPC). - Revenue measures for 2025: - Tax revenue gains needed in 2025 equivalent to 1.5 ppt of GDP (instead of 1.9 ppt at first review). - New measures totaling 0.7 percent of GDP: tax policy 0.4 percent of GDP; tax administration 0.3 percent of GDP. - Lifting import restrictions on motor vehicles would contribute 0.8 percent of GDP. - Package including 2023 overperformance expected to compensate shortfall from property and gift inheritance taxes (1.2 percent of GDP). - Imputed rental income tax: - To be introduced by April 1, 2025; total tax yield 0.4 percent of GDP (full materialization by 2026; partial yield 0.2 percent in 2025). - Data infrastructure actions: database from representative sample of 5,000 standard properties by August 2024 (proposed SB); nationwide SPRR fully operational by end-March 2025 (proposed SB); amend Notaries Act by April 2025. - VAT compliance program and IRD modernization: - VAT compliance program expected to raise about 0.3 percent of GDP in 2025. - IRD instituted quarterly KPI reporting; new KPI on VAT refunds starting September 2024. - Cabinet to approve IT Strategic Plan to deliver RAMIS (version 3.0) by August 2024 (proposed SB). - Social safety nets: - SSN spending: total actual 2023 Rs. 174.1 billion; expected December 2023 total about Rs. 190 billion after retroactive transfers. - 2024 SSN allocation Rs. 205 billion (0.7 percent of GDP) (indicative target); plan to increase to Rs. 225 billion in 2025. - Aswesuma improvements: grievances resolved, second round of applications, empowerment program targeting 1.2 million beneficiaries over 3 years (pilot 16,000 beneficiaries). ### Public Financial Management, PFM law, and SOE reforms - PFM law and fiscal framework: - PFM bill submitted to Parliament in May (Prior Action); implementing regulations by end-December 2025. - Commitments: fiscal strategy statement for 2025 by end-June 2024 (SB); fiscal risks statement; medium-term PFM Reform Strategy and Action Plan by end-December 2024. - PFM law provisions include fiscal rules: primary expenditure ceiling set in law at 13 percent of GDP and medium-term anchors. - SOEs (CPC, CEB, SLA): - Cost-recovery energy pricing introduced in 2022; CPC and CEB profitable in 2023. - Electricity tariffs revised downward by 21.9 percent on March 5 (must maintain forward-looking cost recovery). - Cross-debts between CPC, CEB, SLA and government eliminated in December 2023; legacy debts remain. - Authorities to adopt repayment schedule for CEB debt by end-December 2024; tariff calculation to account for debt repayments from January 2025. - BSTA operationalization delayed; rule requiring regulator to use BSTA by end-June 2024 (proposed SB, reset). - SOE governance reforms to continue with development partner support. ### Debt restructuring, public debt management, and DSA findings - Restructuring progress and scope: - Nearly all components of Domestic Debt Operation (DDO) concluded; remaining key item CPC FX loans held by two state banks. - Authorities close to MOU with OCC; signed agreements with China EXIM Bank; negotiations with bondholders and CDB ongoing. - Net domestic financing projected at 5.8 percent of GDP in 2024; monetary financing prohibited. - Financing assurances and program financing: - Program fully financed with firm commitments for next twelve months and good prospects for program period. - IFI program financing envelope US$3.8 billion over program period (World Bank US$1,716; ADB US$2,120). - Financing Gap and Program Financing table totals: Financing Gap (A) total 2022-27: -25,532; Program Financing (B) total 2022-27: 25,532; IMF EFF total: 23,064; IFI program financing support total: 3,836. - DSA assessment: - Debt operation places Sri Lanka on a downward path; final assessment: Sustainable, but risks High (overall, medium term, long term). - Under program scenario, Fund credit outstanding would peak at 3.2 percent of GDP in 2027; EFF repurchases and charges peak in 2031 at 2.5 percent of exports of goods and services and 3.8 percent of gross reserves. - Public debt (percent of GDP) projections: 2024 Proj. 115.7; 2025 115.9; 2027 113.1; 2031 103.1 (table entries). - Key DSA risks: dependence on completion of debt restructuring, fiscal discipline, access to domestic financing at reasonable rates, and sovereign-bank nexus. ### Monetary policy, exchange rate, and reserves strategy - Monetary stance and policy rates: - Following 2022 devaluation, policy rate hiked by cumulative 900 basis points; reduced by 700 basis points between May 2023 and March 2024 to 9.5 percent (lending facility). - 3-month T-bill and prime lending rates declined by close to 20 percentage points from November 2022 to about 10 percent in April 2024. - Staff view: current monetary stance broadly appropriate; forward-looking real policy rate around 2.5 percent (real neutral rate). - Monetary financing and CBSL balance sheet: - Monetary financing discontinued; CBSL maintained zero primary market purchases (continuous QPC) and offloaded government securities consistent with NCG targets. - NCG declined to Rs. 2,742 billion, Rs. 58 billion below the QPC (Q4-2023). - CBSL equity dropped from Rs. 728 billion in August 2023 to Rs. 56 billion in March 2024; forward-looking stress test suggested capital needs of 0.5 percent of 2024 GDP. - Exchange rate flexibility and reserve accumulation: - Authorities accumulated reserves through outright purchases despite nominal exchange rate appreciation. - NIR target for June 2024 revised up by US$100 million compared to first review. - Roadmap to relax motor vehicle import restrictions by 2025 (phasing: public passenger and special purpose vehicles in 2024 Q3; goods transport vehicles in Q4 2024; rest in 2025). Detailed plan to be finalized by June 15, 2024. - Two MCPs retained: (i) levy 2.5 percent stamp duty on credit card transactions abroad; (ii) levy 14 percent remittance tax on nonresidents’ profits. - MPCC and inflation targeting: - MPCC bands specified; deviations trigger consultations. Measurement details and consultation triggers defined in TMU. ### Financial sector policy, recapitalization, and supervision - Banking sector vulnerabilities and recapitalization: - Banks face elevated credit risk, shrinking net interest margins, large public sector exposures, and debt restructuring effects. - CBSL completed AQR-based recapitalization planning; recapitalization plans for Phase I banks contingent on CPC FX loan restructuring; authorities committed to recapitalize state-owned banks by end-August 2024 (proposed SB). - Private banks to implement capital plans or be recapitalized by December 2024 (proposed SB). - Regulatory and governance reforms: - Banking (Special Provisions) Act and Banking Act amendments to strengthen resolution, deposit insurance, licensing, consolidated supervision, capital and liquidity frameworks, large exposures, related party transactions, and state-owned bank regulation. - Cabinet adopted framework for corporate governance of state-owned banks on May 27, 2024 (SB); CBSL to vet selected personnel. - Suspension of Parate executions scheduled to end December 2024 to allow loan recovery processes to function. - Crisis preparedness: - Financial Sector Crisis Management Committee established chaired by the Governor with Secretary to the Treasury as Deputy Chairperson. ### Governance, anti-corruption, and structural reforms - Anti-corruption milestones and commitments: - CIABOC operationalization: publish strategic plan and submit annual budget by October 2024 (proposed SB); asset declarations of senior officials by end-July (SB). - Asset Recovery Bill to be enacted by November 2024 (proposed SB, reset). - Amend National Audit Act by September 2024 to enable fines on officials failing oversight. - Amend Company Act to bring beneficial ownership framework in line with FATF standards by September 2024. - Tax expenditures and transparency: - MoF estimates tax expenditures 4.1 percent of GDP in 2022. - Authorities committed to refrain from new tax exemptions; submit amendments to SDP Act introducing transparent, rules-based eligibility criteria by end-February 2025 (proposed SB). - Semi-annual publication of procurement contracts and list of firms receiving tax exemptions planned for June and December 2024 (SB). - Structural reform priorities: - Trade liberalization, labor market reforms (Employment Act expected Q3 2024), SOE efficiency, private sector level playing field, female LFP increase, and climate adaptation measures. - Employment Act highlights: compress work weeks, legal recognition for part-time and remote work, National Remuneration Council, measures to relax night-work restrictions for women, maternity/paternity leave provisions. - Female labor force participation: FLFP 32 percent in 2022; male LFP ~70 percent; recommended policies include childcare expansion, safe transport, and gender-responsive budgeting. ### Risks, safeguards, capacity development, and monitoring - Key program risks: - Program financing risks, waning reform momentum ahead of presidential elections (expected fall 2024), delays in banking reforms, social unrest, slow debt restructuring, and external shocks. - Safeguards and central bank assessment: - New CBA enacted incorporating SA recommendations; SA updates noted improved audit and financial reporting; CBSL urged to approve medium-term plan to strengthen financial position. - Capacity development and TA: - CD strategy anchored on revenue mobilization, PFM, public debt management, monetary operations, financial supervision, macro frameworks, governance, and data compilation; extensive FAD, MCM, LEG, STA assistance referenced. - Monitoring and contingency: - Weekly program monitoring meetings; program reviews semiannual; corrective measures and contingency plans specified for underperformance (frontloaded revenue measures, spending prioritization, reserve rules). ### Staff appraisal and recommendation - Assessment: - Reforms are bearing fruit: recovery beginning, inflation contained, reserves accumulating, revenue collection improved. - Vulnerabilities remain: debt restructuring, revenue mobilization, banks’ capital positions, and reserve accumulation momentum. - Policy priorities recommended: - Restore fiscal and debt sustainability via sustained revenue consolidation and finalization of debt restructuring. - Maintain price stability with prohibition of monetary financing and exchange rate flexibility; gradually phase out BoP restrictions. - Restore banks’ capital positions and strengthen governance of state-owned banks. - Implement comprehensive governance and anti-corruption reforms and prioritize structural reforms (trade liberalization, labor market, SOE reform, climate resilience). - Staff recommendation: - Support completion of the Second Review and the financing assurances review; support resetting two SBs, modification of end-June 2024 performance criterion, and introduction of an indicative target. *Source: IMF staff report, content unit 1lkaea2024001.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Context - Reform efforts are bearing fruit with the economy starting to recover, inflation remaining low, revenue collection improving, and reserves continuing to accumulate. - Performance under the program, the design of which benefitted from the 2021 Article IV recommendations, has been strong. - The economy remains vulnerable and the path to debt sustainability remains knife-edge. - Sri Lanka faces considerable uncertainties associated with the upcoming presidential elections and ongoing debt restructuring. - Sustaining the reform momentum is critical to safeguarding gains and ensuring Sri Lanka can emerge from one of its most severe economic crises. - Key recent reforms and developments: - New Central Bank Act (CBA) approved in July 2023 significantly enhanced the autonomy of the Central Bank of Sri Lanka (CBSL), and monetary financing was phased out. - A revised Banking Act (BA) enhanced supervisory powers. - The exchange rate has become more flexible, reserves were rebuilt from critically low levels, and BoP measures are being relaxed. - Tax policy measures and expenditure restraint underpinned a sizeable adjustment and cost-recovery energy pricing was adopted. - Social safety nets were enhanced. - Authorities advancing debt restructuring to restore debt sustainability. ### 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). - A second disbursement of SDR 254 million was approved after the first review on December 12, 2023. - Upon completion of the second review, Sri Lanka would have access to an additional SDR 254 million. ### Program Performance - All quantitative targets for end-December 2023 were met, except the IT on social spending; all continuous Quantitative Performance Criteria (QPCs) were observed. - By end-April 2024, all continuous Structural Benchmarks (SBs) and ten out of fourteen SBs were either met or implemented with a delay. - The prior action on the parliamentary submission of the PFM bill was met. - Full operationalization of the Bulk Supply Transaction Account (BSTA) and the enactment of asset recovery bill were reprogrammed to later this year. - The authorities discussed with staff the breach of the Monetary Policy Consultation Clause's (MPCC) inner band. ### Article IV discussions: Focus Areas - Fiscal reforms to restore debt sustainability and reinstate fiscal discipline while supporting social and developmental objectives. - Monetary and financial reforms to maintain price stability and enhance financial resilience. - Multi-pronged policy reforms to reduce external imbalances. - Structural reforms to strengthen governance and promote inclusive and sustainable growth. ### Policy Recommendations - Fiscal Policy - Sustained revenue mobilization, promptly finalizing the debt restructuring in line with program targets, and protecting priority spending are critical to restoring fiscal sustainability while promoting inclusive growth. - Advancing public financial management to enhance fiscal discipline and state-owned enterprise reforms will help enhance fiscal transparency and contain fiscal risks. - Monetary and Exchange Rate Policy - Monetary policy should prioritize maintaining price stability, supported by sustained commitment to prohibit monetary financing and to safeguard Central Bank independence. - Continued exchange rate flexibility and gradually phasing out the Balance of Payments (BoP) measures remain critical to rebuild external buffers and facilitate rebalancing. - Financial Policy - Restoring bank capital adequacy and strengthening governance and oversight of state-owned banks are top priorities to revive credit growth and support economic recovery. - Anti-Corruption and Governance Reforms - Steadfast implementation of the governance reforms would support the authorities’ broader reform agenda in unlocking Sri Lanka’s growth potential. - Structural Policy - Addressing prolonged structural impediments hinges on comprehensive and sustained reform efforts. - Top priorities include further trade liberalization to promote exports and foreign direct investment, labor reforms to upgrade skills and increase female labor force participation, SOE reforms to improve efficiency, promoting a level playing field for the private sector, and mitigating climate vulnerabilities. ### Requests from Authorities and Staff Support - Staff supports the authorities’ request for: - (i) the completion of the second review under the extended EFF arrangements; - (ii) reprogramming two SBs to later dates; - (iii) the modification of the end-June 2024 performance criterion to lock in reserves overperformance and the introduction of a new IT. ### Recent Macroeconomic Developments and Key Statistics - Real GDP posted two consecutive quarters of expansion of 1.6 and 4.5 percent y-o-y in Q3 and Q4 in 2023. - April manufacturing PMI showed a small dip to contractionary territory due to a decline in new orders and working days during the festive season. - Inflation has been in the low single digits since July 2023 despite temporary upticks in early 2024, led by increased food inflation and new fiscal measures. - External sector and reserves: - The current account balance registered a surplus of 3.1 percent of GDP in 2023, up from a deficit of 1.0 percent in 2022. - Gross reserves were US$4.4 billion (2.4 months of prospective imports) as of end-December 2023. - The CBSL accelerated reserve accumulation with US$1.5 billion net purchases through mid-April 2024—more than half of the projected increase for 2024. - By end-April, gross official reserves had increased to US$5.5 billion, equivalent to 2.6 months of prospective imports or 46 percent of the ARA metric. - Fiscal outcomes and public finance: - Primary balance improved from a deficit of 3.7 to a surplus of 0.6 percent of GDP in 2023, above the targeted deficit of 0.7 percent. - Tax revenue increased from 7.3 to 9.8 percent of GDP in 2023 and the number of taxpayers more than doubled to nearly one million. - Primary spending declined from 12.1 to 10.5 percent of GDP in 2023 due to a lower wage bill and the repayment to the Treasury of the Ceylon Petroleum Corporation (CPC) loan (0.9 percent of GDP). - Primary current spending remained broadly stable at 8.1 percent of GDP while capital spending (excluding net lending) increased marginally to 3.3 percent of GDP. - The large interest bill was 8.9 percent of GDP in 2023, contributing to an overall deficit of 8.3 percent of GDP. - Favorable fiscal and external developments reduced T-bill rates from over 30 percent to around 10 percent by end-April, 2024. - Banking sector and financial vulnerabilities: - NPLs ratio declined marginally from 13.6 to 13.1 percent in January 2024. - Banks face elevated credit risk, shrinking net interest margins, large exposure to the public sector, and effects from debt restructuring. - The joint CBSL-MoF recapitalization plan will ensure adequate capitalization levels based on Asset Quality Review (AQR) results and impact of debt restructuring. - Recapitalization plans for the five Phase I banks, originally received by the CBSL in January 2024, cannot be finalized before settling the restructuring terms of CPC’s FX loans held by the two state-owned banks. - Private credit expanded modestly since June 2023, after sharp contraction. ### Outlook and Risks - The program is starting to bear fruit with real GDP expanding, inflation remaining low, revenue collection strengthened, and reserves continuing to grow. - Significant efforts are still needed to ensure a sustainable recovery. - The authorities remain committed to mobilize revenues, restore debt sustainability, maintain price stability, strengthen external buffers, safeguard financial stability, and advance implementation of comprehensive governance and structural reforms. - Navigating the electoral cycle is critical to safeguard reform momentum: - Presidential elections are expected in the fall of 2024. - Under the Constitution, parliamentary elections need to take place by August 2025. - To weather election-related uncertainties, the program introduced safeguards including new conditionality to frontload revenue measures and a tighter quantitative criterion to lock in overperformance on reserve accumulation. *Source: IMF staff report, "EXECUTIVE SUMMARY" (1lkaea2024001).* ### 8. The near-term outlook is slightly upgraded, but the recovery remains gradual and the ### 1lkaea2024001 - 8. The near-term outlook is slightly upgraded, but the recovery remains gradual and the ### Near-term outlook and macro framework - Growth projections: recover moderately at 2 and 2.7 percent in 2024-25 given constrained bank credit and fiscal consolidation, while facing uncertainties around the debt restructuring and the elections. - Inflation: expected to exceed the 5 percent target in 2024 due to new fiscal measures and base effects before returning to target after transitory effects dissipate. - Current account: expected to remain positive in 2024, driven by improved tourist arrivals and remittances, partially offset by FX deposits abroad. - Gross international reserves (GIR): projected at US$5.6 billion in 2024 (vs. US$5.3 billion at the first review). - Macroeconomic framework reflects the authorities’ indicative debt treatment scenario. ### Risks and contingency management - Risk environment: - Downside risks have subsided somewhat but remain elevated. - Fiscal financing risks: difficulties issuing longer-term bonds, larger-than-envisaged recapitalization needs for banks and the CBSL, and adverse effects from restructuring domestic FX debt. - Domestic risks: waning reform momentum, especially on revenue mobilization, and possibility of social unrest. - External risks: intensified regional conflicts, commodity price volatility, and global slowdown potentially disrupting trade and capital flows, causing sharp exchange rate depreciation and inflation pressure. - Slow progress in debt restructuring would worsen the BoP and widen financing gaps. - Program risk management: - Program overperformance is locked in. - Revenue shortfalls mitigated by stronger ex-ante conditionality, focus on revenue administration reforms, and as last resort capital spending under-execution. - Authorities continue close engagement with creditors to minimize debt restructuring delays. - Authorities committed to refrain from policies inconsistent with program objectives. - Authorities’ views: broadly agreed with risk assessment; highlighted medium-term concerns on climate change, migration of high-skilled labor, and competitiveness loss; noted upside risks from the Port City project. ### Program performance (end-December 2023 and by end-April) - Overall: Performance of quantitative conditionality at end-December 2023 was strong, with all targets met except one. - Fiscal outcomes: - Primary balance: posted a surplus of Rs. 173.3 billion, surpassing the deficit target of Rs. 209 billion. - Tax revenues: Rs. 2,721 billion surpassed the indicative target (IT) floor of Rs. 2,550 billion. - QPCs on arrears and ITs on treasury guarantees and cost of non-commercial obligations for fuel and electricity were met. - IT on social spending: missed by a slim margin due to grievance reviews and challenges opening new bank accounts for beneficiaries. - Tentative March 2024 data: primary balance estimated at Rs. 316 billion (vs. IT of Rs. 70 billion) and tax revenue estimated at Rs. 833 billion (vs. IT of Rs. 750 billion). - Monetary and reserves: - Inflation: 3 percent, fell within the outer band (2 percent), but outside the inner band of the MPCC in Q4-2023. - Net Credit to Government (NCG): declined to Rs. 2,742 billion, Rs. 58 billion below the QPC. - Continuous QPC on primary market purchases of government securities was observed. - Net International Reserves (NIR): reached US$-2.18 billion, exceeding the target. - Adjustors on program NIR reached US$ 832 million due to shortfall in project financing flows; end-March 2024 IT met with NIR at US$-1.4 billion. - By end-April: - Most structural benchmarks (SBs) were either met or implemented with delay. - Key SBs met: parliamentary approval of the 2024 Appropriation Act; creation and implementation within the Large Taxpayers Unit of a High Wealth Individuals (HWI) unit and a design and monitoring unit including a strengthened risk management unit; cabinet approval of reducing the limit on government guarantees; cabinet approval of strategy to build a VAT refund system and full repeal of the Simplified VAT (SVAT). - Some SBs implemented with delay: report on KPIs for tax administration (implemented May 8, 2024); publishing procurement contracts and list of firms receiving tax exemptions (implemented February 13, 2024). - Missed and reset SBs: BSTA’s full operationalization not met (reset to end-June 2024); Asset Recovery Bill enactment missed and reset to end-November 2024; Banking Act amendments approved April 2, 2024 after end-January deadline with full implementation expected by June 2024. - PFM bill: parliamentary submission delayed (end-February SB) but implemented in May 2024 (Prior Action). ### Fiscal policy priorities and measures - Overarching aim: restoring fiscal sustainability and laying foundations for long-term goals through revenue mobilization, preserving primary balance path, advancing debt restructuring, and upgrading fiscal framework to manage fiscal risks. - Primary balance path: - Program envisages about 6½ percent of GDP in tax revenue gains between 2022 and 2025 to bring tax revenue to about 14 percent of GDP. - 2024 Budget targeted a primary surplus of 0.8 percent of GDP in 2024. - Approved measures increase tax revenue by 0.3 ppts to 12.4 percent of GDP. - With broadly unchanged spending execution, primary surplus expected to reach 1 percent of GDP in 2024 (QPC). - Locking in 2023 overperformance reduces revenue-based adjustment needs by 0.4 ppts in 2025 and helps compensate for lost property tax gains. - Stock of expenditure arrears to be maintained at zero (QPC). - Authorities committed to refrain from tax policy or administrative measures that erode tax revenue or jeopardize fiscal path. - Revenue mobilization for 2025: - Tax revenue gains in 2025 needed equivalent to 1.5 ppt of GDP (instead of 1.9 ppt at first review) to bring tax ratio to program target of about 14 percent in 2025. - Revenue gains in 2025 expected to stem from new measures totaling 0.7 percent of GDP: (i) tax policy measures 0.4 percent of GDP, (ii) tax administration measures 0.3 percent of GDP. - Lifting of import restrictions on motor vehicles would contribute 0.8 percent of GDP (slightly revised upwards by 0.1 ppt relative to the first review). - Combined measures including 2023 overperformance expected to fully compensate shortfall from property and gift inheritance taxes (1.2 percent of GDP). - Package of new tax policy measures to be submitted to Parliament by end-June 2024 (proposed SB) and approved by end-July 2024 (proposed SB) to take effect January 2025. - Authorities committed to adopt additional measures to compensate for unexpected revenue shortfalls. - Specific measures and timelines: - Imputed rental income tax: - Critical as substitute for property tax; to be introduced by April 1, 2025 with exemption threshold and graduated rates. - Total tax yield 0.4 percent of GDP, with full materialization by 2026 and partial yield of 0.2 percent in 2025. - Data infrastructure actions: - Establish database on property valuation (information from a representative sample of 5,000 standard properties) by August 2024 (proposed SB). - Fully operationalize nationwide digital Sales Price and Rents Register (SPRR) by end-March 2025, with provisional SPRR possible in August 2024 (proposed SB). - Amend Notaries Act by April 2025 to ensure notarized real property contracts automatically feed into digital SPRR. - VAT compliance improvement program: - Expected to raise about 0.3 percent of GDP in 2025. - Program to identify and prioritize compliance risks, cover taxpayer education, registration, filing, payment, and risk-based verifications (e.g., reintroducing taxpayer field visits). - Requires sufficient resources to IRD and continuing efforts to repeal SVAT by April 2025. - Revenue administration improvements: - IRD introduced quarterly tax administration KPI report (SB for March 2024); new KPI added to improve VAT refund system starting September 2024. - New targets for all KPIs up to March 2025 (proposed SB). - Cabinet to approve by August 2024 a prioritized, time-bound, and costed Information Technology Strategic Plan to deliver RAMIS (version 3.0) with functionality enhancements (proposed SB). - IRD to complete risk profiling of the 100 largest taxpayers and solicit required information as described in MEFP ¶12. - Expenditure prioritization: - Need to reduce reliance on ad hoc capital expenditure cuts that harm growth. - Baseline projects gradual increase of capital expenditure to 4 percent of GDP in 2024 and 4.6 percent by 2029. - Strengthen project selection processes and implement Public Finance Review recommendations to raise public investment efficiency. - Social Safety Nets (SSN): - Continued reforms to protect the poor: improve targeting, adequacy, and coverage since 2023. - Resolved many grievances under Aswesuma by end-February 2024 and started retroactive cash transfers due by end-December 2023. - Second round of applications by end-March 2024 to address exclusion errors; periodic assessment of Aswesuma planned. - Authorities seeking Parliamentary approval to extend cash transfers and increase payments for select groups. - Plan to implement an Empowerment Program with WB and ADB support to help beneficiaries graduate from Aswesuma. *Source: IMF staff report chapter 8 (1lkaea2024001) as provided.* ### 23. The new PFM law will strengthen the fiscal framework and enhance fiscal ### The new PFM law will strengthen the fiscal framework and enhance fiscal responsibility. ### Public Financial Management (PFM) law and fiscal framework - The PFM law was submitted to Parliament in May (PA). - Expected improvements: enhanced fiscal rules framework, better transparency and accountability, more efficient budget preparation processes (Annex IV). - Authorities committed to: - Ensure consistency of future bills with the PFM law. - Adopt implementing regulations of the law by end-December 2025. - Fully integrate PPPs with the public investment management process and ensure the MoF’s gatekeeper role in evaluating viability and affordability of projects. - Fiscal transparency actions and timelines: - Prepare a fiscal strategy statement for 2025 by end-June 2024, including the medium-term fiscal framework (MTFF) (SB). - Submit a fiscal risks statement identifying the main fiscal risks. - Prepare and publish a medium-term PFM Reform Strategy and Action Plan by end-December 2024. ### CPC and Ceylon Electricity Board (CEB): pricing, fiscal risks, and governance - Background and recent actions: - Cost-recovery energy pricing introduced in 2022; CPC and CEB made profits in 2023. - Electricity tariffs revised downward by 21.9 percent on average on March 5. - Conditionality and forward guidance: - The tariff reduction “should maintain cost recovery on a forward-looking basis, given the projections of hydro power usage, favorable exchange rate and interest rate developments.” - Any unforeseen deterioration in the assumptions will be corrected by an increase in tariffs. - BSTA operationalization and regulator rule: - Full operationalization of the BSTA delayed due to lack of formal power purchase and sales agreements. - Authorities will proceed with signed Memoranda of Understanding (MOUs) and adopt a formal rule requiring the regulator to use the BSTA to determine the cost-recovery tariff and government transfers by end-June 2024 (proposed SB, reset). - Legacy debt and efficiency measures: - Cross-debts between CPC, CEB, Sri Lankan Airlines (SLA) and the government were eliminated in December 2023, but substantial legacy debts remain (Annex VIII). - Authorities will adopt by end-December 2024 a repayment schedule for CEB debt starting April 2025 (proposed SB). - Electricity tariff calculation will start accounting for debt repayments starting January 2025. - Dispatch audit of CEB’s operational costs planned for late 2024 to assess scope for efficiency gains in generation and transmission. - Reforms to improve SOE efficiency and governance should continue with support from development partners. ### Revenue, tax policy, and PFM priorities (Authorities’ views) - Authorities reiterated commitment to revenue-based fiscal consolidation and prioritized PFM reforms. - Tax measures and administration: - Expedite efforts to introduce the imputed rental income tax by early 2025. - Support IRD with additional resources to implement a VAT compliance improvement program and strengthen revenue collection from large taxpayers through improved digitalization. - Committed to repeal the SVAT by April 2025. - Noted the economic and social costs of recent tax reforms while stressing need for tax exemptions to attract foreign investment. - PFM and SOE fiscal risk management emphasized. ### Debt sustainability and restructuring - Debt status and restructuring: - Sri Lanka’s debt remains unsustainable pending the resolution of debt restructuring (Annex VII). - Authorities have made significant progress with external creditor negotiations. - Total debt relief, agreed and under negotiation, expected to be consistent with program debt targets; post-restructuring debt sustainability risks will remain high (Annex II). - Creditor engagement: - Authorities close to agreeing on a MOU with the official creditor committee (OCC). - Signed agreements with China EXIM Bank; continuing good faith negotiations with external bondholders and CDB to reach AIP soon. - Domestic financing needs and risks: - Net domestic financing is projected at 5.8 percent of GDP in 2024 due to a large fiscal deficit and limited external financing. - Monetary financing is prohibited; government will rely on domestic borrowing from banks and superannuation funds. - Banks expected to invest more in government securities in 2024, potentially crowding out private credit. - Staff recommendation: reduce borrowing needs from the market by partially using the cash buffer accumulated in 2023 to finance the deficit. - Between 2025 and 2029, domestic financing is expected to decline to below 3 percent of GDP on the back of falling interest rates and deficits. - Public debt management reforms: - Establish the Public Debt Management Office (PDMO) by end-2024 and make it fully functional by end-2025 (proposed SB). - Move toward a holistic debt management strategy with forward-looking plans tied to annual and quarterly issuance and stronger communication. - Public Debt Management Act (PDMA) was submitted for Parliamentary approval on April 26, 2024. - To curb fiscal risks from FX guarantees to SOEs, a ceiling will be introduced (proposed IT); implementing regulations of the PDMA will define guidelines for granting SOE guarantees and on-lending. - FX guarantees would be allowed on an exceptional basis to facilitate IFI financing to SOEs under very strict conditions. ### Authorities’ views on debt management - Authorities broadly agreed with assessment of financing risks and staff recommendations on domestic debt management. - Committed to reaching swift resolution to debt restructuring and restoring debt sustainability. - Confident in capacity to finance the deficit in 2024; financing pressures expected to subside thereafter. - Committed to improving debt management strategy and practices to help lower interest bills and ameliorate financing risks. ### Monetary and exchange rate policies - Recent monetary policy path: - Following 2022 devaluation, policy rate hiked by a cumulative 900 basis points. - As inflation fell, policy rate was gradually reduced by 700 basis points between May 2023 and March 2024 to 9.5 percent (lending facility) to maintain price stability while supporting the recovery. - 3-month T-bill and prime lending rates declined by close to 20 percentage points from November 2022 to about 10 percent in April 2024. - Staff view current monetary stance as broadly appropriate; forward-looking real policy rate around 2.5 percent (real neutral rate). - Policy recommendations: - Prioritize anchoring inflation expectations; adopt a prudent and agile approach. - With inflation projected to exceed the CBSL target this year, Taylor rule implies limited room for further loosening in the near term unless inflationary pressures subside faster than expected. - Future monetary policy decisions should be governed by the MPCC clause and a real policy rate path close to neutral. - Interest rate caps have been eliminated as committed in the MEFP (¶25). - Central bank holdings and capitalization: - Monetary financing discontinued; CBSL maintained zero primary market purchases of government securities on a continuous basis (continuous QPC) and offloaded government securities in line with the NCG targets. - NCG (QPC) level expected to remain flat from September 2024 to March 2025 given limited marketability of the restructured bonds amid election and debt restructuring uncertainties. - CBSL equity dropped from Rs. 728 billion in August 2023 to Rs. 56 billion in March 2024. - Forward-looking stress test suggested capital needs of 0.5 percent of 2024 GDP to bring CBSL to a robust capital position. - CBSL reluctant so far to seek a capital injection; rebuilding capital would enhance credibility in conducting independent monetary policy. - Exchange rate flexibility and reserve accumulation: - Authorities have accumulated reserves through outright purchases despite nominal exchange rate appreciation. - NIR target for June 2024 revised up by US$100 million compared to the first review. - Authorities committed to accumulate reserves further while allowing the exchange rate to adjust freely and limiting FX sales only to disorderly market conditions. - Relaxation of BoP measures: - Roadmap to relax import restrictions on motor vehicles by 2025: - Start with public passenger and special purpose vehicles in 2024 Q3. - Goods transport vehicles in Q4 2024. - The rest in 2025. - Detailed plan, including implications on tax and reserve accumulations, to be finalized by June 15, 2024. - Committed to develop a plan on removing remaining administrative BoP measures, including exchange restrictions, Multiple Currency Practices (MCP), and capital flow measures (CFMs), by end-May 2024. - Based on reassessment following the new MCP policy, Sri Lanka maintains two MCPs: (i) levy of a 2.5 percent stamp duty on credit card transactions abroad; and (ii) levy of a 14 percent remittance tax on nonresidents’ profits. ### Authorities’ views on monetary/external policy - Authorities committed to keeping inflation contained and anchoring inflation expectations; prohibit monetary financing by implementing an effective data-driven and forward-looking inflation targeting framework. - Expressed difficulties in continuing to offload restructured T-bonds before they mature in five years’ time. - Believed partial external adjustment has already happened and that sensitivity of the trade balance to real effective exchange rate adjustment is weaker than staff assessment. - Remain committed to maintain a flexible exchange rate regime. ### Financial sector policies and banking sector resilience - Importance of a well-capitalized banking sector for recovery, investor confidence, credit growth, and rating upgrades. - Banks affected by debt restructuring, high NPLs and weak profit outlook should restore capital positions timely. - Projected bank capital shortfalls reduced since program approval due to: - More appreciated exchange rate. - Higher interest income for banks. - Build-up of provisions. - Better assumed restructuring terms on CPC’s FX loans. - Authorities’ commitments and timetables: - Authorities committed to bank recapitalization if needed to meet CBSL capital requirements. - Complete restructuring of CPC’s FX loans and recapitalization of state-owned banks by August 2024 (proposed SB). - Private banks should implement capital plans or be recapitalized in line with authorities’ strategy by December 2024 (proposed SB). - Supervisory and governance reforms: - Suspension of banks’ repossession of collateral (“Parate” executions) will hinder NPL management and should be lifted as soon as possible; suspension scheduled to end in December 2024. - Parliament approved Banking Act amendments on April 2, 2024 to strengthen supervisory and regulatory standards on state-owned banks. - Cabinet adopted and published a framework for corporate governance of state-owned banks on May 27, 2024 (SB), requiring merit-based, independent, and transparent nominations for board and senior management. - CBSL will vet selected personnel based on educational qualifications and professional experience. - Authorities’ views on bank capital: - Authorities ready to meet capital needs arising from debt restructuring using related 2024 budgetary provisions. - Given capital requirements in Sri Lanka that exceed the Basel minimum by 200 bps (10 percent) and other capital buffers, authorities see no need to increase state-owned banks’ capital beyond the regulatory minimum. - Expect banks to improve capital levels by accumulating profits as the economy recovers and to have capacity to meet additional capital needs without requiring future budget allocations. ### Anti-corruption, governance, and related reforms - Staff analysis: comprehensive and coherent anti-corruption and governance reforms can improve economic outcomes, enhance revenue mobilization and public investment management, promote private investments, and facilitate structural reforms (SIP). - Key milestones and commitments: - CIABOC operationalization: - CIABOC to publish a strategic plan, in consultation with the IMF, describing mission, objectives, timebound actions, and a monitoring framework, together with submission of CIABOC’s annual budget by October 2024 (proposed SB). - CIABOC committed to publish senior officials’ asset declarations by end-July (SB) while working toward fully operationalizing the online asset declaration system. - Asset Recovery Bill to be enacted by November 2024 (proposed SB, reset). - Tax policy and exemptions: - MoF estimates total tax expenditure of 4.1 percent of GDP in 2022, equivalent to more than half of 2022 tax revenue (7.3 percent of GDP) and nearly half the envisaged revenue gains under the program during 2023-25. - VAT and CIT exemptions were partly removed recently, but tax incentives under Strategic Development Projects (SDP) and Board of Investments (BOI) projects remain sizable (1.7 percent of GDP in 2022, MOF estimate). - Authorities committed to refrain from new tax exemptions, incentives, and from approving new projects under the SDP. - Submit amendments to the SDP Act introducing transparent, rules-based eligibility criteria for time-bound incentives to Parliament by end-February 2025 (proposed SB). - Revenue administration and anti-corruption measures: - Each revenue department to develop an implementation plan to launch anti-corruption measures to strengthen Code of Conduct, Internal Affairs department, risk management and automation by August 2024 (proposed SB). - PFM transparency: - Semi-annual publication updates of procurement contracts, list of firms receiving tax exemptions, and the value of all exemptions planned for June and December 2024 (SB). - Public asset oversight and audit: - Authorities will study options to establish and publish a government policy on criteria for allocating rights to public assets, with transparency, competition, and public information requirements, and a timeline to bring existing laws and regulations into compliance. - Amend the National Audit Act by September 2024 to enable the Auditor General to levy fines on officials, including Chief Accounting Officers, who fail in oversight and management of public assets. - AML/CFT and beneficial ownership: - Continue to strengthen AML/CFT regime, including legal amendments, risk-based supervision, stronger use of financial intelligence, and cooperation between FIU, law enforcement, and CIABOC. - Amend the Company Act to bring the beneficial ownership framework in line with FATF standards by September 2024. - Civic space: - It will be important to maintain the civic space needed for civil society organizations to operate. *Source: IMF staff report (excerpts provided in the supplied content).* ### 43. The authorities are motivated to reap the benefits from the governance reforms and ### 1lkaea2024001 - 43. The authorities are motivated to reap the benefits from the governance reforms and ### Governance reforms: progress, constraints, and priorities - Authorities are committed to sustain ongoing governance reforms and are motivated to reap benefits from them. - Corruption vulnerabilities were acknowledged, notably linked to tax exemptions; authorities agreed to maintain transparency on tax expenditures. - CIABOC seeks to expedite full operationalization but is constrained by existing capacity and financing resources and requested technical assistance from the IMF and other international partners. - Authorities are improving fiscal transparency and committed to tackle corruption across revenue agencies. - Authorities recognize the importance of a government policy to manage public assets with enhanced transparency but wish to study implementable options before committing to specific policies. ### Structural impediments to growth (diagnosis) - Long-standing structural impediments hinder growth potential: productivity, investment, and employment growth stagnated, reflecting the crisis and resource misallocation. - Trade regime: Highly protective trade regime inhibited import competition, export diversification, and foreign direct investment. - Labor market: - Labor force participation (LFP) rate has fallen significantly; female LFP remained persistently low (referenced Text chart, Annex VII). - Private sector constraints: SMEs impeded by limited credit and land access, administrative restrictions, and inefficient energy supply. - SOEs: Substantial scope to improve efficiency in the SOE sector. ### Structural reform priorities and specific measures - Overall: Reforms need prioritization and strategic phasing with support from international development partners. Authorities drafted the National Policy on Economic Transformation Bill to outline long-term economic objectives. - Trade - Authorities committed to reducing para-tariffs under the WB’s Development Policy Operation (DPO). - Sri Lanka is phasing out (i) over a period of 3 years the Export Development Board Cess and reducing the Cess by 33 percent from April 1, 2023; and (ii) over a period of 5 years the Port and Airport Levy (PAL) and reducing the PAL by 20 percent from April 1, 2023. - Additional initiatives: updating the National Export Strategy, expediting trade agreements, participating in global value chains, and promoting tourism. - Recommendation: consider streamlining the restrictive investment regime (e.g., fully implement a national single window for investors). - Labor market - Proposed Employment Act to unify and modernize labor laws, address rigidities, gender gaps, and low LFP. - New Act measures: promote female LFP, notably relaxation of restrictions on night-work for women and updates to occupational safety, health, and welfare provisions. - Additional steps: expand childcare facilities, provide safe transportation for women, and introduce gender-responsive budgeting. - Electricity sector - After cost-recovery tariff adjustment, pursue structural reforms with technical support to reduce high electricity cost and meet large generation and transmission investment needs. - Facilitate financing of renewable energy projects to strengthen competition and lower costs. - SOEs and private sector - Improve SOE governance and efficiency to promote resource reallocation, foster competition, and boost productivity (Annex IX). - Promote a level playing field for private firms, upgrade labor skills, facilitate SME integration into global value chains, and encourage formalization. - Adopt digital technology to support productivity gains in SOE and private sectors. - Climate change - Strengthen mitigation efforts including contingency budgeting and insurance schemes for natural disasters. ### Authorities’ views and program modalities - Authorities agreed with staff assessment of structural impediments and committed to growth-enhancing structural reforms; they welcomed staff quantification of economic gains from governance and structural reforms. - Authorities requested IMF and international development partner support for strategies to promote FDI and the climate reform agenda. - Program documentation: LOI and MEFP describe progress and policy commitments; Technical Memorandum of Understanding clarifies program definitions and quarterly targets. - Program target adjustments and safeguards (run-up to elections) - Staff proposes a higher NIR target for end-June 2024 to lock in overperformance from 2023 and early 2024 to build buffers. - MEFP commitment on prohibition of FX guarantees to SOEs relaxed to allow non-financial SOEs to access IFI financing; new IT ceiling on FX guarantees proposed from September 2024. - PFM SB from first review upgraded to prior action (PA). - New SBs proposed to seek parliamentary approval of revenue measures for the 2025 Budget ahead of presidential elections and to expedite preparatory work for introducing an imputed rental tax and implementing 2025 revenue measures. - Reporting of quarterly SBs on KPIs postponed by two months after each quarter for data preparation. ### Financing, debt restructuring, and capacity to repay - Staff assessment: progress on debt restructuring is consistent with restoring medium-term external viability; program is fully financed with firm financing commitments for the next twelve months and good prospects for the program period. - Program financing gaps in 2024-27 expected to be filled through debt restructuring and new financing. - AIPs with main official creditors and consent from Saudi Arabia, Kuwait, Iran, and Pakistan (to which Sri Lanka continues to have arrears) align with Lending into Official Arrears (LIOA). - Authorities are making good faith efforts on debt restructuring with remaining private creditors (external bondholders, CDB and others) and pursuing policies consistent with the EFF program. - Expected milestones: reach AIPs with bondholders and CDB in line with program parameters; reach agreement on MOU with the OCC and secure signed agreement with China EXIM before completion of the third review. - Firm assurances from the WB and ADB received regarding 2024-2025 financing; total non-IMF IFI program financing envelope amounts to US$3.8 billion over the program period. - Table summary highlights (External Financing Gap and Program Financing, 2022-2027, in millions of US dollars): - Financing Gap (A) total 2022-27: -25,532 - Program Financing (B) total 2022-27: 25,532 - IMF EFF total: 23,064 - IFI program financing support total: 3,836 - World Bank total: 1,716 - ADB total: 2,120 - Gross International Reserves memorandum: 13,466 (sum across years) - Project loans memorandum examples: 1,473; 680; 1,000; 1,556; 1,603; 1,651 - Capacity to repay the Fund (Table 7) - Under the program scenario, Fund credit outstanding would peak at 3.2 percent of GDP in 2027, corresponding to 13.4 percent of exports of goods and services and 22.5 percent of gross reserves. - EFF repurchases and charges would peak in 2031, at 2.5 percent of exports of goods and services and 3.8 percent of gross reserves. ### Risks, safeguards, and capacity development - Key risks to the Fund: - Financial risks: capacity to repay and prolonged debt restructuring could extend credit risks beyond the program period. - Business and reputational risks: waning public support for reforms ahead of elections and after debt restructuring. - Mitigating measures: - Buffers from program overperformance at end-December mitigate 2024 performance risks. - Key measures include firm commitment to reforms, timely conclusion of debt restructuring, upfront implementation of anti-corruption measures, adjusted conditionality, and extensive Capacity Development (CD) support. - Weekly program monitoring meetings with authorities to ensure timely implementation. - Coordination with multilateral donors on disbursement of budget support and project financing to boost confidence and growth. - Safeguards Assessment (SA) - Since February 2023 update, a new Central Bank Act enacted incorporating SA recommendations; financial risk management expanded; steps initiated to strengthen internal audit function, including completion of an external quality assessment. - SA recommended CBSL approve a medium-term plan to strengthen its financial position given weakened equity and TA received on balance sheet and monetary operations. - Updated assessment: CBSL’s audit and financial reporting meet international standards; internal control environment anchored in a strong compliance culture; some functions require continued modernization. - Capacity Development strategy - CD strategy anchored on revenue mobilization, public financial management, public debt management, monetary operations, financial sector supervision and regulation, macroeconomic frameworks and financial programming, governance, and data compilation. - CD has supported implementation of past IMF staff advice with good traction (Annex IX). - Data - Macroeconomic statistics broadly adequate for surveillance. - Main data gaps include GDP data by expenditure components; potential CD support needs shown in Annex X. ### Staff appraisal: assessment and policy recommendations - Economic position and risks - Reforms and policy adjustment are bearing fruit: economy starting to recover with contained inflation, reserves accumulation, improved revenue collection and fiscal performance. - Vulnerabilities remain: ongoing debt restructuring, revenue mobilization, banks’ capital positions, and reserve accumulation momentum cloud the outlook. - Program performance - Strong performance overall: all quantitative targets met except IT on social spending (missed by a small margin due to operational challenges resolving a large number of grievances). - All continuous SBs and ten out of fourteen other SBs were met or implemented with delay; one reprogrammed SB on the Banking Act amendment implemented on April 2. - PFM law SB upgraded to a PA. Operationalization of BSTA expected by end-June; delayed enactment of asset recovery bill to allow public consultations. - Policy recommendations and priorities - Fiscal and debt sustainability: - Restore fiscal and debt sustainability through sustained revenue consolidation and finalization of debt restructuring. - Commitment to revenue administration reforms to improve compliance, especially from large taxpayers. - PFM reforms to reinstate fiscal discipline and curb SOE fiscal risks. - Ensure essential spending (including social and capital) is met by meeting revenue targets. - Current tax exemptions are “of macro-critical proportions” and suppress revenue; any further exemptions should be exceptional and follow transparent, rules-based eligibility criteria. - Monetary and exchange rate policy: - Maintain price stability as top monetary priority with prudent and agile policy and continued prohibition of monetary financing. - Gradually phase out BoP restrictions and maintain exchange rate flexibility to rebalance external positions and rebuild buffers. - External position: - External position assessed as moderately weaker than implied by fundamentals and desirable policies. - 2023 current account surplus, adjusted for cyclical and temporary factors (including moratorium on interest payments), reflects an underlying structural deficit of around 0.6 percent of GDP, which should be brought down to a more sustainable level (surplus of 1 percent of GDP) (Annex VI). - Pursue fiscal consolidation, exchange rate flexibility, and further reserve accumulation to reach sustainable external position. - Financial sector: - Restore banks’ capital positions by expediting recapitalization for banks affected by debt restructuring and identified in AQR exercises. - Strengthen governance and oversight for state-owned banks to ensure resilience and efficient credit intermediation. - Governance and anti-corruption: - Implement comprehensive governance reforms to enhance program performance and boost growth potential. - Reinforce revenue-based consolidation with anti-corruption efforts to improve taxpayer compliance. - Structural reforms: - Address prolonged structural challenges: further liberalize trade, improve investment climate, reduce gender gap, improve SOE efficiency, create level playing field for private sector, and mitigate climate vulnerabilities. - International development partner support remains important to prioritize and implement reforms. *Source: 1lkaea2024001 - IMF country report excerpt.* ### 64. Based on Sri Lanka’s overall strong performance and commitments under the ### 1lkaea2024001 - 64. Based on Sri Lanka’s overall strong performance and commitments under the ### Staff recommendation and overall conclusion - Based on Sri Lanka’s overall strong performance and commitments under the program, staff supports the authorities’ request for the completion of the Second Review. - Staff supports the completion of the financing assurances review. ### Specific requests supported by staff - Staff supports the requests for: - (i) resetting two SBs to a later date, - (ii) the modification of end-June 2024 performance criterion and introduction of an indicative target, and - (iii) the completion of the financing assurances review. ### Exchange restrictions and MCPs - Staff supports the authorities’ request for temporary approval of existing exchange restrictions and new MCPs, as the approval criteria are met. - These restrictions are imposed for BOP reasons, are non-discriminatory, and temporary in nature. *Source: 1lkaea2024001 - 64. Based on Sri Lanka’s overall strong performance and commitments under the* ### 65. It is expected that the next Article IV consultation with Sri Lanka will be held in ### It is expected that the next Article IV consultation with Sri Lanka will be held in accordance with the Executive Board decision on consultation cycles for members with Fund arrangements. ### Real Sector - Real growth in 2023 was supported by broad recovery across sectors, with stronger household consumption and private investment momentum. - High frequency indicators point to continued expansion in 2024. - Trade remains weak with continued import compression and sluggish exports. - Inflation remains low due to limited second round effect from tax measures and base effects. - T+1 Inflation Forecast is sourced from the IMF Consensus Forecast Database. ### Fiscal Sector - 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 are large and increased. - Local currency yields have declined and are approaching historic average levels. - Sri Lanka’s Emerging Markets Bond Index (EMBI) spreads continued to decline but remain high. ### Financial Market - Yield curve shifted down substantially and normalized to positive slope. - Policy rate was cut a few times to below 10%. - Market liquidity improved with FX inflows; CBSL holdings of government securities increased and overnight liquidity improved. - Market rates of T-bills moved close to policy rate amid compression of sovereign risk premium. - Lending rates dropped faster than deposit rates, pushing the spread back to long-term average. - Equity market recovered from the crisis and held up well. ### Foreign Exchange and Reserves - The rupee has appreciated in recent months, reflecting improving domestic FX liquidity. - Other regional currencies remained stable or marginally weakened. - REER appreciation occurred as domestic inflation declined. - CBSL accumulated reserves through net purchases despite a recent drop in foreign holdings of domestic securities partly due to declining yields. - Official reserve position improved. - Note: NIR numbers as per CBSL definition. ### Monetary and Financial Sector - Growth of private credit and monetary aggregates remains anemic. - Reserve money growth was lackluster as decumulation of T-bills roughly offset FX reserve accumulation. - Reported capital levels are high before accounting for the full impact of ongoing debt restructuring. - NPLs remained elevated, and provisions increased in 2024. - Banking sector profit outlook diminished on shrinking net interest rate margin and weak credit growth. - Banking sector liquidity improved due to more investment in government securities. - NBFI stands for Licensed Finance Companies and Specialized Leasing Companies. ### Balance of Payments and External Sector - Goods exports declined, in part due to reductions in apparel exports; imports fell by a larger margin reflecting continued import restrictions. - The current account recorded a positive balance for the first time in over two decades in 2023. - Direct and portfolio investment flows slowly picked up in 2023. - Gross International Reserves increased due to large net FX purchases by CBSL. - Improved 2023 current account balance was supported by increased net savings by the private sector and fiscal consolidation by the public sector. ### Selected Projections and Key Figures (Restructuring Scenario) - Real GDP growth: 2023 First Review 4.2; 2023 Prel. -7.3; 2024 First Review -3.6; 2024 Proj. -2.3; 2025 1.8; 2026 2.0; 2027 2.7; 2028 3.0; 2029 3.1. - Inflation (average, Colombo CPI): 2023 First Review 6.04; 2023 Prel. 5.2; 2024 First Review 17.9; 2024 Proj. 17.4; 2025 7.9; 2026 7.0; 2027 5.8; 2028 5.4; 2029 5.2; 2030 5.1; 2031 5.0. - Central government debt (percent of GDP): 2023 First Review 102.7; 2023 Prel. 115.9; 2024 First Review 107.8; 2024 Proj. 109.8; 2025 110.3; 2026 108.8; 2027 108.4; 2028 108.3; 2029 106.6; 2030 103.2; 2031 100.1. - Public debt (percent of GDP): 2023 First Review 114.8; 2023 Prel. 126.3; 2024 First Review 114.1; 2024 Proj. 115.7; 2025 115.9; 2026 114.2; 2027 113.1; 2028 112.5; 2029 110.2; 2030 106.5; 2031 103.1. - Gross official reserves (end of period, in millions of U.S. dollars): 2023 Act 3,139; 2023 Prel. 1,898; 2024 First Review 3,806; 2024 Proj. 4,387; 2025 5,346; 2026 5,605; 2027 7,174; 2028 9,262; 2029 13,466; 2030 15,105; 2031 15,286. - Usable gross official reserves (end of period, in millions of U.S. dollars): 2023 Act 1,565; 2023 Prel. 462; 2024 First Review 2,371; 2024 Proj. 2,951; 2025 3,910; 2026 4,169; 2027 7,174; 2028 9,262; 2029 13,466; 2030 15,105; 2031 15,286. - Current account balance (in percent of GDP): 2023 First Review -3.7; 2023 Prel. -1.0; 2024 First Review 1.5; 2024 Proj. 3.1; 2025 -0.8; 2026 0.5; 2027 -1.1; 2028 -1.2; 2029 -0.9; 2030 -0.9; 2031 -0.8. - Gross external financing needs (in millions of U.S. dollars): 2021 -5,136; 2022 -5,305; 2023 -1,390; 2024 -5,035; 2025 -7,588; 2026 -6,040; 2027 -5,088; 2028 -4,819; 2029 -4,547. - Total public debt (end-2023 debt stock, in US$mn): Total public debt 98,660 (100.0 percent total debt, 115.7 percent GDP). - External (foreign law) debt (end-2023): 43,323 (43.9 percent total debt, 50.8 percent GDP). - Domestic (local law) debt (end-2023): 55,338 (56.1 percent total debt, 64.9 percent GDP). - Debt service on end-2023 debt stock (2024–2026, US$mn): 2024 principal and interest total 24,082; 2025 total 11,870; 2026 total 9,404. External (foreign law) debt service: 2024 5,491; 2025 6,144; 2026 4,461. - IMF Fund repurchases and charges (in millions of SDR): 2023 208.2; 2024 266.0; 2025 294.7; 2026 309.5; 2027 325.3; 2028 347.6; 2029 397.7; 2030 433.5; 2031 493.5; 2032 484.7; 2033 440.0; 2034 338.2; 2035 240.6; 2036 147.8. - Fund credit outstanding (in millions of SDR): end-2023 1,176.8; end-2024 1,526.1; end-2025 1,875.4; end-2026 2,234.7; end-2027 2,348.8; end-2028 2,188.6; end-2029 1,968.5; end-2030 1,693.3; end-2031 1,333.5; end-2032 952.5; end-2033 592.7; end-2034 317.5; end-2035 127.0; end-2036 21.2. - Four-year Extended Arrangement availability and disbursements: total 2,286.0 (millions of SDR), percent of quota 395.0. *Source: IMF staff calculations and data provided by Sri Lankan authorities (selected charts, tables, and projections from the referenced IMF document).* ### Annex I. Implementation of the Key Recommendations of the ### Annex I. Implementation of the Key Recommendations of the 2021 Article IV Consultation ### Fiscal Policy - Recommendation: Revenue-based fiscal consolidation through high-quality and permanent revenue measures. - Status and actions: - The authorities adopted a package of tax reforms since September 2022 comprising of: - (i) increasing PIT and CIT marginal tax rates and lowering the liable thresholds, - (ii) reintroducing mandatory income tax withholding, - (iii) increasing the VAT tax rates and reducing registration threshold, and - (iv) removing many VAT tax exemptions. - Work is underway with FAD TA assistance to introduce an imputed rental income tax in lieu of the property tax. - Recommendation: Strengthen revenue administration. - Status and actions: - Authorities are focusing efforts to improve compliance from large taxpayers through reforms to the Large Taxpayers Unit (LTU) of IRD. - Work is underway to adopt performance indicators for IRD to improve on-time payments, tax filings, reporting and registration. - The authorities have adopted a strategy to repeal the SVAT in April 2025. - Recommendation: Adopt cost-recovery energy pricing. - Status and actions: - The authorities introduced automatic formula-based adjustments for setting fuel prices on a monthly basis and on a quarterly basis for electricity prices. - Both CPC and CEB made small profits in 2023. - Recommendation: Improve budget formulation and execution. - Status and actions: - A draft PFM bill focusing on enhancing the fiscal rules framework through better compliance and accountability mechanisms as well as improved transparency was submitted to Parliament in May 2024. - Recommendation: Implement social safety net (SSN) reforms to protect the poor and the vulnerable. - Status and actions: - Major SSN reforms were introduced to improve targeting, coverage, and adequacy including establishing a welfare benefit payment scheme and the application of the new eligibility criteria to better identify low-income families for receiving welfare benefit payments. - The full transition to the new scheme is delayed due to a large number of grievances, which the authorities are trying to resolve by March 2024. ### Monetary and Financial Sector Policies - Recommendation: A tighter monetary policy to bring inflation closer the CBSL target. - Status and actions: - Policy rate hikes in 2022 helped the CBSL reduce inflation from 70 percent to low single digits. - Recommendation: Phase out monetary financing. - Status and actions: - Net Credit to Government has declined in 2023 and further offloading of government securities is expected in 2024 until September under the EFF. - The revised CBA, enacted in September 2023 prohibits further monetary financing except for extraordinary circumstances. - Recommendation: Strengthen the institutional and legal framework of debt management by passing the Public Debt Management Law and setup of Public Debt Management Office. - Status and actions: - The public debt management law was submitted for Parliamentary approval on April 26, 2024. - Preparation work for the setup of public debt management office will be further delayed; the office is expected to be fully functional by the end of 2025. ### Balance of Payments (BoP) Policies - Recommendation: Rebuild reserves and ensure a gradual return to a market-determined and flexible exchange rate. - Status and actions: - The CBSL dropped the guidance to confine daily movements within a pre-defined band in March 2023. - The CBSL has gradually rebuilt GIR through outright FX purchases under the EFF. - Recommendation: Relax import restrictions and remove temporary capital flow management measures (CFMs). - Status and actions: - The authorities relaxed import restrictions apart from motor vehicles, with removal of remaining restrictions to be considered after the completion of the debt restructuring so as not to generate undue current account pressures. - Some CFMs identified in the 2021 AIV SR were eliminated. - Recommendation: Develop a comprehensive strategy to restore debt sustainability. - Status and actions: - Authorities engaged in: (a) macroeconomic adjustment including fiscal, exchange rate, monetary and structural policies, (b) working to complete debt restructuring with their external creditors, and (c) finalizing the treatment of the foreign exchange denominated portion of their domestic debt operation. ### Governance - Recommendation: Undertake efforts to strengthen governance and reduce corruption vulnerabilities. - Status and actions: - The authorities enacted a new Anti-corruption bill and published an IMF-led Governance Diagnostic Report in 2023, and an action plan based on the recommendations in GD report in February 2024. - CIABOC commissioners were appointed and rules for the selection process of commissioners were published by end-December 2023. --- ### Annex II. Sovereign Risk and Debt Sustainability Analysis (SRDSA) — DSA Assumptions and Assessment ### DSA Assumptions (summary of key points) - Macroeconomic framework updates since November 2023: - Include (i) a small upside surprise to 2023 growth, (ii) stronger primary balance in 2023 which was offset by a larger interest bill, and (ii) less than expected depreciation by end 2023. - Debt-to-GDP outcomes in 2023 stood at 115.7, higher than projected at first review due to: - i) the assumption on the restructuring date changing to 2024, and - ii) overfinancing by the government to build cash buffers. - Medium-term projections remain anchored at: - (i) Sri Lanka’s medium-term growth potential, - (ii) the central bank's inflation target, and - (iii) the External Balance Assessment (EBA)-based misalignment and external adjustment needs. - REER adjustment is similar to the first review; given a more appreciated starting position of the exchange rate, medium-term nominal exchange rate levels are stronger than projected during the first review—contributing to a slightly lower projected debt to GDP path. - Table excerpt (DSA Macroeconomic Assumptions — Differences with First Review): - Real growth (%): - 1st Review: -3.6 1.8 2.7 3.0 3.1 3.1 3.1 - Current: -2.3 2.0 2.7 3.0 3.1 3.1 3.1 - GDP deflator inflation (yoy, %): - 1st Review: 20.4 10.1 6.3 5.4 5.3 5.2 5.2 - Current: 17.5 9.8 6.9 5.4 5.2 5.1 5.0 - Primary balance (% of GDP): - 1st Review: -0.7 0.8 2.3 2.3 2.3 2.3 2.3 - Current: 0.6 1.0 2.3 2.3 2.3 2.3 2.3 - Nominal GDP (Rs bln): - 1st Review: 28,033 31,422 34,291 37,226 40,397 43,812 47,515 - Current: 27,630 30,917 33,958 36,839 39,959 43,287 46,869 - Financing assumptions and domestic market conditions: - Domestic interest rates declined since the DDO execution but remained high in 2023 relative to first review projections, leading to a greater than projected interest bill (8.9 percent of GDP). - Q1 2024 has seen an improvement in the sovereign risk premium, with the T-bill rates coming down to 10 percent, but rates on longer term bonds remain high. - Authorities found it challenging to issue larger amounts of longer-term bonds amid uncertainties on external debt restructuring and upcoming elections. - This update raises the effective interest rate and increases dependence on shorter term T-bonds in the total financing mix for 2024. - Includes updated assumptions on remaining SOE local law FX-denominated debt restructuring (CPC FX loans). - Recapitalization contingency for banks and the central bank remains at 5 percent of 2022 GDP. - Key risk highlighted: - Ability to access continued domestic financing at reasonable interest rates. - Most gross domestic issuances in 2024 (mostly T-bills and shorter end T-bonds) are expected to be absorbed by banks and pension funds within their absorptive capacity following the DDO. - Starting 2025, the framework assumes authorities can issue more long-term T-bonds in line with historical patterns. - Downside risks: non-bank domestic sector financing provision may lag, delaying transition to long-term bonds, forcing banking system to absorb more short-term debt, crowding out private credit, sapping economic growth, and potentially reversing reductions in sovereign risk premium. - Authorities expected to employ part of their cash buffers in 2024-26 to limit borrowing and mitigate risks. ### Debt Restructuring Assumptions and Compliance with Debt Targets - Debt restructuring assumptions: - Reflect indicative terms consistent with recent AIPs with external official creditors and the authorities’ indicative debt treatment scenario. - Indicative terms feature principal haircut and step-up coupon in proposed ISB treatment (in line with authorities’ latest offer to bondholders), maturity extension with lower interest rate and progressive amortization profile in proposed bilateral debt treatment. - Proposed treatments for foreign creditors imply a meaningful NPV reduction to meet program’s debt targets; terms are still under negotiation and cannot be further described in the DSA. - Compliance with debt targets: - All four debt targets are respected in the authorities' restructuring strategy and the restructuring along with macroeconomic adjustment will restore debt sustainability. - The DSA update assumes full execution of the authorities' indicative and announced debt treatments. - The four debt targets (on program period external debt service relief, post-program GFNs and FX debt service, and debt stock) are met, though with small buffers—particularly on the post program flow targets—highlighting substantial implementation risks. - Flow targets on GFNs and FX debt service limit liquidity risks by restricting debt service to significantly lower levels than in recent history: - GFNs in 2013-2022 averaged 23 percent of GDP, - FX debt service averaged 9 percent of GDP. - By 2032, domestic and local currency debt are projected to constitute around 54 percent of Sri Lanka’s debt (local currency debt was 45.5 percent of total debt in 2022), lowering exchange rate valuation and sudden stop risks. - Sri Lanka’s historical private savings averaged 33 percent of GDP in 2010-22. - Banking sector absorption of government debt as of end-2023 was higher than initially projected, at around 39.3 percent of banking system assets. - As of end-2021, the weighted average maturity of Sri Lanka’s T-bonds was over 11 years. - 2027-32 average GFNs: 13.0 percent (chart note). ### DSA Summary Assessment and Risk Diagnostics - DSA summary assessment: - Sustainability assessment: The debt operation will put Sri Lanka on a firm downward path. But the reduction of debt vulnerabilities to safe levels will take time. Meanwhile, external shocks or domestic policy reversals could lead to renewed debt increase. - Final assessment: Sustainable. - Comment: The debt operation and fiscal adjustment, combined with debt restructuring, will eventually restore debt sustainability; however, downside risks remain high under a restructuring scenario. - Risk of sovereign stress (Restructuring Scenario): - Overall: High - Medium term: High - Long term: High - Debt stabilization in the baseline: Sri Lanka is in a deep crisis, as debt is unsustainable. Deep fiscal reforms are necessary but not sufficient; contributions from creditors and new concessional financing are needed to restore debt sustainability. Even after a successful program and debt restructuring, debt risks will remain high for many years. - Additional long-term risks: slowing growth due to a declining labor force and climate vulnerabilities. - Debt coverage and disclosures (selected points): - Debt coverage in the DSA: central government, public nonfinancial corporations, central bank, other public financial corporations included. - If central government, are non-central government entities insignificant? Yes. *Source: IMF staff estimates and projections; excerpted text from Annex I and Annex II of the IMF document.* ### 5. Debt consolidation across sectors: ### 5. Debt consolidation across sectors: ### Perimeter and recording - DSA perimeter includes (i) central government debt; (ii) SOE debt guaranteed by the central government; and (iii) liabilities of the central bank arising from the 2016-20 EFF and bilateral swap arrangements. - Oth. pub. fin. corp. holdings of CG debt includes holdings by state-owned banks, but excludes retirement funds. - Provincial and local governments do not carry debt as they are not authorized to borrow. - Notes on recording and valuation: - Stock of arrears could be used as a proxy in the absence of accrual data on other accounts payable. - IPSGSs = Insurance, Pension, and Standardized Guarantee Schemes, typically including government employee pension liabilities. - Includes accrual recording, commitment basis, due for payment, etc. - Nominal value definition: the amount the debtor owes to the creditor; reflects instrument value at creation and subsequent economic flows. - Face value definition: the undiscounted amount of principal to be paid at (or before) maturity. - Market value: value as if acquired in market transactions on the reporting date; only traded debt securities have observed market values. ### Public debt structure and dynamics (central government perimeter) - Residual maturity: 6. years - Commentary: 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. Dynamics reversed partially in 2023 as the exchange rate appreciated and inflation slowed. Foreign-law and multilateral law debt account for close to half of Sri Lanka's debt. The debt operation is assumed to rebalance the maturity profile, increasing the residual maturity. ### Baseline scenario (percent of GDP unless indicated) - Public debt (Prel. 2023 → 2034): 115.7, 114.2, 113.1, 112.5, 110.2, 106.5, 103.0, 99.7, 96.4, 93.2, 90.1, 87.2 - Change in public debt: -10.6, -1.5, -1.1, -0.7, -2.2, -3.8, -3.4, -3.4, -3.3, -3.2, -3.0, -2.9 - Contribution of identified flows: -6.4, -1.1, -1.7, -1.7, -3.0, -3.1, -2.8, -2.8, -2.7, -2.7, -2.6, -2.5 - Primary deficit: -0.6, -1.0, -2.3, -2.3, -2.3, -2.3, -2.3, -2.3, -2.3, -2.3, -2.3, -2.3 - Noninterest revenues: 11.0, 13.5, 15.0, 15.2, 15.3, 15.3, 15.3, 15.3, 15.3, 15.3, 15.3, 15.3 - Noninterest expenditures: 10.4, 12.4, 12.7, 12.9, 13.0, 13.0, 13.0, 13.0, 13.0, 13.0, 13.0, 13.0 - Automatic debt dynamics: -5.7, -0.4, -0.4, -0.4, -0.7, -0.8, -0.5, -0.5, -0.4, -0.4, -0.3, -0.2 - Real interest rate and relative inflation: -1.1, 1.9, 2.6, 2.9, 2.6, 2.5, 2.7, 2.6, 2.5, 2.5, 2.5, 2.5 - Real interest rate: -10.0, -1.7, 0.3, 1.3, 1.1, 1.0, 1.2, 1.2, 1.2, 1.2, 1.3, 1.4 - Relative inflation: 8.9, 3.5, 2.3, 1.6, 1.6, 1.5, 1.4, 1.4, 1.3, 1.3, 1.2, 1.1 - Real growth rate (multi-year entries): 3.0, -2.2, -3.0, -3.3, -3.4, -3.3, -3.2, -3.1, -3.0, -2.9, -2.8, -2.7 - Other identified flows: 0.0, 0.3, 1.0, 0.9, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 - Contribution of residual: -4.2, -0.4, 0.7, 1.1, 0.8, -0.7, -0.6, -0.6, -0.5, -0.5, -0.5, -0.5 - Contingent liabilities: 0.0 across projection years - Other transactions: 0.0, 0.3, 1.0, 0.9, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 ### Gross financing needs and currency composition (percent of GDP) - Gross financing needs: 27.8, 25.0, 23.7, 20.5, 16.6, 13.1, 11.9, 11.7, 12.1, 12.6, 13.4, 13.2 - of which: debt service: 28.5, 26.0, 26.0, 22.8, 18.9, 15.4, 14.2, 14.0, 14.4, 14.9, 15.7, 15.5 - Local currency financing needs: 26.8, 23.5, 22.7, 19.7, 15.8, 11.5, 10.1, 9.6, 10.2, 10.8, 11.7, 11.6 - Foreign currency financing needs: 1.7, 2.6, 3.3, 3.2, 3.0, 3.8, 4.1, 4.3, 4.3, 4.1, 4.1, 3.9 ### Macro memos (exact values preserved) - Real GDP growth (percent): -2.3, 2.0, 2.7, 3.0, 3.1, 3.1, 3.1, 3.1, 3.1, 3.1, 3.1 - Inflation (GDP deflator; percent): 17.5, 9.8, 6.9, 5.4, 5.2, 5.1, 5.0, 5.0, 5.0, 5.0, 5.0 - Nominal GDP growth (percent): 14.8, 11.9, 9.8, 8.5, 8.5, 8.3, 8.3, 8.3, 8.3, 8.3, 8.3 - Effective interest rate (percent): 8.4, 8.1, 7.3, 6.6, 6.3, 6.1, 6.3, 6.3, 6.4, 6.4, 6.6, 6.7 ### Staff assessment and drivers - 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. In 2023, automatic debt dynamics (exchange rate appreciation, primary surplus, low real interest rate) all contributed to the decline of debt to GDP. Near-term debt drop is supported by inflation and contribution from creditors (assumed in 2024 and shown in the residuals). Longer-term debt reduction depends on continued fiscal discipline and adherence to the macroeconomic adjustment program. ### Realism and historical track record - Commentary: Sri Lanka's forecasts in the past have shown optimism for most debt drivers. Domestic yields are presently high but expected to normalize under the program. Fiscal adjustment efforts are ambitious but backed by identified measures needed to restore fiscal sustainability. Growth recovery will be slow due to sovereign default and economic crisis, and associated balance sheet impacts. ### Medium-term risk analysis (selected indicators and probabilities) - Fanchart width: 72.0, 1.0 - Probability of debt not stabilizing (pct): 9.3, 0.1 - Terminal debt level x institutions index: 65.3, 1.4 - Debt fanchart index: 2.5 - Average GFN in baseline: 16.2, 5.5 - Bank claims on government (pct bank assets): 40.1, 13.0 - Change in claims on govt in stress (pct bank assets): 4.7, 1.6 - GFN financeability index: 20.1 - Prob. of missed crisis, 2024-2029 (if stress not predicted): 54.5 pct. - Prob. of false alarm, 2024-2029 (if stress predicted): 3.4 pct. - Commentary: MT tools (2025-30) point to high risks associated with relatively high levels of debt and GFNs, a strong sovereign-bank nexus, and vulnerability to large shocks. The banking sector is expected to absorb higher amounts of government debt as a proportion of its assets (estimated at 40.1% in end-2024) compared to the first review. Natural disasters (e.g., typhoons) could push debt and GFNs to very high levels, threatening sustainability further. Debt drivers from 2023 are excluded from historical draws of the debt fanchart in line with SRDSF guidance. ### Long-term modules - Only the large amortization module is triggered. The module indicates overall risk of large amortizations is low, as GFN-to-GDP and amortization-to-GDP ratios in the long term are not significantly different from historical norms. ### Risk Assessment Matrix — selected risks, likelihoods, expected impacts, and policy responses - Program financing risks (lower reserve accumulation, financing shortfalls from external partners, high interest burden, higher-than-expected bank and CBSL recapitalization needs, lower tax revenue collection) - Likelihood: High - Expected impact: H: Program becomes underfinanced - Policy response: Depending on triggers, a combination of actions including (i) higher IFI financing (ii) deeper debt restructuring, (iii) broader and more frontloaded revenue mobilization measures could be considered. - Waning reform momentum (especially on revenue mobilization ahead of 2024 presidential elections) - Likelihood: High - Expected impact: H: Can result in fiscal slippages and weaken confidence and delay access to external financing, slowing economic stabilization. - Policy response: Enforce program slippages through corrective actions. Streamline and prioritize reforms in line with program objectives. Continue frequent engagement on program performance through weekly meetings with the authorities. - Delays in addressing banking sector reforms - Likelihood: High - Expected impact: H: Weak balance sheets can hinder credit growth and weigh on economic recovery. - Policy response: Expedite implementation of banks’ recapitalization strategy and legislative changes to strengthen governance of state-owned banks. - Social unrest (from falling real incomes, tax hikes, cost-recovery pricing, insufficient anti-corruption efforts, delayed local elections) - Likelihood: High - Expected impact: M: Can delay or reverse progress of important reforms - Policy response: Implement inclusive reforms including social security and anti-corruption reforms. Strengthen communication to increase public understanding of program design and objectives. - Upside inflation risks (stronger rebound, second-round effects from new tax measures, exchange rate depreciation pressure) - Likelihood: Medium - Expected impact: M: can de-anchor inflation expectations and reduce real income - Policy response: Monitor inflation closely and tighten monetary policy if needed to keep inflation anchored around the target level. - Slow progress in debt restructuring - Likelihood: High - Expected impact: H: Worsen government financing and balance of payments, creating financing gaps - Policy response: Improve government financing through revenue mobilization efforts. Address BOP pressure by allowing the exchange rate to adjust and seeking higher access to external financing support. - External risks highlighted with Likelihood and Policy Responses: - Intensification of regional conflicts: Likelihood High; Impact H; Response: ease monetary policy, targeted fiscal support, allow exchange rate adjust, seek higher external financing. - Commodity price volatility: Likelihood High; Impact H; Response: monitor inflation, maintain agile monetary policy. - Deepening geoeconomic fragmentation: Likelihood High; Impact M; Response: develop export and FDI promotion strategies, promote domestic suppliers, improve labor skills, monitor inflation and maintain monetary agility. - Abrupt global slowdown: Likelihood Medium; Impact M; Response: ease monetary policy, targeted fiscal support, allow exchange rate adjust, seek higher external financing. ### Key public financial management reforms (Annex IV) 1. Powers, duties and functions: provisions on roles and powers of the Ministry of Finance and the Secretary to the Treasury. 2. Annual budget process: elements on budget preparation and approval, roles and responsibilities, indicative budget calendar, requirements for budget documentation, strengthened in-year budget amendment provisions and safeguards on commitment controls. 3. Fiscal responsibility framework: - Objectives: (i) reducing public debt and maintaining it at sustainable level, (ii) creating and maintaining fiscal buffers against future shocks, and (iii) managing fiscal risks prudently. - Core fiscal rules: a primary balance target (as a percent of GDP) consistent with the debt reduction objective and a primary expenditure ceiling set in the law at 13 percent of GDP. - Requires preparation and publication of an annual Fiscal Strategy Statement, including a Medium-Term Fiscal Framework (MTFF) that sets the primary balance targets as a medium-term fiscal anchor. - Contains specific accountability mechanisms in cases of non-compliance. 4. Public investment management and PPPs: stronger management of public investment and PPPs; integration of planning into the budget process; a new Public Investment Committee to recommend a pipeline of viable investment projects. 5. SOEs: requires SOEs to submit an annual report containing financial statements, investment and business plans, and information on guarantees and borrowing. *Source: 5. Debt consolidation across sectors (PDF chapter).* ### 6. Public procurement. The law focuses on key aspects of procurement related to PFM, such ### 6. Public procurement. The law focuses on key aspects of procurement related to PFM, such ### Public procurement - The law requires ministries to produce annual procurement plans to facilitate efficient budget preparation and execution, as well as cash management procedures. - Other procurement aspects are left to procurement law under preparation. ### Accounting and reporting - The law strengthens transparency provisions: - Each public entity must publish an annual report within six months from the end of a financial year. - The minister of finance must prepare and publish fiscal position reports twice a year, as well as before the reading of the budget in Parliament and before general elections. - The ministry of finance will publish statements on financial performance on at least a quarterly basis. ### Other provisions - The law introduces provisions to modernize and improve cash management, as well as oversight and management of statutory funds. ### Precedence - The PFM law has precedence on PFM matters in the event of a conflict or inconsistency with any other existing laws. - Future PFM-related bills should ensure consistency with the PFM law. ### Annex V — External Sector Assessment: Overall assessment and policy implications - Overall assessment: - The external position of Sri Lanka in 2023 was moderately weaker than the level implied by fundamentals and desirable policies. - Assessment informed by the current account model, based on staff’s estimate for the 2023 current account after adjusting for temporary factors; estimates are subject to large uncertainty. - After the external default in 2022, Sri Lanka steadily built external reserves in 2023, improved its primary balance, and is on track to restructure its public debt in line with IMF program parameters. - Potential policy responses: - Continue with recommended policies on fiscal consolidation, exchange rate flexibility, and reserve accumulation. - Pursue further structural reforms to boost export capacity and encourage FDI in export sectors. ### Foreign Assets and Liabilities: Position and trajectory (key facts) - Background: - Under the EFF program in 2023, monetary financing of the government was curtailed. - Inflation declined from 70 percent to around 4 percent in 2023. - The primary balance registered a surplus of 0.6 percent of GDP. - Under the debt service moratorium, authorities are only servicing debt to multilaterals and other forms of non-restructurable debt. - External asset position: - Net external liabilities fell to 61 percent in 2023 from 75 percent of GDP in end-2022 (after increasing from 51 percent of GDP on average during 2012-2018 to 75 percent of GDP in end-2022). - CBSL gross international reserves increased by US$2.5 billion in 2023. - External deleveraging by private banks and businesses around US$1.2 billion. - As at end-2023, 81 percent of external liabilities were in the form of debt. - The government holds 66 percent of total debt liabilities. - Successful conclusion of public debt restructuring will help reduce total external debt stock and improve external sustainability. - NIIP: - Large negative NIIP (-75% of GDP) prior to improvements; NIIP improved to about -61 percent of GDP in 2023. - Table (Assessment year 2023, % GDP): NIIP: -61.0; Gross Assets: 14.9; Debt Assets: 5.8; Gross Liab.: -75.8; Debt Liab.: -61.4 ### Current account (key statistics and adjustments) - 2023 current account registered a surplus of 3.1 percent of GDP driven by: - Tourism receipts: 82 percent yoy growth. - Remittances: 60 percent yoy growth. - Goods imports compression: - 8.1 percent yoy. - Goods exports decline: - 9.1 percent yoy (garments and textiles exports -18 percent yoy; garments and textiles constitute over 40 percent of goods exports). - Temporary supporting factors for 2023 current account: - Moratorium on debt service, leading to low interest payments. - Import restrictions on goods that used to account for around 10 percent of imports in 2018-19. - Historical/current projections: - Current account averaged -2.2 percent of GDP between 2018-22. - Current account balance projected to average -1.0 percent over 2024-28. - Cyclically adjusted measures and model adjustments: - Cyclically adjusted CA balance for 2023 estimated at 0.1 percent of GDP. - Cyclical factors contributed a net increase of 3.0 percent of GDP in the current account balance. - Adjustment for nonpayment of interest on restructurable debt: expected additional interest payments of about 0.7 percent of GDP from 2024 onwards; adjustment of -0.7 percent of GDP included. - Adjusted CA norm estimated at 1.0 percent of GDP. - EBA CA model estimates current account norm of -0.4 percent of GDP; staff adjusted norm consistent with stabilizing NIIP-to-GDP ratio at -35.0 percent of GDP from 2022 levels of -73.8 percent. - With a cyclically adjusted CA of -0.6 percent of GDP and an adjusted CA norm of 1. 0 percent of GDP, the EBA-based current account gap for 2023 is estimated at -1.6 percent of GDP. - Policy gaps (mainly a large fiscal deficit and low FX reserves) account for -0.9 percent of GDP. - Residual: -0.8 percent of GDP (structural and governance impediments affecting competitiveness). - Assessment: - Staff assesses Sri Lanka’s external position to be moderately weaker than implied by medium-term fundamentals and desirable policy settings. - CA model shows a negative current account gap in 2023 of around -1.6 percent of GDP, consistent with an REER overvaluation of about 6.6 percent. - EBA-Lite REER model shows a negative CA gap of 1.0 percent of GDP. ### Real Exchange Rate (REER) - 2023 REER movements: - REER appreciated by around 8 percent in 2023. - Nominal exchange rate appreciated by 12.4 percent during the year. - Model assessments: - EBA CA model implies REER overvaluation of 6.6 percent. - EBA-lite REER model yields REER overvaluation of about 6.4 percent (corresponding CA gap of -1.0 percent of GDP). - EBA-lite REER model table: - Ln(REER) EOP 2023[1]: 4.49 - Ln(REER) Fitted [2]: 4.43 - Ln(REER) Norm [3]: 4.43 - Residual [1]-[2]: 0.06 - REER Gap [4] = [1]-[3]: 6.4% - Elasticity [5]: -0.15 - CA gap, % GDP [6]=[4]*[5]: -1.0% ### Capital and financial accounts; FX controls and CFMs - Authorities have started to loosen temporary FX control measures introduced over 2020-22. - Measures included import restrictions, exchange restrictions, multiple currency practices (MCPs), and capital flow management (CFM) measures. - By end-2023, most import restrictions were relaxed, with only restrictions on motor vehicles remaining. - Relaxed three out of six MCPs, and three out of seven exchange restrictions before the program’s first review. - Some CFMs loosened by increasing limits on restrictions on capital flows. ### FX intervention and reserves level - Gross international reserves (GIR): - GIR grew from about US$1.9 billion (1.2 months of prospective imports) at end-December 2022 to US$4.4 billion in end-December 2023 (2.4 months of prospective imports). - CBSL net foreign exchange purchases around US$1.7 billion in 2023. - End-2023 GIR of US$4.4 billion equivalent to 37.4 percent of the Fund’s Assessing Reserve Adequacy (ARA) metric (adequacy recommended range: 100-150 percent). - Excluding temporarily unusable assets related to the PBOC swap, usable GIR in 2023 remain at 25 percent of the ARA metric. - Net international reserves (program definition) grew but remained negative at US$2.2 billion at end-2023. - FX intervention and policy: - CBSL allowed a flexible approach to exchange rate policy in 2023 and mostly limited intervention to purchases (US$1.7 billion). - CBSL sold around US$130 million during June-July 2023 and provided US$225 million from reserves to a state-owned bank for FX position needs. - Staff emphasized such sales should not be used beyond cases of truly disorderly market conditions. ### Annex VI — Developments in Debt Restructuring Negotiations (highlights) - Official sector involvement (OSI): - Negotiations with Official Creditor Committee (OCC) and China EXIM bank. - Agreement in principle (AIP) with China EXIM bank on October 11, 2023 and with the OCC on November 29, 2023. - Both treatments assessed by IMF staff as consistent with program debt targets; discussions ongoing to finalize agreements. - Private Sector Involvement (PSI): - International Sovereign Bonds: - Discussions ongoing with the foreign bondholders’ committee (represented by Rothschild and White & Case) considering offers that include state-contingent features. - Initial bondholder proposal (October 2023) included a macro-linked bond with a test date in 2027. - In February 2024 authorities presented a proposal that included a value recovery instrument. - Restricted negotiations with bondholders’ committee in late March 2024 ended on April 16, 2024 with publication of a cleansing statement. - Key sticking points: quantum of debt relief in upside states, and instrument design. - China Development Bank: - Authorities exchanged offers with CDB since December 2023; advisors visited China in April. - Other private creditors: offers tabled and productive discussions ongoing. - Domestic Debt Operation (DDO): - Mostly concluded in 2023 with three portions: - Maturity extension of T-bonds held by superannuation funds. - Exchange of SLDBs and other small FX-denominated bank loans into local currency bonds. - Exchange of T-bills held by CBSL into long term T-bonds. - Restructuring of FX loans from CPC held by two state banks remains outstanding; treatment designed with long maturity extensions and contemplated within holistic bank recapitalization plan. - Litigation note: - Litigation brought by Hamilton Reserve Bank is ongoing; US court granted Sri Lanka’s motion for a stay until August 2024. ### Annex VII — Labor reform and implications on female labor force participation (FLFP) - Importance: - Improving labor force participation (LFP) critical to unlocking productive growth post-crisis. - Proposed Employment Act (EA) is a significant step to improve labor market flexibility and address low FLFP. - FLFP statistics and context: - LFP fell to a 10-year low of 49 percent in 2022. - Average LFP for emerging markets and middle-income economies (EME) is 60 percent (WB, 2024; ILO, 2024). - Male LFP in Sri Lanka around 70 percent in 2022 (on par with EMEs); FLFP was 32 percent in 2022 compared to 53 percent for EMEs. - FLFP has been persistently low at around 32-36 percent over the past decade (DCS, 2023). - Gender gap and growth implications: - Sri Lanka performs well in gender parity in education and health; lags in economic participation and opportunity with an index value of 0.56 versus 0.65 for EMEs. - ILO study for South Asia: reducing gender gaps could increase GDP growth by over one percentage point. - Other studies: closing the gender gap over a 50-year horizon could raise incomes by about 21 percent by the year the gap is closed. - Integrating educated women into the labor market could help offset economic costs of an aging population. - Labor migration and FLFP: - Outward labor migration increased by over 50 percent in 2022 compared to 2019. - Household surveys show nearly 25 percent of households considered migrating abroad during the crisis. - Improving FLFP could help counter negative effects of increasing labor migration. *Source: SRI LANKA — INTERNATIONAL MONETARY FUND* ### 4. The authorities plan to introduce a new EA to unify existing labor laws and adopt new ### 4. The authorities plan to introduce a new EA to unify existing labor laws and adopt new ### Overview of the Employment Act (EA) - EA is expected to be enacted in Q3 2024 and will replace 13 existing labor legislations. - Key objective: streamline employment terms and conditions and minimize discrimination across different sectors and categories of work (under existing labor laws, working arrangements differ across 44 wage setting bodies, Wages Boards, and employment under the Shop and Office Act). - EA will improve flexibility of working arrangements by: - introducing compressed (5-day) work weeks; - streamlining leave; - simplifying processes related to the termination of employment; - introducing measures to retain employees during a crisis. - EA will provide legal recognition for part-time employment, remote work, training, and apprenticeships. ### National Remuneration Council and wage determination - EA will introduce a National Remuneration Council for the determination of minimum wage. - Objective: modernize the existing system of minimum wages determined by Wages Board decisions that incorporate collective bargaining (system criticized for increasing labor costs, impeding employment growth, and shifting of jobs to the informal sector). - EA will introduce an electronic wage system and impose restrictions on unfair trade union activity. - Highlighted caveat: a proper definition of renumeration is needed to avoid policy inconsistencies related to wage determination. ### Gender equality, women’s empowerment, and female labor force participation (FLFP) - Complementary legislation: Gender Equality and Women Empowerment Acts expected to be approved by parliament in June 2024 to implement National Policies on Gender Equality, Advancement, and Empowerment of Women and establish a National Commission on Women. - EA provisions to support FLFP: - relax restrictions on night work for women; - legally recognize domestic workers (predominantly female); - introduce a female quota in executive boards of trade unions to improve female representation in collective bargaining; - provide for maternity leave irrespective of the employee category; - provide for paternity leave to allow for better burden-sharing within the family unit. ### Addressing gender-based violence and workplace protections - EA will address gender-based violence and discrimination in line with the National Action Plan (NAP) for the implementation of the UN Security Council’s Resolutions on Women, Peace and Security. - EA will broaden scope to address discrimination and sexual violence in the workplace and update provisions in occupational safety, health, and welfare of employees. ### Further efforts and policy recommendations to encourage FLFP - Need to ensure EA provisions align with international standards including the ILO Conventions ratified by Sri Lanka (Sri Lanka has ratified 43 ILO conventions). - Empirical evidence from South Asia suggests policies that can narrow gender gaps in the labor market, including: - support for higher levels of female education; - legal rights for women and control of corruption; - better infrastructure such as enhanced sanitation facilities and digital services; - higher public expenditure on health and education. - Other suggested policies to improve FLFP: - expanding affordable childcare facilities; - ensuring safe transportation for women; - increasing maternity and paternity leave allowance; - introducing employment insurance and unemployment benefits; - incorporating gender-responsive budgeting. - Charted statistic: LFP gap: 48 percent (as reported in the source figure). *Source: IMF staff report text (chapter section provided).* ### Appendix I. Letter of Intent ### Appendix I. Letter of Intent ### I. Context and Macroeconomic Developments - Commitment: Continued implementation of the four-year EFF program, prioritizing restoring macroeconomic stability and debt sustainability, mitigating impact on the poor and vulnerable, safeguarding financial sector stability, and strengthening governance and medium-term growth potential. - Economic activity and inflation: - Real Gross Domestic Product (GDP) growth turned positive (1.6 percent y-o-y) in Q3-2023 after 6 consecutive quarters of contraction and increased to 4.5 percent y-o-y in Q4-2023. - After the contraction of 2.3 percent in 2023, the economy is projected to expand at 2.0 percent in 2024, followed by gradual convergence towards the growth potential of around 3 percent over the medium term. - Inflation decelerated rapidly from the peak of nearly 70 percent in September 2022 down to 1.5 percent in April 2024. - External sector and reserves: - Current account estimated at a surplus of 3.1 percent of GDP in 2023 driven by large import compression and strong growth in remittances and tourism receipts. - Net purchases of US$1.7 billion in 2023 brought gross international reserves to US$4.4 billion at end-2023. - In 2024, a small current surplus is expected; fiscal adjustment, recovery in tourism, and competitiveness gains through a flexible exchange rate will support a small non-interest current account deficit after import restrictions are unwound. - Fiscal outcomes: - Primary balance improved by 4.3 percentage points of GDP from a deficit of 3.7 percent of GDP in 2022 to a surplus of 0.6 percent in 2023, exceeding the targeted deficit of 0.7 percent. - Tax revenue increased from 7.3 percent of GDP in 2022 to 9.8 percent in 2023. - Overall fiscal deficit stood at 8.3 percent of GDP in 2023. - Program monitoring and performance: - As of end-December 2023, all quantitative targets (including continuous targets) for the second review were met, except the indicative target (IT) on social spending. - All standard performance criteria were observed, all continuous structural benchmarks (SBs) were met, and most SBs due by end-April 2024 were either met or implemented with delay. ### II. Economic Program (Objectives and Pillars) - Program objectives: - (i) Ambitious revenue-based fiscal consolidation, strong social safety nets, fiscal institutional reforms, and cost-recovery based energy pricing. - (ii) Restoration of public debt sustainability. - (iii) Restoring price stability and rebuilding reserves under greater exchange rate flexibility. - (iv) Safeguarding financial sector stability. - (v) Structural reforms to address corruption vulnerabilities and enhance growth. - Key pillars of the reform program: - Revenue-based fiscal consolidation and fiscal institutional reforms. - Stronger social safety nets. - Sovereign debt restructuring strategy to restore public debt sustainability. - Multipronged strategy to restore price stability and rebuild international reserves under continued exchange rate flexibility. - Policies to safeguard financial system stability. - Focused reforms to address governance and corruption vulnerabilities. - Broader structural reforms to unlock growth potential. - Implementation status: - Policies already implemented include tax reforms, cost recovery energy pricing, and social safety nets. - At end-December 2023, all continuous quantitative performance criteria (QPCs) were observed and all QPCs and indicative targets (ITs) were met, except for the IT on social spending. - Structural benchmarks by end-April 2024 were either met or implemented with delay, except for: operationalization of the BSTA; submission of the PFM bill to Parliament; enactment of the asset recovery bill (¶17, 19, 32). ### III. Advancing Revenue-Based Fiscal Consolidation and Reforms to Social Safety Nets, Fiscal Institutions, and SOEs - 2024 fiscal posture and targets: - The 2024 Budget targets a primary surplus of 0.8 percent of GDP in 2024 and is consistent with program targets (structural benchmark). - Given 2023 revenue outperformance, approved measures underpinning the 2024 budget are expected to raise tax revenue to 12.3 percent of GDP, 0.2 percentage point higher than at the first review. - Expectation: primary surplus to reach 1 percent of GDP in 2024 (quantitative performance criterion). - Medium-term fiscal targets and safeguards: - Target central government primary surplus of 2.3 percent of GDP by 2025 and in subsequent years. - Annual budgets approved by Parliament will be consistent with program parameters on primary balance, revenues, and non-interest expenditure; revenue measures requiring legislative amendments to be approved by Cabinet by end-September of the preceding year (structural benchmarks). - Continued quantitative targets to: (i) increase tax revenue collection (quantitative performance criterion); (ii) reduce the stock of budget expenditure arrears to zero (quantitative performance criterion); (iii) maintain a ceiling on issuance of treasury guarantees (indicative target); (iv) establish a new ceiling on new treasury guarantees on FX borrowing (new IT). - Commitment to refrain from tax policy or administrative measures that may erode tax revenue or deviate from agreed fiscal path. - Revenue mobilization strategy and expected yields: - Commitment to raise the tax ratio to at least 14 percent of GDP by 2026. - Adoption of tax policy and revenue administration measures effective from January 1st, 2025 (¶8, 9 and 10), unless otherwise stated in ¶9, with an expected yield of 1.5 percent of GDP in 2025 to reach revenue and primary surplus objectives. - Specific tax policy measures for 2025 (expected yields and design): - Expected yield from tax policy measures: at least 1.2 percent of GDP in 2025. - Measures to partially compensate for property tax shortfalls: expected yield of at least 0.4 percent of GDP as agreed with IMF staff. - Planned measures and yields: - Introduce an imputed rental income tax (0.15 percent of GDP). - Introduce the VAT at a rate of 18 percent on items currently subject to the special commodity levy (which will be removed), and on the supply of digital services (0.08 percent of GDP). - Remove the CIT exemption on the export of services (0.04 percent of GDP). - Increase the CIT rate on betting and gaming, tobacco and liquor industries from 40 to 45 percent (0.08 percent of GDP). - Raise about 0.8 percent of GDP from the lifting of import restrictions on motor vehicles (¶31). - Increase stamp duties on lease contracts from 0.1 to 0.2 percent (0.03 percent of GDP), which would lower transfers to provincial councils and thus lower spending. - Commitment: if yields do not fully materialize, adopt additional measures to compensate for the shortfall. - Imputed rental income tax introduction and sequencing: - Rationale: delays to property tax and gift and inheritance tax due to constitutional and data constraints; imputed rental income tax to be introduced before April 1st, 2025. - Expected yields: - Full revenue yield estimated at 0.4 percent of GDP and would materialize in 2026 (with a partial yield of 0.15 percent in 2025). - This still falls short by 1 percent of GDP relative to the expected yield of 1.2 percent of GDP from the property tax envisaged for 2025 onwards; shortfall compensated by new revenue measures with a yield of 0.7 percent of GDP and revenue overperformance from 2023 (0.2 percent of GDP). - Preparatory measures and structural benchmarks: - Establish the first database on estimated current market values by end-December 2024, with immediate efforts to digitize valuation records held by the government valuation department, starting with municipal councils, finalizing by end-2025. - Collect information from a representative sample of 5,000 standard properties that includes key variables, including annual values, latest assessment date, and property type, of all properties in all municipal councils by August 2024 (new Structural Benchmark). - Introduce a provisional nationwide digital Sales Price and Rents Register (SPRR) by August 2024; ensure SPRR fully established and operational by end-March 2025 and accessible by the IRD, valuation department, land registry and the general public (new structural benchmark). - Improve data-sharing: gazette notification on March 21, 2024 under the IRA requires the Registrar General’s Department to share all real estate sales information with the IRD; amend the Notaries Act by April 2025 to ensure comprehensive information on each notarized real property contract is automatically fed into the digital SPRR. - VAT compliance and administration strengthening: - VAT compliance improvement program in 2025 expected to raise about 0.3 percent of GDP in 2025. - Program features: identify, assess, and prioritize compliance risks by taxpayer segment; proactive strategies across registration, filing, payment, and risk-based verifications; reintroduce taxpayer field visits. - Resource commitment: provide IRD with additional resources (staffing, funding, transportation) to conduct core operations including field inspections. - Revenue administration performance indicators and IT modernization: - Introduced and tracking 7 Key Performance Indicators related to: (1) payment; (2) filing; (3) reporting; and (4) registration (end-March 2024 structural benchmark). A new KPI will be added as of September 2024 to improve the functioning of the VAT refund system. - Agreed with IMF mission on new targets for all KPIs up to March 2025 (revised structural benchmark); quarterly KPI data to be shared with IMF staff within two months after the end of each quarter as specified in table 2). - Obtain Cabinet approval by August 2024 of a prioritized, time-bound, and costed Information Technology Strategic Plan to deliver the Revenue Administration Management Information System (RAMIS) (version 3.0) with needed functionality enhancements and design improvements (new structural benchmark). - Large taxpayer measures: completion of risk profiling of the largest 100 High Wealth Individuals (HWI) taxpayers by September 2024; IRD to solicit, by end-December 2024, information from 100 profiled HWI taxpayers via questionnaire (mission recommendations). *Source: Appendix I. Letter of Intent and Attachment I. Memorandum of Economic and Financial Policies (May 28, 2024).* ### 12. We have already initiated work to fix the VAT refund system to ensure the full repeal ### 12. We have already initiated work to fix the VAT refund system to ensure the full repeal of the SVAT system by April 2025. ### VAT refund system and SVAT repeal - Cabinet adopted a strategy in December 2023 laying out a gradual multi-step process to fully repeal the SVAT by April 2025 (structural benchmark). - A committee has been formed to oversee the SVAT repeal; its role and responsibilities will be specified in coming months working with the Risk Management Committee in IRD. - IRD will prepare a project management plan with concrete next steps by end-April 2024. - Expedited actions to transition to a new refund program: - (i) identify the exporters that would strictly be eligible for VAT refunds, - (ii) extract from IT systems a comprehensive compliance history of eligible VAT taxpayers, - (iii) commence risk profiling for exporters, - (iv) develop post payment validation and verification procedures, - (v) ensure adequate funding for the VAT refund account. - Expectation to begin testing new procedures in a limited and controlled manner by September 2024. - Parallel work to ensure current foreign exchange repatriation requirements do not create unnecessary delays in the refund process. ### Inland Revenue Department (IRD) modernization - Commitments: - (i) streamline the online portal for simplified individual income tax filing by June 2024; - (ii) accelerate outreach to re-register VAT taxpayers who dropped out; - (iii) finalize enhancements of the RAMIS to support the assessment of 2022/23 income tax returns and to administer and assess the Social Security Contribution Levy (SSCL) by end June 2024. - Processing tax collections to be carried out only through RAMIS as of June 2024. - Medium-term IRD Modernization Strategy and Implementation Plan with IMF FAD CD assistance will be fully documented and endorsed for implementation by end-July 2024. ### Creation of a semi-autonomous Revenue Authority - Drafting legislation to create a semi-autonomous Revenue Authority, initially incorporating the Inland Revenue Department, and later Customs and Excises departments. - Anticipated benefits: strengthen revenue collection long-term; increase revenue administration professionalism and effectiveness. - Acknowledgement that creation will take time and significant resources; consultation with IMF experts before further steps. ### Expenditure rationalization and public investment - Commitment to avoid over-reliance on capital expenditure cuts so as not to harm long-term growth. - Past under-execution of capital expenditure helped meet the primary balance target in 2023; future capital spending cuts, if needed, will rely on transparent criteria to guide project cancellation decisions. - Measures to raise public investment efficiency as recommended by the 2018 IMF Public Investment Management Assessment and to strengthen project prioritization. - Commitment to implement recommendations from the forthcoming World Bank public finance review exercise. ### Social Safety Nets (SSN) - Total actual spending on SSN during 2023 was Rs. 174.1 billion. - Full transition to the new Welfare Benefit Payment Scheme (Aswesuma) was not completed by end-December 2023 due to a large number of grievances; grievances resolved by end-February 2024 and retroactive cash transfers are being made. - With completion of retroactive cash transfers, expected total SSN spending for December 2023 to be about Rs. 190 billion. - 2024 budget allocation of SSN spending raised to Rs. 205 billion (or 0.7 percent of GDP) (indicative target) to maintain the real value of cash transfers per household. - SSN spending coverage: cash transfers under Samurdhi/Aswesuma and three categorical programs (benefits for elderly, disabled, and chronic kidney disease). - Samurdhi cash transfers will cease and categorical beneficiaries will be included under Aswesuma by end-December 2024. - Plans to raise and protect social spending related to nutrition and education (school nutrition program and nutrition for expectant mothers) over the medium-term. - Aswesuma improvements: - Targeting: second round of applications called in February 2024; data verification expected complete by June 2024; annual recertification of beneficiaries planned; survey data to be used to assess eligibility, selection methodology, and economic impact. - Coverage: Cabinet approved extending cash transfers for transitional and vulnerable groups by another year till end-December 2024; expect to increase coverage of Aswesuma up to 2.4 million families by end-2024. - Adequacy: increased per beneficiary payments of transitional group and categorical beneficiaries effective January 2024. - Cabinet approval in March 2024 to implement an empowerment program targeting 1.2 million Aswesuma beneficiaries over a 3-year period. - Pilot targeting 16,000 Aswesuma beneficiaries in all 25 districts initiated in Q1 2024 with financial support from the Asian Development Bank and the World Bank. - Amend Samurdhi regulations to ensure only Aswesuma beneficiaries are selected for the empowerment program. - In 2025, increase total spending on Aswesuma and the empowerment program to Rs. 225 billion. - Ministry of Finance will continue to lead discussions on external financing for SSN programs. ### Energy SOEs, pricing, and fiscal risks - Automatic fuel and electricity pricing mechanisms to mitigate fiscal risks from energy SOEs. - Since November 2022, retail fuel prices adjusted monthly in line with cost-recovery; CPC consistently profitable. - CEB recorded a cumulative profit of Rs 61 billion in 2023; part used to repay Rs 40 bn of CEB’s debts. - Electricity tariffs revised with effect from March 5, 2024, lowering the average tariff by 21.9 percent; revision accounts for more favorable projections of exchange rate and interest rates and improved CEB financing ability from domestic banks. - Estimated that the downward revision will nevertheless ensure cost recovery for CEB in the coming months. - Going forward: - Continue to set retail fuel prices to cost-recovery levels monthly using the formula and compensate CPC for residual fuel subsidies with on-budget transfers (continuous structural benchmark). - Maintain electricity tariff at cost-recovery level overall across different types of final consumers with quarterly formula-based adjustments in January, April, July and October each year (effective from January 1, April 1, July 1, and October 1, respectively); CEB to submit tariff revision requests to the Public Utilities Commission of Sri Lanka (PUSCL) by end-October (for January revisions), by end-January (for April), by end-April (for July) and by end-July (for October). - Compensate electricity sector for residual electricity subsidies with on-budget transfers; use tariff surcharges between revisions to restore cost recovery if CEB is making losses (continuous structural benchmark). - Monitor CEB’s financial performance continuously and stand ready to increase tariff as soon as losses emerge. - Undertake a dispatch audit of CEB’s operational costs later in 2024 to assess scope for efficiency gains in generation and transmission. - Bulk Supply Transaction Account (BSTA): - Full operationalization encountering delays due to slower signing of power purchase and power sales agreements. - Proceed on basis of MOUs signed in lieu of formal agreements and fully operationalize BSTA by end-June 2024 by adopting a formal rule requiring the regulator to use the BSTA to determine cost-recovery based electricity tariff and government transfer requirement (revised structural benchmark). - Once operational, BSTA will allow continuous monitoring of CEB’s buffers and corrective tariff changes between formal revisions. - Fiscal safeguards: - A zero ceiling on the cost of non-commercial obligations for fuel and electricity (net of government transfers) is set under the program (indicative target; see the Technical Memorandum of Understanding for details). - By June 2024, introduce legislative reforms making the Minister of Power and Energy responsible for implementing cost-recovery based fuel and electricity price adjustments. ### Fiscal data, ITMIS, and fiscal reporting - Expected completion of ITMIS in October 2024; MOF’s Department of State Accounts will report monthly cash flows from revenues, expenditures, and financing by the third business day of the subsequent month. - Preliminary steps taken to update fiscal reporting framework to the GFSM 2014 standard by end-2024. - A committee will hold bi-weekly meetings to address issues regarding timeliness, accuracy, and coverage of fiscal data. ### Public Financial Management (PFM) law and fiscal rules - New PFM bill finalized with IMF TA support and submitted to Parliament on May 22, 2024 (prior action). - Implementing regulations of the new law to be adopted by end-December 2025. - PFM law expected to improve fiscal discipline through enhanced fiscal rules, better transparency and accountability, and more efficient budget preparation processes. - Ensure future PFM-related bills (including PPP, SOE, procurement and investment bills) are consistent with the PFM law. - Full integration of PPPs with public investment management process and Ministry of Finance to have a strong gatekeeper role for project viability and affordability evaluation. ### Strengthening PFM functions and budget processes - Commitments: - Obtain Cabinet approval by end-June 2024 of the fiscal strategy statement (FSS) including the medium-term fiscal framework (MTFF) (structural benchmark); FSS to be published. - Prepare and publish a medium-term PFM Reform Strategy and Action Plan on the MOF website by end-December 2024. - Continue integrating the Macro-Fiscal Unit into fiscal policy decision making; allocate trained staff dedicated to macroeconomic forecasting and research by end-June 2024 with IMF CD assistance. - Strengthen commitment-based spending controls by introducing an IT-based commitment control framework (e.g., e-procurement) for public investment. - Expand ITMIS in October 2024 when remaining 13 budget heads will be added to the system to improve analytical content of in-year budget execution reports. ### SOE financial viability, governance, and restructuring - December 2023 budget-neutral transaction provided additional equity injections into CEB and SLA, allowing repayment of CPC debts and nearly cancelling the CPC debt to the Treasury already reported in the fiscal accounts. - CPC reforms: - Entry of additional private sector firms into downstream petroleum sector; three foreign companies started operating 150 fuel stations with another 300 to commence operations. - Fuel pricing formula includes a small margin that allowed CPC to repay US$20 million of old obligations to the Iranian Oil Company in 2023 and another US$15 million in early 2024; US$216 million of these obligations remain. - CEB reforms: - Separating generation, transmission, and distribution businesses. - Plan to settle CEB’s remaining legacy debts, estimated at about Rs. 180 billion as of end-February 2024. - By end-December 2024, obtain cabinet approval of the repayment schedule of CEB’s legacy debts, starting in April 2025 (new structural benchmark); repayments to be included in electricity tariff calculation starting January 2025. - SLA reforms: - Implementation of SOE restructuring unit draft strategy to reform SLA’s business model via divestment strategy approved by Cabinet in November 2022. - March 2024 cabinet approved transfer of US$310 million of SLA loans (already included in program’s debt stock perimeter) to government balance sheet. - Remaining US$175 million of government-guaranteed FX bonds will be restructured. - Governance and transparency measures for SOEs: - Clarify mandates via Statements of Corporate Intent and hold management accountable using key performance indicators. - Review framework for selecting SOE board members to ensure qualified and independent members. - Ensure all 52 major SOEs publish audited financial statements by end-June of the following year; in 2023 audited statements of all but five smaller SOEs were available by end-December; expect to complete auditing and publish audited 2023 financial statements of all 52 major SOEs by end-June 2024. - Drafting SOE law with World Bank assistance to incorporate transparency and governance requirements; ensure consistency with PFM Act and government authority to exercise financial oversight; consult IMF before submitting SOE law to Parliament. ### SOE borrowing framework and guarantees - New SOE borrowing limited to financing commercially viable activities; subsidies and quasi-fiscal activities to be remunerated through government transfers. - Except for project loans on-lent by Treasury and short-term trade financing, no new foreign currency borrowing for non-financial SOEs with less than 20 percent of revenues denominated in foreign currency. - New PDM Act (¶25) to define principles and processes for government borrowing and debt management, require credit risk assessment, and collection of risk-based fees for loan guarantees and on-lending. - Implementing regulations to define guidelines, prudent measures for risk mitigation, regular disclosure of guarantees and on-lending, and strict eligibility criteria for SOEs. - Guarantees on FX borrowing allowed on exceptional basis to facilitate IFI financing to SOEs under very strict conditions. - Ensure SOEs comply with reporting requirements to the Ministry of Finance under PFM and PDM laws. - Total outstanding stock of treasury guarantees will continue to comply with program indicative target and limit to be set under the PFM Act or related regulations. - Comply with a ceiling on issuance of treasury guarantees of FX borrowing as of September 2024 (new indicative target). - Strengthen governance and oversight of state-owned banks to ensure lending to SOEs is guided solely by commercial considerations (¶34). *Source: 1lkaea2024001 - 12.* ### 23. We remain committed to putting public debt onto a sustainable path. Debt ### 23. We remain committed to putting public debt onto a sustainable path. Debt ### Debt sustainability targets and restructuring progress - Debt sustainability targets under the EFF program: - 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 US$17 billion over the EFF program period. - Restructuring progress and perimeter: - Nearly all components of the DDO concluded, with debt treatments executed 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; - holdings of Sri Lanka Development Bonds by resident and non-resident investors. - Finalizing strategies to restructure remaining FX local law debt originally contracted by CPC to the state banks, aiming to address adverse impact on banks’ capital and FX net open positions within the program debt targets and observe transparent accounting standards and regulatory treatment. - Commitment to complete this restructuring by August 2024 as part of the completion of the broader bank recapitalization plan (new structural benchmark, ¶31). - External creditor engagement: - May 2023: shared an indicative debt treatment scenario with external creditors consistent with program targets. - Proposed restructuring perimeter: all FX foreign law debt except debt to international financing institutions, bilateral currency swaps, and emergency financing credit lines extended in 2022. - Preliminary agreement reached with the EXIM Bank of China and an agreement in principle (AIP) with the OCC in 2023. - Continued contacts with two ISB bondholder committees, the China Development Bank, and other external creditors. - Working towards an MOU with the OCC, signed bilateral agreements with OCC member countries, and bilateral agreements with China EXIM Bank. - Reiterated commitment to refrain from resuming debt service payments to any external commercial or bilateral creditor unless it agrees to comprehensive debt treatment in line with IMF program parameters, debt sustainability targets, and the comparability of treatment principle (as per President’s open letter to official bilateral creditors on March 14, 2023). - Commitment to communicate transparently with all creditors on debt treatments and report regularly indebtedness to ensure full transparency. - Arrears resolution approach: - Priority to resolve arrears to external creditors as soon as possible. - Continued engagement with external commercial creditors in good faith through early dialogue, timely information sharing, and opportunities to provide input on restructuring strategies. - Appreciate bilateral official creditors’ strong commitment, including through specific and credible assurances by all major bilateral creditors and consent to Fund financing notwithstanding arrears to them by other bilateral creditors. - Will keep IMF staff informed of tentative debt treatment agreements, with consent of parties, to facilitate timely analysis for consistency with debt targets. *Source: IMF country document (content unit 1lkaea2024001, sections 23–30).* ### Improving debt management and debt transparency (¶24) - Institutional changes: - Current public debt management by CBSL’s Public Debt Department, MOF’s External Resources Department and Treasury Operations Department. - Public debt management law submitted to parliament on April 26, 2024 to establish a public debt management Office (PDMO). - PDMO to be established by end-December 2024 (new structural benchmark) and fully functional by end-December 2025. - PDMO responsibilities: - 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. - PDMO staffing: hire key personnel for front, middle, and back offices and execute basic functions on debt issuance, debt reporting and debt strategies within transitional provisions of the Act. - Transparency enhancements: - MOF commenced publishing a quarterly bulletin of public debt and debt service in February 2023 covering debt profile as of end-September 2022. - Latest bulletin published in February 2024 reflecting outstanding debt as of December 2023. - Commitment 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 of extrabudgetary central government units. - Will issue guidelines regarding the statistical treatment of guaranteed debt of distressed corporations, and the transfer of government liabilities to SOEs, to be approved by Cabinet. ### Restoring price stability and monetary policy framework (¶25) - Inflation targeting and MPCC: - Key CBSL objective: maintain inflation around target level of 5 percent (YoY). - MPCC to monitor 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 in June 2024 and onwards (Quantitative Performance Criterion). - Policy consultation with IMF staff ahead of each Monetary Policy Board meeting. - Nonobservance of inner and outer bands triggers policy consultation with IMF staff and IMF Board, respectively (see Technical Memorandum of Understanding). - Recent inflation developments: - Headline and core inflation fell from peaks of 70 and 50 percent in September 2022 to 3 and 0.8 percent in 2023 Q4 respectively; currently at 4.3 and 2.7 percent in 2024 Q1. - Deviation largely driven by stronger than expected Rupee appreciation and food deflation. - Inflation expectations remain broadly anchored at single digit levels. - Policy rates and monetary conditions: - Following 2022 devaluation, policy rate hiked by cumulative 900 basis points. - Policy rates reduced by 700 basis points between June 2023 and March 2024; currently stand at 8.5-9.5 percent. - Treasury yields (3 months) and prime lending rate fell from peaks of 30 and 33 percent to 8.76 and 9.68 percent in May 2024, respectively. - Monetary conditions have loosened significantly. - Interest rate caps and removal: - CBSL imposed caps: pawning facilities at 18 percent, pre-arranged temporary overdrafts at 23 percent, credit cards at 28 percent, per annum; capped penal interest rate at 2 percent over regular interest rates for all licensed banks. - Restrictions on access to standing lending facility removed on February 16, 2024; remaining restrictions to access standing deposit facility removed on April 1, 2024. - Distortionary interest rate caps eliminated in April 2024 to enhance monetary policy transmission. - Risks to monitor in calibrating policy: - (i) second-round effects of recent tax measures; - (ii) potential exchange rate passthrough in reaction to financial outflows; - (iii) banks’ NOP as result of debt restructuring; - (iv) relaxing import restrictions. - Framework and readiness: - Flexible inflation targeting under new Central Bank Act (CBA) enacted on September 15, 2023. - 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. ### Refraining from monetary financing and CBSL net credit ceilings (¶26) - Policy stance: - Continue to refrain from monetary financing (direct credit to government to finance budget deficits). - Fiscal adjustment, debt relief, and new external financing under the program intended to allow sustainable budget financing without monetary financing. - CBSL to gradually unwind remaining large holdings of Treasury securities; pace informed by market absorption capacity and need to prevent excessive expansion of CBSL’s balance sheet while rebuilding reserves. - Monitoring and quantitative ceilings: - Monitored by: - (1) quantitative performance criterion on the 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. - Ceilings: - NCG ceiling set at Rs. 2,720 billion for end-June 2024. - NCG target set at Rs. 2,560 billion from end-September 2024 and kept flat until end-March 2025. - Ceiling for continuous PC on new primary purchases of Treasury securities set at zero. - Domestic borrowing amounts raised to maintain an adequate cash balance – including a buffer – to meet cashflow needs without reliance on monetary financing. ### CBSL balance sheet assessment and potential recapitalization (¶27) - Assessment and accounting: - CBSL to objectively assess impact of the DDO on its balance sheet by September 2024 ahead of central government budget preparation. - Maintain adequate capital to conduct monetary policy, in close consultation with IMF staff and external auditors. - Follow good accounting standards to evaluate and confirm discount rates applicable for the DDO and resulting accounting entries in consultation with External Auditors. - Continue monitoring impact of sterilization beyond recorded losses in CBSL financial statements prepared according to the IFRS. - Capital injection commitment: - If needed, MOF committed to boost CBSL equity through a capital injection to reach an adequate capital level. - Authorities will consult with IMF staff on design and implementation of these steps. ### Exchange rate flexibility and rebuilding reserves (¶28) - Exchange rate policy: - Maintain a flexible exchange rate to serve as buffer against external shocks. - March 2023: eliminated market guidance confining daily exchange rate movements within a pre-defined band around weighted average spot interbank rate of previous trading day; rupee allowed to move in line with fundamentals since then. - Reserves accumulation: - Commit to gradually rebuild gross international reserves including through outright FX purchases in the market, supported by a non-interest current account surplus, new external financing, other non-debt creating inflows, and sovereign debt relief. - Commitment to meet program targets on Net Official International Reserves (NIR) (quantitative performance criterion), which for 2024 are predicated on CBSL’s outright FX purchases on a net basis of US$2 billion. - Pledge to save any overperformance in accumulating the NIR; cap on this adjustor for NIR target as signal of proactive approach. - Encourage banks to close potential net open position issues in a planned and orderly fashion to avoid disorderly FX market conditions. - FX intervention policy: - Limit FX interventions on the sale side to truly disorderly market conditions that could lead to destabilizing inflation and/or balance sheet effects. - Transparently disclose intervention transactions to guide market expectations. - Rationalize intervention decisions based on objective criteria and subordinate to CBSL’s price stability mandate while ensuring net FX intervention consistent with meeting NIR targets. ### Strengthening institutional framework for inflation targeting and FX flexibility (¶29) - New CBA provisions: - Establish price stability as CBSL’s primary objective and financial system stability as the other objective. - Buttress CBSL’s operational autonomy by removing government representation from the Governing Board and Monetary Policy Board. - Include an 18-month transitory period to allow monetary financing as a last resort (not fully aligned with program objective of prohibiting monetary financing); commitment to discontinue monetary financing governed by program conditionality (¶26). - Market development and risk management: - Commit 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 balance-of-payments measures (¶30) - Import restrictions: - Over 2020-22 suspended import of many non-priority non-critical goods; removal of temporary suspension began in September 2022 with removal of 707 items and continued with relaxation of: - 286 goods in June 2023; - 325 goods in July 2023; - 299 goods in October 2023. - With October 2023 relaxation, import restrictions removed on all items apart from motor vehicles. - Initial timeline for removal of restrictions on motor vehicles provided to IMF staff for consultation on May 21 2024; detailed plan to be finalized by June 15, 2024. - Plan tied to removing tax exemptions on imports of motor vehicles granted to specific groups including civil servants to curb revenue leakages; will relax restrictions on vehicles used for commercial purposes by June 2024. - Existing exchange restrictions and MCPs: - Current exchange restrictions include: - prohibitions on converting Sri Lanka Rupees into FX for certain current international transactions (e.g., servicing certain external loans, payment of any income on certain nonresident investments); - levy of a 2.5 percent stamp duty on credit card transactions abroad; - levy of a 14 percent remittance tax on nonresidents’ profits; - limits on repatriation by nonresidents of proceeds derived from current transactions; - requirement to provide a tax clearance certificate prior to permitting transfers for certain current transactions. - Two MCPs in place per IMF’s new MCP policy: - levy of a 2.5 percent stamp duty on credit card transactions abroad; - levy of a 14 percent remittance tax on nonresidents’ profits. - Plan to eliminate these restrictions and MCPs when conditions allow in later years of the program. - Capital flow management measures (CFMs): - Since 2020 introduced new CFMs and tightened existing CFMs related to capital transactions; actions taken include removal of surrender requirement for banks on purchases of proceeds from service exports and inward worker remittances and relaxation of CFMs related to outward remittances on capital transactions made by residents and outward transfers of funds by emigrants since program approval. - Commitment to phase out administrative measures: - Import restrictions, exchange restrictions, MCPs and CFMs viewed as short-term mitigants for FX shortages, not substitutes for comprehensive policy package and macroeconomic adjustment. - Will develop a plan by end-May 2024 for phased removal of these measures during the program period, tied to progress on exchange rate, debt sustainability, financial stability, market access prospects, and accumulation of reserves above critical levels. - Seeking temporary approval of all exchange restrictions and MCPs. - During 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 (continuous performance criteria). *Source: IMF country document (content unit 1lkaea2024001, sections 23–30).* ### 31. We are committed to ensuring a healthy and adequately capitalized banking system ### 1lkaea2024001 - 31. We are committed to ensuring a healthy and adequately capitalized banking system ### Banking system vulnerabilities and objectives - Banks face elevated credit risk in their private sector loan books, shrinking net interest margin, large exposures to the public sector, and the impact of the debt restructuring (including on their foreign exchange Net Open Positions). - A well-capitalized banking sector is critical to sustain economic recovery through the revival of interbank lending, adequate credit supply for both private and public sector, affordable borrowing cost and credit rating upgrade. - Capital injections will be provided in the form of marketable government securities. ### Immediate supervisory and resolution actions - The CBSL will take appropriate action regarding banks unable to ensure their viability, beginning with intensifying supervision and imposing prompt corrective actions. - CBSL completed the assessment of the recapitalization plans of the four remaining banks two months ahead of schedule on December 29, 2023. - The five largest banks submitted capital and net open position restoration plans by end-January and the remaining four banks by March 2024. - For the five largest banks, CBSL reviewed plans and completed the review of the plans for the remaining four banks by April 2024. - CBSL will continue to monitor the capital positions of banks on the basis of forward-looking stress tests and stands ready to impose capital requirements under Pillar 2 of the Basel capital standards, as needed. ### Recapitalization, restructuring, and government support - MOF will complete the restructuring of SOEs FX debt mainly comprising of CPC debt by August 2024 (new structural benchmark). - The potential impact on the NoP and capital of two state banks will be assessed objectively by CBSL in consultation with the IMF team. - Taking into account CPC and other FX loans restructuring and AQR adjustment, government capital injections required under those plans into the two largest state-owned banks will be completed by end-August 2024 (structural benchmark). - For the remaining seven banks, if they are unable to implement their plans as agreed, further action (government capital injection with appropriate conditions or other intervention as set out in the authorities’ recapitalization plan) will be taken by end-December 2024 (structural benchmark). CBSL will consult with IMF staff on this assessment. - MOF stands ready to provide additional recapitalization funds, if needed, for these purposes as a last resort at the latest by the next Budget after the capital shortfall has been identified. - MoF will inject capital (if needed) to the affected banks upon the execution of restructuring to preserve the capital adequacy of the state-owned banks that can’t raise sufficient capital in the market. - The valuation of the restructured instruments will be consistent with sound valuation principles and assessed by the CBSL. - We are committed to a restructuring treatment that would avoid creating significant net open position problems for banks or destabilizing the FX market and the program’s reserve accumulation goals. ### Legal, regulatory, and supervisory reforms - Parliament approved the Banking (Special Provisions) Act in July 2023 to strengthen key elements of the CBSL’s crisis management powers. - Amendments to the Banking Act were approved in principle by Cabinet in June 2023 and final Cabinet approval was obtained in January 2024. - The amendments to the Banking Act, due for end-January 2024, were approved by Parliament on April 2, 2024 (Structural Benchmark). - The full implementation of the amendments to Banking Act, due for end-March 2024, will be completed by June 2024 (Structural Benchmark). - The Banking (Special Provisions) Act and amendments to the Banking Act will strengthen: - (i) the resolution authority mandate of the CBSL, as well as powers, tools, and appropriate funding mechanisms for resolution of distressed financial institutions; - (ii) the deposit insurance framework – including appropriate backstop funding arrangements from the government – and the regime for liquidation of banks; - (iii) regulatory standards in areas including bank licensing, bank ownership, consolidated supervision, the capital and liquidity framework, large exposures and related party transactions, requirements, and recovery planning and early intervention powers; and - (iv) regulation and supervision of state-owned banks. - For non-bank deposit-takers the CBSL has already reduced regulatory arbitrage on non-performing loan classification and capital requirements. The review of the Finance Business Act will take further steps to minimize regulatory arbitrage. - Staffing of the Bank Supervision Department and the structure, staffing, and funding of the Resolution and Enforcement Directorate in the CBSL will be strengthened. - The CBSL updated its framework for provision of Emergency Loans and Advances (ELA) for banks in November 2022 and the 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 these Non-Bank Finance companies by the deposit insurance fund will be ended. ### Governance and state-owned banks - Amendments of the Banking Act 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. - The existing large exposure will be reduced within the transition period specified in the Banking Act. - The Cabinet adopted and published a framework prepared in consultation with IMF and WB staff to strengthen the governance of state-owned banks, requiring their boards to have a majority of independent members, and nominations for board and senior management to be made by the banks’ nomination committees following open search procedures with clear requirements for independence and professional experience on May 27, 2024 (structural benchmark). - Clear mandates will be defined to ensure that 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. - Future capital raising plans for both private and public banks will be in line with the recapitalization plans agreed with CBSL. ### Crisis preparedness and legal environment for loan recovery - A Financial Sector Crisis Management Committee has been established, chaired by the Governor with the Secretary to the Treasury as Deputy Chairperson; membership includes senior representatives from the MoF and the CBSL with responsibility for crisis preparedness and management, in-crisis coordination, information-sharing and communication among the authorities. - The recent temporary Parate law suspension will not be renewed after it expires in December 2024 because it negatively affects banks’ ability to recover value from non-performing loans and thus reduces banks’ capacity to provide private credit. *SRI LANKA INTERNATIONAL MONETARY FUND* ### 36. We stand ready to deploy contingency measures should downside risks materialize. ### 36. We stand ready to deploy contingency measures should downside risks materialize. ### Risks to program implementation and contingency measures - Risks are described as high given adverse initial conditions, a complex debt restructuring with a potential for delays, and large downside risks to the program baseline. - Debt restructuring: - A delay in concluding debt restructuring negotiations with creditors could suspend Sri Lanka’s access to financial support from IFIs, causing a deeper and prolonged BOP crisis. - Authorities will intensify engagement with creditors to accelerate debt restructuring negotiations and minimize this risk. - Authorities commit to stay current on payments to the IMF and Multilateral Development Banks. - Monetary policy and inflation risk: - Lack of macroeconomic policy space limits ability to address downside risks relative to the baseline. - Signs of sustained increases in inflation and de-anchored inflation expectations would require a tighter monetary policy stance than envisaged under the baseline. - Authorities commit that monetary policy will remain prudent and tuned to inflation risks stemming from economic uncertainties. - Banking sector and FX market risks: - Stresses due to banks’ net open positions (NOPs) may affect bank solvency and create significant FX market pressure. - To avoid banks crowding the FX market to close NOPs, authorities will work on a plan in the banking sector roadmap for an orderly resolution to bank capital and NOP issues after the debt restructuring is executed. - Remedial measures for program underperformance: - Any program underperformance will be corrected by remedial measures. - Possible further revenue shortfalls will be mitigated by enhanced revenue administration and enforcement, and through targeted spending cuts as a last line of defense instead of depending solely on capital expenditure reductions. - Slippages in the reserves buildup relative to targets 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. - Monitoring: Authorities are conducting monitoring meetings on a weekly basis with the IMF to report progress and discuss strategies and plans to meet commitments. - Program overperformance resulting from better-than-expected outturns should be locked-in to the extent possible to assure achieving program objectives. ### Program monitoring, reviews, and requests to the Executive Board - Reviews and timing: - Program will be subject to semiannual reviews with performance criteria, the MPCC bands, and indicative targets set out in Table 1 attached to the MEFP and TMU. - Completion of the third review will require observance of the quantitative performance criteria for end-June 2024, continuous performance criteria, as specified in Table 1 attached to this MEFP, as well as standard PCs. - The third and fourth reviews of the program will take place on or after October 1, 2024, and April 1, 2025, respectively. - Safeguards: - Authorities recognize the importance of the safeguards assessment of the Central Bank finalized in February 2023. - The recently passed CBA would serve to address some identified safeguards issues, and the CBSL has initiated steps to implement other safeguards recommendations. - Requests to the Executive Board: - Modification of existing and setting of new Quantitative Targets: request an upward revision of the end-June 2024 QPC for NIR from USD -1810 million to -1710 million to lock-in overperformance on reserves accumulation. - Change in the reporting date of the quarterly SBs on the introduction, tracking and reporting of KPIs on tax compliance: request that SB reporting is postponed by two months after the end of each quarter to allow time for data production and preparation. - New proposed quantitative targets: adopt a new IT ceiling on FX guarantees as of September 2024 to help mitigate underlying fiscal risks. - Request that the Executive Board completes the financing assurances review and the second review of the EFF arrangement. ### Key program instruments and conditionality (high-level) - Semiannual reviews with performance criteria, MPCC bands, and indicative targets (Table 1). - Continuous performance criteria and structural benchmarks (Table 2) will be assessed during reviews. - Monitoring meetings on a weekly basis with the IMF to report progress and discuss strategies and plans. *Source: Sri Lanka — MEFP excerpt (section 36–39, Table 1 and Table 2).* ### Appendix II. KPIs for Inland Revenue – Quarterly Targets ### Appendix II. KPIs for Inland Revenue – Quarterly Targets ### KPI-1.1: Risk Based Audit - Objective: Shift to data-driven, risk-based audit case selection and assignment, away from discretion-based selection by auditor and/or supervisor. - Baseline: "No cases are currently selected on a systematic, data-driven, risk basis." - Quarterly targets: - 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" - Proposed March 2025 Target: "50 new LTU cases selected in Q1, & 10 percent of new non-LTU cases in Q1" ### KPI-2.1: Tax Return Filing Compliance of Large Taxpayers - Definition: Percentage of expected tax returns from large taxpayers by the due date: (1) VAT – one-month after monthly or quarterly deadline; (2) PAYE by April 30; (3) CIT by November 30. - Baseline (From 2023 TADAT Assessment (P4.12)): - On-Time CIT Filing: 93.4 percent - On-Time VAT Filing: 82.6 percent - Only baseline for PAYE is 23.6 percent but covers all employers not just under LTU control. - Quarterly targets: - March 2024 Target: "85 percent of VAT returns on-time" - June 2024 Target: "87 percent of VAT returns on-time & 90 percent of PAYE returns on-time" - September 2024 Target: "89 percent of VAT returns on-time" - December 2024 Target: "91 percent of VAT returns on-time & 95 percent of CIT returns on-time" - Proposed March 2025 Target: "95 percent of VAT returns on-time" ### KPI-2.2: Tax Return Filing Compliance of Non-Large Taxpayers - Definition: Percentage of expected tax returns from non-large taxpayers by the due date. - 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 - Quarterly targets: - March 2024 Target: "48 percent of VAT returns on-time" - June 2024 Target: "52 percent of VAT returns on-time & 60 percent of PAYE returns on-time" - September 2024 Target: "56 percent of VAT returns on-time" - December 2024 Target: "60 percent of VAT returns on-time & 50 percent of CIT returns on-time" - Proposed March 2025 Target: "65 percent of VAT returns on-time" ### KPI-2.3: Electronic Filing of Individual Income Tax (IIT) Returns - Note: "First three quarters will reflect 2022/23 IIT returns, Q4 will reflect 2023/24 IIT return." - Baseline (From 2023 TADAT assessment (P4.14)): "23 percent of IIT returns filed electronically in 2021" - Quarterly targets: - 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" - Proposed March 2025 Target: "60 percent filed electronically" ### New KPI-2.4: VAT Refunds - Context: "Demand for VAT refunds by exporters will surge when SVAT is repealed. The refund system must be overhauled to meet legal requirement to issue the refund within 45 days from date of claim." - Baseline: "VAT Refund processing is extremely backlogged with delays of months or years to be processed and paid. True baseline situation will be determined in March during TA to overhaul Refund system prior to SVAT repeal." - Status: "Baseline Determined" - Quarterly targets (timing tied to filing dates and risk assessments): - June 2024 Target: "At least 90 percent of new VAT refund requests received since April 2024 from exporters that have been assessed as low or medium risk are issued within 90 days of filing of the VAT return." - September 2024 Target: "At least 90 percent of new refund requests received since July 2024 from exporters that have been assessed as low or medium risk are issued within 60 days of filing of the VAT return." - December 2024 Target: "At least 90 percent of new refund requests received since October 2024 from exporters that have been assessed as low or medium risk are issued within 45 days of filing of the VAT return – this is the target in the VAT Act that needs to be achieved by IRD by the time SVAT ends." ### KPI-3.1: Management of Collectible Debt - Definition: "Collectible debt is that portion of arrears owed to IRD that is not subject to dispute and where there is no legal impediment to collection action." - Baseline (From 2023 TADAT assessment (P5.18)): "At end of 2021, ratio of collectible debt to annual collections was 13.75 percent, but deteriorated to 15.4 percent by end-2022." - Quarterly targets (expressed relative to revenue targets): - March 2024 Target: "Collectible debt is not above 15 percent of 2024 revenue target" - June 2024 Target: "Collectible debt is not above 14 percent of 2024 revenue target" - September 2024 Target: "Collectible debt is not above 13 percent of 2024 revenue target" - December 2024 Target: "Collectible debt is not above 12 percent of 2024 revenue target" - Proposed March 2025 Target: "Collectible debt is not above 11 percent of 2025 revenue target" ### KPI-4.1: VAT Registration - Context: "The registered VAT population was nearly 29,000 before the 2019 changes and has fallen to 12,000. IRD seeks to rebuild VAT and SSCL taxpayer base to 20,000 by end-2024" - Baseline: "14,000 active VAT and SSCL registered taxpayers" - Quarterly targets: - March 2024 Target: "16,000 active VAT and SSCL registered taxpayers" - June 2024 Target: "18,000 active VAT and SSCL registered taxpayers" - September 2024 Target: "20,000 active VAT and SSCL registered taxpayers" - Proposed March 2025 Target: "22,000 active VAT and SSCL registered taxpayers" --- ### Attachment II. Technical Memorandum of Understanding — Highlights - Purpose: "This Technical Memorandum of Understanding (TMU) sets out a framework for monitoring the performance of Sri Lanka under the program supported by the Extended Arrangement under the Extended Fund Facility (EFF)." - Monitoring instruments listed (quantitative performance criteria and indicative targets) include: - a) central government primary balance (floor) - b) central government tax revenue (floor) - c) stock of expenditure arrears of the central government (ceiling) - d) net official international reserves (floor) - e) CBSL’s net credit to the government (ceiling) - f) continuous criterion on new external payment arrears of the nonfinancial public sector and the CBSL (ceiling) - g) CBSL’s purchases of government securities in the primary market - h) monetary policy consultation clause - i) social safety net spending (floor, indicative) - j) cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling, indicative) - k) treasury guarantees (ceiling, indicative) - l) foreign exchange treasury guarantees (ceiling, indicative) - Definitions and measurement notes: - Central government scope: includes line ministries, departments, and other public institutions; excludes CBSL, state-owned enterprises, parastatals and agencies that do not receive central government subventions. - Primary balance (cash basis) measured as overall balance plus interest payments; GFSM1986 definitions apply. - For 2023: "primary balance of the central government on cash basis measured in this manner was Rs 173 billion (the overall balance was Rs. minus 2,282 billion and the interest payment was Rs 2,456billion)." - Components of financing (2023 amounts): - Net borrowings from domestic instruments: "Rs. 3,296 billion." - Net decreases in central government banking system balances: "Rs. minus 655billion (an increase in bank balances)." - Net increases in CBSL advances, net of changes in central government deposits at the CBSL: "Rs. minus 236 billion." - Net borrowings from SLDBs and domestic FX loans: "Rs minus 393 billion." - Commercial borrowings under foreign law: "Rs 0 billion." - Net borrowings from official project and program loans and trade credit lines: "Rs 495 billion." - Net borrowings from all other bonds, loans, and advances: "Rs minus 224 billion." - Proceeds from privatization/commercialization: "Rs 0 billion." - Equity injections to banks are excluded from central government expenditure for monitoring; equity injections to other corporations are recorded as expenditure. - Expenditure arrears definition: invoices unpaid beyond contractual grace period or beyond 3 months after due date; wages/pensions/transfers pending longer than 3 months. - Central government tax revenue: excludes asset sales, grants, and non-tax revenues; 2023 central government tax revenue was "Rs 2,721 billion." - Net Official International Reserves (Program NIR): - Program NIR measured as difference between (a) CBSL conventional NIR and DSTs Special Dollar/Japanese Yen/Chinese Yuan Revolving accounts (market values) and (b) CBSL outstanding liabilities in FX swaps with domestic commercial banks. - On January 3, 2023: - Program NIR at market exchange rates: "minus US$3,524 million." - Program NIR at program exchange rates: "minus US$3,520 million." - CBSL conventional NIR at market exchange rates: "minus US$3,222 million." - CBSL outstanding liabilities in FX swaps with domestic banks: "US$302.4 million." - Conversion rules: assets/liabilities converted at exchange rates prevailing on January 3, 2023; monetary gold valued at "US$1,831.615 per troy ounce." - Program exchange rates (Rates as of January 3, 2023): - Sri Lanka rupee 363.11 per 1 US dollar - British pound 0.838012 per 1 US dollar - Japanese yen 132.650000 per 1 US dollar - Canadian dollar 1.365800 per 1 US dollar - Euro 0.948317 per 1 US dollar - Chinese yuan 6.892800 per 1 US dollar - Australian dollar 1.497006 per 1 US dollar - Swiss franc 0.939650 per 1 US dollar - SDR 0.752014 per 1 US dollar - Memorandum: Gold price, US$/oz 1831.62 - Adjustment clauses for Program NIR: - Adjustors apply if: (i) foreign program financing (exclusive of EFF disbursements) to central government; (ii) net borrowings from SLDBs and FCBUs in FX terms; (iii) external commercial loans; (iv) project loans and grants disbursed as FX cash flows; and (v) proceeds from commercialization of public assets to non-residents differ from program assumptions—floor on Program NIR adjusted by cumulative differences subject to caps specified in Tables 2a/2b. - Specific caps noted: project loans/grants disbursed FX cash flows adjustor capped at "US$1.15 billion in 2023, and at US$250 million in 2024." The 2024 adjustor on amortization and interest payments in FX for restructured CPC loans capped at "US$100 million." Other adjustors uncapped. - Program assumption snapshots (selected lines from Table 2b): - Mar. 2023, Jun. 2023, Sep. 2023, Dec. 2023 (cumulative, million US$) include entries such as: - Foreign program financing of the central government: "0", "330750900" - Amortization of total external debt owed by the central government (excl. IMF): "239778877989" - Interest payments on total external debt owed by the central government (excl. IMF): "47107337568" - Project loans and grant FX cash amounts disbursed to the central government (Dec. 2023): "1,204" - Mar. 2024, Jun. 2024, Sep. 2024, Dec. 2024 include entries such as: - Foreign program financing of the central government: "425650800800" - Amortization of total external debt owed by the central government (excl. IMF): "187374561748" - Interest and Amortization payments on FX restructured CPC loans by central government: "255075100" - Interest payments on total external debt owed by the central government and central bank (excl. IMF): "3086159191,226" - Project loans and grant FX cash amounts disbursed to the central government: "105210315420" *Source: Appendix II. KPIs for Inland Revenue – Quarterly Targets; Attachment II. Technical Memorandum of Understanding (from the provided PDF content).* ### 14. In the event NIR outcome outperforms its program target(s), the CBSL will consult with ### 14. In the event NIR outcome outperforms its program target(s), the CBSL will consult with ### E. Performance Criterion on the CBSL’s Net Credit to the Government (NCG) - Measurement: NCG = (a) – (b) - (a) The CBSL’s claims on the central government, which 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. - Exclusions for program monitoring: government securities acquired through purchases solely for monetary policy purposes (e.g., standing lending facility and short-term open market operations) and emergency liquidity assistance (ELA) operations on a temporary basis with an agreement to reverse the transaction in less than 90 days. - Measurement convention: stock of government securities held by the CBSL measured in the face value. - (b) The central government’s Rupee-denominated deposits at the CBSL. - Exclusion: deposits related to foreign program financing (including IMF disbursements) placed at the government’s account at the CBSL are not part of the central government’s Rupee-denominated deposits at the CBSL. ### Adjustment to NCG Ceiling - 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 as set out in Table 2). - Applicability: This adjustor will only apply to the NCG ceiling during six months after the Board date of the First review. - Conversion: Foreign currency amounts will be converted to Sri Lankan rupees using the program exchange rates defined in paragraph 9. ### II. Continuous Performance Criteria - F. New External Payment Arrears (nonfinancial public sector and the CBSL) - Continuous performance criterion: non-accumulation of new external payments arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL. - Definitions and scope: - Nonfinancial public sector defined following the 2001 Government Finance Statistics Manual and the 1993 System of National Accounts; includes central government (as in paragraph 3) and nonfinancial public enterprises (boards, enterprises, agencies with government controlling stake). - External payments arrears = debt-service obligations (principal and interest) to nonresidents not paid when due per contractual agreements, subject to any applicable grace period. - Exclusions: overdue debt and debt service obligations in dispute; arrears for which rescheduling or restructuring agreement is being sought. - Monitoring: authorities will monitor continuously and report any non-observance immediately to the Fund. - G. New CBSL Purchases of Government Securities in the Primary Market - Continuous performance criterion: ceiling of zero on new purchases of government securities by the CBSL in the primary market, on a continuous basis. ### Adjustment to Ceiling on CBSL Purchases - The ceiling (¶17) will be adjusted upward by the amount of shortfalls in foreign program financing of the central government (measured against programmed amounts as set out in Table 2). - Applicability: This adjustor will only apply to the ceiling ((¶17) during six months after the Board date of the First review. - Conversion: Foreign currency amounts will be converted to Sri Lankan rupees using the program exchange rates defined in paragraph 9. ### H. Other Continuous Performance Criteria - During the program period, Sri Lanka will not: - a) impose or intensify restrictions on the making of payments and transfers for current international transactions; - b) introduce or modify multiple currency practices (MCPs); - c) conclude bilateral payment agreements that are inconsistent with Article VIII of IMF Articles of Agreement; and - d) impose or intensify import restrictions for balance of payments purposes. ### III. Monetary Policy Consultation Clause - Inflation target bands: specified in Table 1 attached to the MEFP around the projected 12-month rate of inflation measured by the headline Colombo Consumer Price Index (CCPI) (2021=100) published by the Department of Census and Statistics of Sri Lanka. - Measurement of year-on-year inflation for each test date: - Formula: { CCPI*(t) – CCPI*(t-12) } / CCPI*(t-12) - Definitions: - t = the month within which the test date is included - CCPI(t) = CCPI index (all items) for month t - CCPI(t-k) = CCPI index (all items) as of k months before t - CCPI*(t) = { CCPI(t-2) + CCPI(t-1) + CCPI(t) } / 3 - CCPI*(t-12) = { CCPI(t-14) + CCPI(t-13) + CCPI(t-12) } / 3 - Consultation triggers: - If observed year-on-year inflation for end-December 2023 and end-June 2024 falls outside the outer bands in Table 1, authorities will consult with the IMF Executive Board on: (i) stance of monetary policy and program trajectory; (ii) reasons for deviation; and (iii) proposed policy response. 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 for end-December 2023, end-March 2024, end-June 2024, and end-September 2024, authorities will consult with IMF staff on reasons for deviation and proposed policy response. ### IV. Indicative Targets - I. Indicative Target on Social Safety Net (SSN) Spending - SSN spending = central government’s spending on SSN programs comprising: 1) Aswesuma cash transfers (transition from Samurdhi to Aswesuma expected 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 Ministry of Finance Annual Report reporting (Table 9). - J. Indicative Target on Cost of Non-Commercial Obligations (NCOs) for Fuel and Electricity (Net of Government Transfers) - NCOs defined: obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery levels. - Target: cost of fuel and electricity NCOs net of government transfers = cost of NCOs not compensated by central government budget. - Fuel NCO measurement (each quarter): cost of sales (including fuel cost, terminal charges, transport charges, personnel cost, other operational expenses, exchange rate variation, and finance cost; excluding sales taxes) minus revenues (net of sales taxes) for CPC supplies to transport, power generation, aviation, industries, kerosene and LPG, and agrochemicals. If revenues (net of taxes) exceed cost of sales, cost of fuel NCO = zero. - Electricity NCO measurement: - Starting January 1, 2024: total expenditures (including energy purchases and allowed revenue for transmission) minus total sales revenues from 5 distribution licensees under CEB, as shown in the Bulk Supply Transaction Account managed by CEB. If sales revenues exceed expenditures, cost of electricity NCO = zero. - Until January 1, 2024: measured by total losses as reported on CEB’s financial statement. - Government transfers: measured as central government current transfers disbursed to CPC and central government transfers disbursed (including capital injection as specified in paragraph 6) to CEB. - Program monitoring calculation (accounting for time lag): - For test date end-March 2024: NCO(2023Q4) – G(2024Q1) - For test date end-June 2024: { NCO(2023Q4) + NCO(2024Q1) } – { G(2024Q1) + G(2024Q2) } - For test date end-September 2024: { NCO(2023Q4) + NCO(2024Q1) + NCO(2024Q2) } – { G(2024Q1) + G(2024Q2) + G(2024Q3) } - Notation: - NCO(q) = NCO_fuel(q) + NCO_electricity(q) - G(q) = G_fuel(q) + G_electricity(q) - K. Indicative Target on Treasury Guarantees - Definition: outstanding debt guarantees issued by the central government; a guarantee = explicit legal obligation of central government to service such debt in event of nonpayment by recipient. - Exclusions: letters of comfort. - Measurement: outstanding guarantees = drawn amounts of guaranteed debts (distinct from issued guarantees which include undrawn amounts). - Inclusion: outstanding treasury guarantees published in the Statement of Contingent Liabilities in the Annual Report of the Ministry of Finance. - Conversion: Rupee values for guarantees issued in other currencies calculated using the exchange rate for the last day of the calendar year as in the Statement of Contingent Liabilities. - Stock: As of end-2023, the outstanding treasury guarantees were valued at Rs 1,931 billion. - L. Indicative Target on Foreign Exchange Treasury Guarantees - Definition and measurement: outstanding debt guarantees issued in foreign currency by the central government; same conventions and exclusions as K. - Conversion: Rupee values for FC guarantees calculated using the exchange rate for the last day of the calendar year as in the Statement of Contingent Liabilities. - Stock: As of end-2023, the outstanding treasury FX guarantees were valued at Rs 1,304 billion. ### V. Data Reporting Requirements - General: Sri Lanka shall provide the Fund with requested information and program monitoring data via the Ministry of Finance and the CBSL. - Data formats: fiscal performance and expenditure arrears (Tables 3–5); NCG targets (Table 6); external sector performance (Tables 7–8); SSN spending (Table 9, quarterly); financial performance of CEB, CPC, Sri Lankan Airlines (Tables 10–12, quarterly); cost of fuel NCO net of transfers (Table 13, quarterly); treasury guarantees (Table 14, quarterly); Multiple Currency Practices assessment data as requested. - Reporting deadlines: - Fiscal targets (Tables 3–5): within no more than five weeks after end of each month, except salaries & wages, goods and services, subsidies and transfers (and subcomponents) within no more than seven weeks; total recurrent expenditure and interest payments within no more than five weeks. - Monetary targets (Table 6): within no more than four weeks after end of each month. - External targets (Tables 7–8): within no more than 25 days after end of each month. - SSN spending (Table 9): within no more than two months after end of each quarter. - SOE financials (Tables 10–12): within no more than 2 months after end of each quarter. - Cost of fuel NCO net of transfers (Table 13): within no more than 5 weeks after end of each quarter. - Treasury guarantees (Table 14): within no more than two months after end of each quarter. - Financial sector monitoring (quarterly written update and bank-by-bank information): - 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 of delivery: - Daily data within one week of end of reporting period - Weekly data within two weeks - Monthly data within four weeks - Quarterly data within six weeks *Source: 1lkaea2024001 - 14. In the event NIR outcome outperforms its program target(s), the CBSL will consult with* ### 2. Total outflows, without swaps ### 2. Total outflows, without swaps ### Components of total outflows (public sector debt service) - Public sector amortization (excl. to IMF) - Official loans - Multilateral creditors - India credit lines - Other loans - SLDBs - FCBU loans - Syndicated loans - Settlement of ISBs - Public sector interest payment (incl. to IMF) - Interest to IMF - Interest to external creditors - Interest on domestic FX debt (SLDB, FCBU, etc) ### Net FX purchases and market operations - Net FX purchases from market - Outright purchases of FX from commercial banks - Outright sales of FX to commercial banks - Swaps with domestic commercial banks - OMO FX swap transactions-inflows - OMO FX swap transactions-outflows - Net inflows calculations (at current rates) - Net inflows (incl. swaps = 1-2+3+4) at current rates - Net inflows (excl. swaps = 1-2+3) at current rates ### Reserve positions, swaps, and related liabilities - Reserves and valuation - Net International Reserves (at market rates) - Net International Reserves (at program rates) - Gross International Reserves (at market rates) - Valuation changes - Changes in Reserve Related Liabilities - Change in ACU liabilities - Change in liabilities to IMF - existing debt service (amortization) - new purchases - International swaps with foreign CBs - inflows - outflows - Changes in CBSL other liabilities - Note: 1/ As agreed for the purpose of monitoring the program. ### Fund relations and quota/accounting figures (as of April 30, 2024) - Membership Status - Joined: August 29, 1950; Article VIII - General Resources Account: SDR Million Percent Quota - Quota 578.80 100.00 - Fund holdings of currency 1,742.77 301.10 - Reserve Tranche Position 2.86 0.49 - SDR Department: SDR Million Percent Allocation - Net cumulative allocation 950.21 100.00 - Holdings 25.57 2.69 - Outstanding Purchases and Loans: SDR Million Percent Quota - Extended Arrangements 1,166.81 201.59 ### Latest financial arrangements (dates and amounts) - EFF 03/20/2023 expiration 03/19/2027 Amount Approved 2,286.00 Amount Drawn 508.00 (SDR Million) - EFF 06/03/2016 expiration 06/02/2020 Amount Approved 1,070.78 Amount Drawn 952.23 (SDR Million) - Stand-By 07/24/2009 expiration 07/23/2012 Amount Approved 1,653.60 Amount Drawn 1,653.60 (SDR Million) ### Overdue obligations and projected payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs) - Forthcoming - 2024 Principal 148.71; Charges/interest 72.11; Total 220.83 - 2025 Principal 158.70; Charges/interest 88.10; Total 246.80 - 2026 Principal 148.71; Charges/interest 80.04; Total 228.75 - 2027 Principal 139.91; Charges/interest 72.71; Total 212.61 - 2028 Principal 138.98; Charges/interest 65.35; Total 204.33 - Note: When a member has overdue financial obligations outstanding for more than three months, the amount of such arrears will be shown in this section. ### Safeguards assessment and central bank measures - Safeguards assessment findings (since February 2023 updated assessment) - New Central Bank Act enacted incorporating SA recommendations. - Financial risk management expanded. - Steps initiated to strengthen the internal audit function, including completion of an external quality assessment. - Recommendation: CBSL to approve a medium-term plan to strengthen its financial position. - Staff will continue to engage with the CBSL on implementation of remaining recommendations. - Exchange rate arrangement classification - De jure: free floating - De facto: other managed - Exchange restrictions maintained (examples listed in source) - Prohibitions on converting LKR into FX for certain current international transactions - Levy of a 2.5 percent stamp duty on credit card transactions abroad - Levy of a 14 percent remittance tax on nonresidents’ profits - Limits on repatriation by nonresidents of proceeds derived from current transactions - Requirement to provide a tax clearance certificate prior to permitting transfers for certain current transactions - Restrictions notified under Executive Board Decision 144 (52/51) - Multiple currency practice (MCP) notes - Sri Lanka maintains MCPs subject to Fund jurisdiction under Article VIII, Section 3 arising from a 2.5 percent stamp duty on credit card transactions abroad and a 14 percent remittance tax on nonresidents’ profits. - Revised MCP policy: MCPs maintained under the previous MCP policy are considered eliminated as of Feb 1, 2024; certain MCPs considered eliminated as of July 1, 2022 (per source text). ### Capacity development, TA, and governance diagnostics (selected) - FAD: Wide-ranging TA on tax policy, VAT and excise reform, new property tax, VAT refund system, revenue administration reform, RAMIS, customs and excise diagnostics, Public Finance Management Bill drafting, macro-fiscal unit strengthening, fiscal strategy statement, fiscal risks, cash management; placement of resident tax advisor to IRD and resident public finance management advisor to MoF. - ICD: TA on FPAS and semistructural QPM; integration of FPAS into CBSL decision-making; macroeconomic framework support to MoF and CBSL. - LEG: Assisted in drafting new Central Bank Act and Governance Diagnostic Report; supported drafting of various legislations and regulations. - MCM: TA to CBSL on monetary policy implementation, liquidity forecasting, supervision capacity, macroprudential framework, balance sheet analysis, risk appetite framework, payments and settlements diagnostics; support for Public Debt Management Law and Debt Management Office. - STA and SARTTAC: TA on national accounts, price statistics, government finance statistics, fiscal reporting, revenue mobilization, liquidity forecasting, FX market development, and regional training courses. - Governance Diagnostic Assessment: conducted March 2023, report published September 2023; prompted authorities to publish a governance action plan. ### Contextual note from authorities (June 12, 2024 statement) - Authorities expressed gratitude for support during the program, noting: - Unprecedented stakeholder support contributed to stabilizing the Sri Lankan economy. - Real GDP growth turned positive in Q3-2023 after a one-and-a-half-year contraction, with momentum continuing thereafter (text ends at growth rate mention). *Source: IMF staff report excerpts and tables as provided in the content unit.* ### 4.5 percent (y-o-y) recorded in Q4-2023. Headline inflation sharply decelerated from 70 percent in ### 4.5 percent (y-o-y) recorded in Q4-2023. Headline inflation sharply decelerated from 70 percent in ### Program performance and authorities’ commitment - The EFF arrangement has been "particularly instrumental in restoring macroeconomic stability." - Authorities met all quantitative targets except one, which was "missed by a small margin." - "All continuous structural benchmarks (SBs) were met," and most other SBs were either met or implemented with delay; measures are being taken to meet remaining SBs. - Authorities committed to implementing comprehensive fiscal and pro-growth reforms, effective monetary and financial sector policies, and enhancing resilience in the external sector and governance. - Next immediate milestone: completion of the public debt restructuring process with bilateral partners and commercial creditors. - Economic Transformation Bill: key elements of the program incorporated and "submitted to Parliament in May 2024." ### Recent macroeconomic outcomes and outlook - Headline consumer price inflation: "around 70 percent (y-o-y) in September 2022" reduced to "below the target level by August 2023." - Headline inflation: "0.9 percent (y-o-y)" as of May 2024. - Reserves: "now cover about three months of imports"; gross official reserves "rose to approximately US$ 5.5 billion, sufficient to cover over three months of imports." - Exchange rate: "cumulative appreciation against the US dollar of about 20 percent during 2023 and thus far in 2024," compared to "a depreciation of about 45 percent in 2022." - External current account: surplus of "1.8 percent of GDP in 2023" versus deficit of "1.9 percent in 2022." - Net FX intervention: "US$ 420 million" in April 2024; "net FX purchases of US$ 1.6 billion from January to April 2024." - Domestic foreign exchange market: improved liquidity and "the Sri Lanka rupee appreciated over 7 percent against the US dollar thus far in 2024." ### Fiscal policy and reforms - Government revenue forecast: increase from "8.2 percent of GDP in 2022" to "15.0 percent of GDP in 2025," with "11.0 percent of GDP already achieved in 2023." - Primary balance: expected improvement from a deficit of "3.7 percent of GDP in 2022" to "2.3 percent of GDP by 2025 and beyond"; recorded a surplus of "0.6 percent of GDP" in 2023. - Upcoming policy measures: - Package of new tax policy measures "set to take effect from January 2025." - Establishing a property valuation database and operationalizing a nationwide digital Sales Price and Rents Register to support property tax introduction. - Enhancing VAT compliance, digitizing revenue systems, and bolstering governance of revenue authorities. - Public Financial Management (PFM) Law: "submitted to Parliament in May 2024"; a medium-term PFM reform strategy and action plan "scheduled for publication by the end-2024." - SOE reforms: adoption of cost-recovery pricing in energy led to SOE profits in 2023; restrictions on SOE borrowings to finance commercially viable activities and a new indicative program target to limit issuance of Treasury guarantees for foreign exchange borrowing. ### Protecting the vulnerable and strengthening social safety nets - Economic shocks and adjustment measures pushed many vulnerable households below the poverty line. - Reforms to social safety nets aim to improve targeting, coverage, and adequacy, and shift away from large-scale untargeted subsidies (e.g., subsidized energy prices). - Welfare Benefit Payment Scheme (Aswesuma): grievances addressed and retroactive cash transfers being made to eligible individuals, "potentially surpassing the social spending floor agreed upon under the program for 2023." - An empowerment program is being implemented to support selected families, with assistance from the Asian Development Bank and the World Bank. - Authorities remain committed to continually enhancing spending on social safety nets. ### Debt restructuring efforts - Priority: "expeditious completion of the debt restructuring through a transparent process aligned with debt sustainability targets under the EFF arrangement." - Domestic debt restructuring: "completed nearly all components," providing significant liquidity relief while minimizing banking sector impact and preserving financial stability. - Bilateral agreements: authorities pursuing signed agreements with OCC member countries and with the EXIM Bank of China; engaged in good-faith negotiations with private commercial creditors and China Development Bank to reach an agreement in principle at the earliest opportunity. - Public Debt Management Act: "submitted to Parliament in April 2024" with technical assistance from the World Bank and IMF. - A Public Debt Management Office will be established "by end-2024," with full functionality planned "by end-2025." ### Monetary and exchange rate policies - Commitment to the inflation targeting regime and a flexible exchange rate regime; the Central Bank of Sri Lanka Act strengthened Central Bank independence and prohibited monetary financing. - Monetary policy: "data-driven" and aligned with the monetary policy consultation clause under the EFF arrangement; committed to phasing out the existing stock of net credit to the government "along the path agreed under the program or earlier if market conditions warrant." - Despite conversion of Treasury Bill holdings to Treasury Bonds under the domestic debt operation, the Central Bank's net equity position "remains positive." - Reserve accumulation: "surpassed the program target for net international reserves." - Plans to phase out remaining restrictions on motor vehicle imports and develop a plan to eliminate remaining administrative measures imposed to support balance of payments. ### Financial policies - Authorities will "continue to closely monitor the capital adequacy of banks using forward-looking stress tests" and provide recapitalization funds as a last resort if shortfalls emerge. - Finalizing restructuring of foreign exchange debt owed by the Ceylon Petroleum Corporation (CPC) to state-owned banks and addressing associated capital requirements. - Amendments to the Banking Act approved by Parliament in April 2024 and the Banking (Special Provisions) Act enacted in September 2023 will enhance supervision, governance of state-owned banks, and crisis management. ### Structural reforms and reducing corruption vulnerabilities - Stabilization and debt restructuring create opportunities for growth-enhancing reforms: trade liberalization, National Export Strategy, expedited Free Trade Agreement negotiations, and integrating with global value chains. - Proposed Employment Act to implement labor market reforms: improve labor productivity, eliminate labor market rigidities, narrow the gender gap in employment, and mitigate population aging impacts on labor supply. - Public sector digitization to enhance productivity and reduce corruption vulnerabilities. - Climate vulnerability: Sri Lanka faces increased incidence of droughts, floods, and landslides; financing for climate adaptation and mitigation needed from private sector and multilateral lenders. - Governance and anti-corruption measures: - Anticorruption Act enacted in August 2023, strengthening CIABOC investigative powers. - Governance Diagnostic report published in September 2023 and an Action Plan published in February 2024. - Streamlining tax incentives to strategic development projects using transparent, rules-based criteria. - Plans to amend the National Audit Act "by September 2024" to strengthen public asset oversight. - Strengthening AML/CFT legal framework: National AML/CFT Risk Assessment Framework Report published and AML/CFT National Policy (2023-2028) approved in 2023. ### Conclusion and program risks - Authorities are dedicated to ensuring long-lasting macroeconomic stability and maintaining sustainable public debt levels with support from creditor nations and international institutions. - "Room for maneuverability remains limited"; authorities remain committed to meeting program commitments under the EFF arrangement. - Program monitoring: authorities and staff monitor program performance "on a weekly basis" to allow timely corrective measures and contingency planning. - Authorities appreciate support for the completion of the second review under the EFF arrangement and remain committed to implementing required measures. *IMF staff report content (extract provided).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1lkaea2024001.pdf_