## _cr0468 ## Source details **Canonical URL:** [_cr0468](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0468.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0468.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0468.pdf.json) --- ### Executive summary — macro developments and program engagement - Ceasefire held since February 2002; peace talks facilitated by Norway but negotiations stalled at times. - Donor commitments total $4½ billion over the medium term (25 percent of 2003 GDP), with major pledges: Japan ($1 billion), AsDB ($1 billion), World Bank ($1 billion), IMF ($560 million). - Fund engagement through Stand-By, PRGF, and Extended Arrangements; key policy advice included floating the exchange rate, introducing a VAT system, amending banking laws, and restructuring financial markets. - Recent macro outcomes: - GDP growth estimated at 5½ percent in 2003 (up from 4 percent in 2002). - Colombo CPI inflation: 6⅓ percent in 2003 (9½ percent in 2002). - Gross reserves rose by $0.5 billion through December 2003 to over $2 billion (about 2¾ months of imports and 100 percent of short-term debt). - Current account deficit estimated at 1 percent of GDP in 2003. - Fiscal deficit: about 8 percent of GDP in 2003 (½ percentage point above the budget target); 2004 budget aims at 6¾ percent of GDP; staff estimate could reach 7¼ percent of GDP. - Structural reform progress noted in electricity, petroleum, telecommunications, privatizations (SLIC, stakes in SLT/CWE), labor law amendments (January 2004), FMRA (December 2002), and financial market infrastructure (scripless securities, RTGS). ### Fiscal policy — findings, 2004 budget measures, and risks - Revenue and administration findings: - Tax revenue has fallen by about 4 percentage points of GDP since the mid-1990s. - Income tax yields are among the lowest in the region. - Recent revenue shortfalls largely due to poor compliance under the dual-band VAT system and collection slowdowns tied to resistance to a Revenue Authority. - Import tax base narrowed by exemptions and preferential rates; proliferation of exemptions depressed direct tax revenue. - Measures initiated in 2003 and in the 2004 budget: - Administrative: restarted audit program after tax amnesty ended in August; increased LTU staffing. - Policy: extended VAT to nonbank financial services; raised excise taxes and import duties on select items; unified VAT at 15 percent and extend to wholesale/retail beginning in July 2004. - 2004 budget targets and estimates: - Deficit target: 6¾ percent of GDP (draft target noted as 6.8 percent of GDP). - Total revenue estimated at 16.4 percent of GDP (a rise of 1 percent of GDP). - Overall spending budgeted to fall by 0.4 percent of GDP. - Post-conflict spending budgeted at close to 1 percent of GDP. - Capital spending projected to increase by ½ percent of GDP. - Authorities estimate potential additional revenue from measures could amount to 1½ percent of GDP, but counted only 1 percent of GDP of increased revenue towards the 2004 budget. - Additional 2004 revenue items and estimated yields: - Import surcharge cut to 10 percent; move towards three-band tariff regime by 2006; yield about 0.1 percent of GDP. - Service charge of 1 percent on assets or turnover for companies over two years old; yield about 0.1 percent of GDP. - Corporate measures (cap carry-forward losses at 35 percent of taxable income; tax partnership income at 10 percent; withhold interest income) yield around 0.1 percent of GDP. - Other measures (excises, duties, fares, cell phone fee, streamlining exemptions) expected to yield 0.2 percent of GDP. - Spending items: public employment targeted to decline by 10 percent via targeted early retirement scheme costing 0.4 percent of GDP; capital expenditures to rise by about 0.5 percent of GDP; 0.2 percent of GDP for unemployment insurance seed money/supports/subsidies. - Risks and contingency planning: - Since 2000, actual revenue shortfalls about 1½ percent of GDP annually. - If tax revenue falls short by ¾ percent of GDP and extra drought-related spending of ¼ percent of GDP occurs, deficit would be 1 percent of GDP above budget target. - To limit domestically financed capital spending and remain on track to debt reduction, overall deficit should be contained to at most 7¼ percent of GDP—½ percent of GDP higher than budgeted—requiring expenditure cuts of ½ percent of GDP. - Contingency measures: increases in excises and custom duties and reductions in tax exemptions; staff advises custom-duty changes in context of long-term single-rate goal. ### Medium-term fiscal priorities and public debt projections - Objectives: enhance sustainability while providing resources for post-conflict reconstruction. - Debt projections and targets: - Debt-to-GDP ratio expected to fall to 95 percent in 2004 from 101 percent in 2003. - PRSP and FMRA target: debt-to-GDP ratio of 85 percent by 2006. - Primary balance in 2005–2006 needs reduction by about ½ percent of GDP per year more than current policies to reach 85 percent target. - Stress tests show debt dynamics unstable if policies revert to late 1990s. - Policy focus: move to a single-rate corporate tax regime, simplify tariff structure further, rationalize tax incentives. - Institutional steps: integrate Needs Assessment, donor commitments, and PRSP projects into MTBF; new Aid and Development Agency planned; public debt management office reform and domestic debt restructuring underway. ### Monetary and exchange rate policy — stance, operations, and guidance - 2003 actions: - CBSL cut repo rates by 275 basis points over 2003 while sterilizing foreign exchange inflows to keep to programmed reserve money path. - Real interest rates remained low but positive; regular public announcements on monetary policy begun in 2003. - Policy guidance: - Maintain flexible exchange rate; confine exchange rate interventions to smoothing short-term volatility. - If political uncertainty deepens and fiscal pressures rise, monetary authorities should tighten policy. - Improving monetary transmission: - CBSL to expand instruments: longer-term repos, secondary market auctions, direct sales. - Credit channel hampered by banking sector weaknesses: high NPLs and poor risk management. ### Structural reforms — growth drivers, constraints, and implementation - Potential growth drivers if lasting peace achieved: tourism, communications, transshipment, financial activities, agro-industries. - Constraints: high business costs, unreliable electricity, inadequate infrastructure, rigid labor market conditions, shallow financial markets, skills gaps. - Priorities: reconstruct infrastructure, reduce state dominance, restructure power sector, strengthen financial markets, enhance labor market flexibility, rationalize trade regime. - Implementation work: sectoral policy papers, MTBF, Aid and Development Agency legislation pending, ongoing bank and capital market reforms. ### Outlook and risks (authorities and staff projections) - Authorities expect: - Growth around 6 percent in 2004. - Inflation to stabilize around 6 percent. - Current account deficit of 2¼ percent of GDP in 2004. - Gross reserves projected to reach $2¼ billion (covering 3 months of imports and 120 percent of short-term debt) in 2004. - Medium-term growth average 6½ percent, reserves $3 billion (covering 3½ months of imports) by 2006. - Upside risks: - Stronger global outlook boosting exports, tourism, remittances. - Easing power and infrastructure bottlenecks accelerating tourism, shipping, telecommunications. - Downside risks: - Prolonged peace-process impasse deterring private investment. - Political uncertainty delaying donor financing and reforms. - Drought reducing agricultural output and power generation; these factors could depress growth, widen fiscal deficit, increase domestic financing needs, and leave reserves vulnerable if donor financing reduced. - Staff recommendation: develop an alternative macroeconomic scenario and mitigation plans for identified risks (including exogenous factors such as removal of textile quotas in 2005) when updating the PRSP in 2004. ### Program status, structural benchmarks, and sequencing - First reviews of PRGF and Extended Arrangements delayed by political uncertainty. - Except for end-December performance criterion on net domestic financing, quantitative performance criteria for June and December are estimated met; some end-December indicative targets likely missed (revenue, primary balance, banks’ net claims on government, credit to public corporations). - Key delayed structural measures: Revenue Authority bill (June 2003 performance criterion) cannot be presented before elections; restructuring of People’s Bank delayed. - Structural benchmarks (selection and status as reported): - Extend VAT to wholesale/retail (Structural Benchmark; target Jan 31, 2004): Not met. Expected by July 2004. - Rationalize tax incentives (Structural Benchmark; Jan 31, 2004): Modest progress made. - Reduce import surcharge to 10 percent from 20 percent (Structural Benchmark; Jan 31, 2004): Met on time (January 2004). - Presentation of AMC law to Parliament (Structural Benchmark; Jun 30, 2003): Not met. Pending resumption of Parliament. - Presentation of amended Banking laws and Exchange Management Act (Structural Benchmark; Jun 30, 2003): Met with delay (November 2003). - External evaluation of People’s Bank (Structural Benchmark; Sep 15, 2003): Not met. Expected by end-March 2004. - Complete restructuring of People’s Bank (Structural Benchmark; Mar 31, 2004): Likely delayed until end-October 2004. - Sale of 8.5 percent government shares in SLT (Structural Benchmark; Dec 31, 2003): Not met. Expected by end-December (year implied) with Hilton Colombo to point of sale end-September 2004. - Binding redundancy compensation formula (Structural Benchmark; Apr 30, 2003): Met with delay (January 2004). ### Monetary transmission mechanism and financial sector (Chapter I highlights) - Economy and infrastructure indicators (selected): - GNI per capita (U.S. dollar series preserved as provided): 840 480 360 410 1,980 3,540 710 20,690 - Informal economy (percent of GNI series preserved): 45 23 36 37 53 31 19 13 - Per capita electricity consumption (kwh series preserved): 244 384 813 371 1,345 2,554 320 ... - Financial infrastructure and credit: - Public Credit Registry: No; Public Credit Bureau: Yes; Public Credit Bureau coverage (per 1000 capita): 8 ... ... ... 97 461 ... 512. - Private credit (percent of GDP series preserved): 29 27 24 26 96 100 29 11 0. - Five bank concentration ratio (percent): 79 43 51 60 74 55 85 60. - Banking sector performance and prudential measures: - NPLs remain high: system NPLs (percent of total loans) series: 16.6 15.0 17.0 15.7 16.7 17.3 16.4. - Net NPLs (net of provisions, percent of total loans): 10.7 10.2 10.1 8.5 9.1 9.9 8.9. - Capital adequacy ratio (total capital over risk-weighted assets): 10.6 8.3 7.8 8.1 7.5 7.4 7.9. - After-tax return on average equity: -10.1 13.1 15.5 22.0 23.8 ... - CBSL measures: stepped up supervision, raised capital requirements, tightened provisioning, imposed “hair cuts” on collateral valuation; AMC law to facilitate bank restructuring expected. - Bank restructuring and capital markets: - External evaluation of People’s Bank net worth expected by April (external evaluation noted) to launch divestment by June; process expected completed by end-October (year implied). - NPLs of People’s Bank about ½ percent of GDP net of provisions; half eligible for future AMC transfer. - Domestic capital markets shallow: market capitalization of listed companies about 15 percent of GDP; EPF assets around 18 percent of GDP (mostly in Treasury securities). - Staff advice: broaden EPF reference portfolio, consider selective easing of abroad investment and outsourcing management; begin implementation by late 2004. ### Debt sustainability — central government and external projections - Central government debt baseline projections (percent of GDP): - Central government debt (2003–2008): 100.9, 95.4, 91.2, 86.5, 81.5, 76.8. - Of which foreign-currency denominated: 46.8, 45.8, 44.6, 45.1, 45.3, 44.1. - Revenue and grants (percent of GDP): 15.9, 16.3, 17.3, 17.8, 17.9, 18.2. - Baseline external debt projections and stress tests: - External debt (2003–2008): 55.2, 52.1, 52.8, 51.2, 49.9, 47.9 (percent of GDP). - Gross external financing need (in billions of US dollars): 2.2, 2.5, 2.6, 2.9, 3.0, 3.0. - Stress scenarios: - A1 (10-yr historical averages): external debt-to-GDP to 64.4 by 2008. - A3 (1999–2001 averages): external debt-to-GDP to 83.1 by 2008. - B5 (one-time 30 percent nominal depreciation in 2004): external debt-to-GDP jumps to 73.1 in 2004, persistently higher thereafter. - Vulnerabilities: nearly 50 percent of debt denominated in foreign currency; a 30 percent nominal depreciation in 2004 can raise central government debt-to-GDP to nearly 120 percent in stress scenarios. ### Key macroeconomic indicators and projections (selected table values preserved) - Nominal GDP (2002): US$16.5 billion. - Population (2002): 19 million. - GDP per capita (2002): US$868. - Real GDP growth (percent): -1.5 (2001), 3.9 (2002), 5.5 (2003), 6.0 (2004 proj.). - Colombo CPI inflation (period average): 14.2 (2001), 9.6 (2002), 6.3 (2003), 6.0 (2004 proj.). - Gross official reserves (net of ACU balances; in billions of U.S. dollars): 1,180 (end-2001), 1,595 (end-2002), 2,084 (end-2003), 2,385 (end-2004 proj.). - Current account balance (in percent of GDP): -1.5 (2001), -1.6 (2002), -1.0 (2003), -2.2 (2004 proj.). - Central government total revenue (percent of GDP): 16.6 (2001), 16.5 (2002), 15.4 (2003 est.), 15.8 (2004 proj.). - Central government overall balance (percent of GDP): -10.8 (2001), -8.9 (2002), -8.1 (2003), -7.2 (2004 proj.). - Government debt (percent of GDP): 103.2 (2001), 105.5 (2002), 100.9 (2003), 95.4 (2004 proj.). - Banking sector NPLs (system, percent of total loans): 16.6 15.0 17.0 15.7 16.7 17.3 16.4 (series preserved). ### Program monitoring, data, safeguards, and institutional support - Statistical reporting: - Coverage and timeliness assessed as adequate for program monitoring; authorities participating in GDDS and aiming for full SDDS compliance by mid–2004. - Migration to GFSM 2001 methodology underway; compilation improvements for monetary statistics, quarterly GDP from expenditure side, and retail sales data advised. - Safeguards: - CBSL made substantial progress on 2001 Safeguards Assessment recommendations; full Safeguards Assessment for PRGF completed July 30, 2003; external audit and IAS adoption advanced. - Technical assistance and Fund relations: - Stand-By, EFF, and PRGF arrangements active with amounts approved and drawn detailed in the report. - Extensive TA on monetary policy, banking supervision, AML/CFT, GFS, debt management, and revenue administration noted. ### IMF staff appraisal — core policy recommendations and sequencing - Urgently press forward with tax administration reforms and establishment of the Revenue Authority after April elections. - Maintain tight control over spending; be ready to take corrective revenue and expenditure measures if collections fall short. - Stand ready to tighten monetary policy if political situation deteriorates or severe budget pressures materialize; continue flexible exchange rate regime. - Accelerate restructuring of state-owned banks (notably People’s Bank) and speed power sector unbundling and regulatory agency establishment. - Ensure civil service voluntary retirement scheme is carefully targeted to avoid excessive long-term cost and skill losses. - Implement well-targeted social safety net reforms informed by PSIA and expand Samurdhi coverage in the North and East within Welfare Benefits Act framework. - Prepare alternative macro scenario and mitigation plans when updating the PRSP in 2004. _Italic: Source: IMF staff report and selected issues paper extracted from _cr0468 (IMF country report PDF)._ ### Executive Summary ...................................................................................................... ### Executive Summary ### Introduction and background - Ceasefire held since February 2002; peace talks facilitated by Norway but negotiations stalled at times. - Donor commitments total $4½ billion over the medium term (25 percent of 2003 GDP), with major pledges: Japan ($1 billion), AsDB ($1 billion), World Bank ($1 billion), IMF ($560 million). - Fund engagement through Stand-By, PRGF, and Extended Arrangements; key policy advice included floating the exchange rate, introducing a VAT system, amending banking laws, and restructuring financial markets. ### Recent developments - Political developments: - November: President suspended Parliament for two weeks and took control of defense, interior, and media ministries. - Early February: President dissolved Parliament calling for general elections on April 2; provincial council elections postponed. - Political impasse has slowed reform implementation and delayed presentation of key legislation (e.g., Revenue Authority bill). - Growth and demand: - GDP growth estimated at 5½ percent in 2003 (up from 4 percent in 2002). - Growth drivers in 2003: private consumption, tourism, exports, and private investment (picked up in H2 2003). - Inflation and exchange rate: - Colombo CPI inflation declined to 6⅓ percent in 2003 from 9½ percent in 2002. - Rupee appreciated during 2003 then depreciated in the last two months of the year amid political instability. - External sector and reserves: - Gross reserves rose by $0.5 billion through December 2003 to over $2 billion (about 2¾ months of imports and 100 percent of short-term debt). - Current account deficit estimated at 1 percent of GDP in 2003, supported by strong exports, remittances, and tourism receipts. - Financial sector and monetary policy: - Equity market strong until November 2003, then weakened and became volatile. - Bank profitability increased in 2003; nonperforming loans (NPLs) remained high. - CBSL cut repo rates by 275 basis points over 2003; substantial liquidity persisted; broad money growth as expected; private sector credit picked up late in the year. - Fiscal developments: - Fiscal deficit declined by about 2 percentage points of GDP in 2002 to 9 percent of GDP. - 2003 fiscal deficit estimated at around 8 percent of GDP (½ percentage point above the budget target), reflecting revenue shortfalls of around 1¾ percent of GDP, higher post-conflict capital spending, and additional restructuring costs. - 2004 budget aims at a deficit of 6¾ percent of GDP; staff estimate it could reach 7¼ percent of GDP due to slower revenue turnaround and drought-related expenses. - Government cut nonpriority capital spending while protecting PRSP-related projects; lower-than-expected interest and pension payments helped contain expenditure. - Structural reforms progressed in several areas: - Electricity Reform bill enacted December 2002 to begin unbundling CEB. - Petroleum sector opened to private participation; Indian Oil entry in retail market. - 12 percent stake in Sri Lanka Telecom sold in November 2002; telecommunications market liberalized. - 2003 privatizations: SLIC sold in April; 40 percent stake in CWE retail network sold in November. - Labor law amendments implemented January 2004 (streamlining dispute settlement, eliminating restrictions on overtime work by women, increasing penalties for child labor); implementation delayed by 9 months for institutional arrangements and schemes. - FMRA enacted December 2002 to limit borrowing from CBSL, set medium-term fiscal deficit targets, and mandate “pre-election budget reports”. - BOI power to grant tax holidays repealed by Parliament in December 2002 (repeal still needs enactment). - Draft Revenue Authority bill and implementation plan presented to Cabinet; presentation to Parliament delayed. - Banking Act amendments and Foreign Exchange Management bill tabled in Parliament; CBSL introduced scripless securities and RTGS; AMC bill approved by Cabinet. ### Outlook and risks - Authorities' and staff projections: - Authorities expect growth of around 6 percent in 2004. - After rapid decline in 2003, inflation should stabilize at around 6 percent. - Current account deficit expected at 2¼ percent of GDP in 2004. - Gross reserves projected to reach $2¼ billion (covering 3 months of imports and 120 percent of short-term debt) in 2004. - Medium-term growth projected to average 6½ percent, predicated on macroeconomic stability and deeper reforms. - Official reserves expected to rise to $3 billion (covering 3½ months of imports) by 2006. - Upside risks: - Stronger global outlook could boost exports, tourism, and remittances. - Easing power and infrastructure bottlenecks could accelerate tourism, shipping, and telecommunications. - Downside risks: - Prolonged peace-process impasse could deter private investment. - Political uncertainty has already slowed legislative reform momentum and may delay donor-supported public and private investment. - Ongoing drought could reduce agricultural output and power generation. - Combination of factors could depress growth, widen the fiscal deficit and domestic financing, and keep reserves vulnerable if donor financing is reduced. - Staff recommendations: - Develop an alternative macroeconomic scenario and mitigation plans for identified risks (including exogenous factors such as the removal of textile quotas in 2005) when updating the PRSP in 2004. *Source: _cr0468 - Executive Summary* ### 14. Against the backdrop of a challenging economic and political terrain, the ### _cr0468 - 14. Against the backdrop of a challenging economic and political terrain, the ### Fiscal Policy — Findings and Measures - Revenue performance and causes - Tax revenue has fallen by about 4 percentage points of GDP since the mid-1990s. - Income tax yields are among the lowest in the region. - Chief causes of the recent revenue shortfall included poor compliance under the dual-band VAT system and a slowdown in collection efforts by tax officers resisting the creation of a Revenue Authority. - The import tax base was narrowed with exemptions and preferential rates; direct tax revenue depressed by proliferation of exemptions and preferential treatment. - Indirect taxes bear much of the revenue burden; the two-band VAT regime (10 percent and 20 percent) coupled with a vast array of exemptions suffered from significant leakages. - Deep-rooted problems in tax administration: weak management and poor governance prevented a successful transition from high import tariffs/turnover levies to the broad-based income tax and VAT regime. - Measures initiated in 2003 (administrative and policy) - Administrative: restarted audit program after tax amnesty ended in August; increased number of officers in the large taxpayer unit (LTU). - Policy: extended VAT to nonbank financial services; raised excise taxes and import duties on select items; increased corporate tax rate on foreign banking units to that on domestic banking operations. - Several measures came into operation only in 2004 because suspension of Parliament in November prevented enactment. - 2004 budget tax and spending measures (Box 2 summary) - Unify two-band VAT at 15 percent and, beginning in July 2004, extend it to the wholesale and retail sectors. - Introduce a minimum corporate tax to expand the tax base; curtail tax incentives. - Raise railway and postal charges. - Import surcharge halved to 10 percent; number of custom duty bands reduced to 5 from 6 (simultaneous rate adjustments and reduction of exemptions kept these changes revenue neutral). - Authorities estimate potential additional revenue from these and delayed measures could amount to 1½ percent of GDP, but counted only 1 percent of GDP of increased revenue towards the 2004 budget. - 2004 budget targets: - Deficit of 6¾ percent of GDP (Box 2 notes a draft target of 6.8 percent of GDP). - Total revenue estimated at 16.4 percent of GDP (a rise of 1 percent of GDP). - Overall spending budgeted to fall by 0.4 percent of GDP. - Post-conflict spending budgeted at close to 1 percent of GDP. - Capital spending projected to increase by ½ percent of GDP. - Additional 2004 budget tax items and estimated yields (Box 2): - VAT unified at 15 percent; inclusion of retail/wholesale in July; short-term revenue neutral but simplifies system. - Import surcharge cut from 20 percent to 10 percent and move towards three-band tariff regime by 2006; could yield about 0.1 percent of GDP. - Service charge of 1 percent on assets or turnover for companies over two years old, offset against income tax; could yield about 0.1 percent of GDP. - Corporate measures (capping carry-forward losses at 35 percent of taxable income; taxing partnership income at 10 percent; withholding interest income on consolidated accounts) should yield around 0.1 percent of GDP. - Other revenue measures (excises, duties, fares, cell phone fee, streamlining exemptions) expected to yield 0.2 percent of GDP. - Budget spending items (Box 2): - Post-conflict spending will rise to nearly 1 percent of GDP, from 0.7 percent of GDP in 2003. - Public employment targeted to decline by 10 percent via targeted early retirement scheme, cost 0.4 percent of GDP. - Capital expenditures to rise by about 0.5 percent of GDP relative to 2003. - Another 0.2 percent of GDP for unemployment insurance seed money, support to selected industries, and fertilizer subsidies. - Risks to budget implementation and contingency planning - Since 2000, actual revenue had fallen short of budget targets by around 1½ percent of GDP each year, largely due to deterioration in tax administration. - Fundamental reforms in tax administration required: leadership, staffing, organization, incentives. - Revenue Authority legislation postponed due to political impasse; authorities preferred waiting for a conducive political climate to present a strong bill after the April elections. - Proposed tax measures hinge on improvements in collection and cannot be enacted until Parliament reconvenes (though effective from January). - Likely fiscal outturns and staff assessment: - Tax revenue could fall short of target by ¾ percent of GDP. - Extra spending of ¼ percent of GDP expected for drought relief (including emergency power supply). - Combined, these would increase the budget deficit by 1 percent of GDP above the budget target. - To limit domestically financed capital spending and remain on track to debt reduction, overall deficit should be contained to at most 7¼ percent of GDP—½ percent of GDP higher than budgeted—requiring expenditure cuts of ½ percent of GDP. - Authorities set monthly and quarterly tax revenue targets; contingency measures if targets missed could include increases in excises and custom duties, and reductions in tax exemptions; if those failed, further cuts in nonpriority capital expenditures would be needed. - Staff advice: changes in custom duties should be undertaken in the context of the long-term goal of a single-rate duty regime, not to meet short-term revenue needs. - Medium-term fiscal priorities and public debt - Medium-term priorities: enhance sustainability while providing adequate resources for post-conflict and reconstruction needs. - Public debt projections and targets: - Debt-to-GDP ratio expected to fall to 95 percent in 2004 from 101 percent in 2003. - PRSP and FMRA target: debt-to-GDP ratio of 85 percent by 2006. - Primary balance in 2005 and 2006 needs to be reduced by about ½ percent of GDP per year more than projected under current policies to reach the 85 percent target. - Stress tests show debt dynamics turn unstable if policies return to those of the late 1990s. - Policy focus: single-rate corporate tax regime, further simplify tariff structure, rationalize tax incentives. - Institutional and implementation developments: - Working to integrate post-conflict Needs Assessment, donor commitments from June donor conference, and PRSP capital projects into a medium-term budget framework (MTBF). - Sectoral policy papers being prepared with World Bank assistance to inform 2005 budget allocations. - New Aid and Development Agency planned to streamline donor-financed project selection and implementation; legislation pending. - Program to restructure domestic debt underway (increase term structure, convert old rupee loans into marketable bonds). - Public debt management office reform underway with technical assistance from the U.S. Treasury. ### Box 1 — Challenges of Large Aid Inflows (medium-term macro considerations) - Monetary policy implications - If aid is converted into domestic currency and not used for imports, money supply will increase, exert inflationary pressure and force the central bank to sterilize inflows. - Sterilization operations need coordination with fiscal policy, especially on timing of aid flows and impact on the monetary base. - Fiscal policy implications - Volatile and unpredictable timing of aid complicates government expenditure planning; spending plans should be based on realistic projections of likely aid materialization. - Given high public debt, spending plans need flexibility so shortfalls in aid do not necessitate higher public borrowing. - Magnitude and domestic impact - During 2004-2006, net external financing and grants are expected to average about 3 percent of GDP a year. - This is modest compared to receipts by other developing countries and only about 1½ percent of GDP above recent experience in Sri Lanka. - Constraints on project implementation capacity could lengthen disbursement; external leakage on imports for investment projects and sterilization should minimize impact on relative prices and real exchange rate. - Composition and sectoral effects - Most aid will finance projects expected to boost productivity across sectors, including export sector (PRSP projects in agriculture, roads, ports, energy). - Aid expenditure on housing projects and civil service reform could create price pressure on nontradables. - Aid to the North and East: majority for infrastructure projects, but a significant portion is humanitarian aid to support basic consumption needs, which could have a Dutch disease effect. ### Monetary and Exchange Rate Policies — Findings and Recommendations - Monetary stance and operations - Mission considered the stance of balancing support to recovery with restraint on inflation appropriate. - In 2003, CBSL used higher-than-expected foreign exchange inflows to build up official reserves while keeping to the programmed reserve money path through sterilization, using government and CBSL securities. - Cuts in policy rates were cautious and broadly in line with the pace of disinflation; real interest rates remained low but positive. - Regular public announcements on monetary policy begun in 2003 increased transparency. - Risks and policy guidance - If political uncertainty deepened and fiscal pressures rose, monetary authorities would need to tighten policy to contain inflation and maintain investor confidence. - Exchange rate interventions should be confined to smoothing short-term volatility. - Improving monetary transmission - CBSL intends to expand its instrument mix: longer-term repos, secondary market auctions, and direct sales to improve liquidity management and deepen capital markets. - Development of the credit channel is slowed by banking sector weaknesses: high level of NPLs and poor risk management. ### Structural Reforms — Growth Drivers and Policy Challenges - Objective and potential growth drivers - Main challenge: turn recovery into sustained high growth to reduce poverty and unemployment. - If lasting peace achieved, opportunities in outward-oriented services (tourism, communications, transshipment, financial activities) and agro-industries. - Constraints to growth and reform priorities - Business costs remain high by regional standards; need reliable and affordable electricity, better infrastructure, predictable labor market conditions, deeper financial markets, and better skilled labor force. - Authorities’ reform focus: - Reconstruct dilapidated infrastructure. - Reduce state dominance in the economy. - Restructure the power sector. - Strengthen financial markets. - Enhance labor market flexibility. - Establish a rationalized and transparent trade regime. - Implementation and institutional work - Sectoral policy papers and MTBF to guide budget allocations, aided by World Bank. - New Aid and Development Agency planned to improve donor project selection/implementation; legislation pending. - Public debt and debt management reforms underway (see fiscal section). *Source: IMF staff report content from the supplied PDF chapter/section.* ### Chapter I of the selected issues paper analyzes the monetary transmission mechanism. ### Chapter I — Monetary Transmission Mechanism (selected issues paper) ### Economy characteristics and infrastructure (comparative indices) - GNI per capita (in U.S. dollar): 840 480 360 410 1,980 3,540 710 20,690 - Informal economy (in percent of GNI): 45 23 36 37 53 31 19 13 - Per capita electricity consumption (kwh): 244 384 813 371 1,345 2,554 320 ... - Electricity charge for business purpose (in U.S. dollar) - Base charge per month: 0.3 1-8.30 4.2 0.0 0.0 5.1 4.6 2.7 5.1 - Charge per kwh: 0.08 0.08 0.02-0.13 0.09 0.04 0.05 0.04 0.07 - Paved road ratio (in percent of all roads): 2 3 4 6 10 43 98 76 46 100 ### Credit market and financial infrastructure - Public Credit Registry: No No Yes Yes No Yes Yes No - Public Credit Bureau: Yes No No Yes Yes Yes No Yes - Public Credit Bureau coverage (per 1000 capita): 8 ... ... ... 97 461 ... 512 - Creditor Rights Index (scale 0 to 4): 2 3 2 2 3 2 2 3 - Private credit (in percent of GDP): 29 27 24 26 96 100 29 11 0 - Five bank concentration ratio (in percent): 79 43 51 60 74 55 85 60 ### Labor market and contract enforcement indices - Hiring index (scored 0–100): 3 3 2 2 3 3 4 8 6 0 3 3 7 4 3 3 - Conditions of employment index (scored 0–100): 2 5 5 6 6 8 5 7 1 6 5 2 6 5 2 2 3 - Firing index (scored 0–100): 2 4 2 1 9 3 8 1 8 4 3 9 4 3 1 1 - Duration to resolve a dispute (days): 4 40 10 6 27 0 36 5 2 10 27 0 36 5 2 25 50 - Procedural complexity index (0–100): 3/5 95 05 1 54 48 47 56 54 - Notes: - Scale and sub-index definitions are as provided: creditor rights scale 0 to 4; hiring/conditions/firing scored between 0 and 100; procedural complexity constructed by averaging six sub-indices and varies between 0 and 100. ### Governance and regulatory reform progress - Over the past 18 months, substantial progress on legislative reforms; implementation remains challenging. - Multisector regulatory bill enacted; three regulatory bodies set up (utilities, transport, communications); another planned for nonbank financial services. - Staffing constraints due to lack of skilled personnel; authorities expanding training institutes in public-private partnerships. ### Public corporations, utilities, and infrastructure plans - Two-pronged strategy: divest/close some enterprises; restructure others to improve efficiency. - State petroleum company (CPC): financial position improved; negotiations to allow a third party in retail sector scheduled for completion in early 2004. - CEB (electricity board) restructuring: delayed; unbundling (to create a wholesale electricity market) slated for completion in 2004. - Authorities plan to commission three large generation plants over the next 10 years; locations not yet determined. Staff stressed early decision to avoid power shortages experienced two years ago. - Government intends to divest a further stake in SLT during 2004; continued sales of shares in various hotels planned. ### Banking sector performance, nonperforming loans, and prudential measures - Poor lending practices and inefficiencies have kept interest rate spreads high and restrained private-sector credit growth. - Two state banks (People’s Bank and Bank of Ceylon) account for almost half of total deposits and exhibit high interest margins due to large legacy NPLs and high operating costs. - Market behavior: foreign and private domestic banks have followed spreads of market leaders. - Public sector borrowing declined significantly over the past 18 months, freeing substantial liquidity. - CBSL measures implemented: stepped up supervision, raised capital requirements, implemented prudential norms, raised provisioning requirements, imposed “hair cuts” on collateral valuation. - Bank behavior: cautious lending—limiting corporate loans to blue-chip clients, guarded expansion into highly collateralized consumer lending, holding excess liquidity with the CBSL. - Recent developments expected to change dynamics: banks introducing risk management systems and new products; decline in public borrowing expected to induce more aggressive competition and consolidation. - Planned legal and regulatory changes: new AMC law to help restructure bank balance sheets; amendments to the Banking Act and envisaged new banking laws to be introduced by end–2004 to facilitate orderly consolidation. - Supreme Court ruling: a provision of the 1990 Debt Recovery Act (quasi-judicial power for banks to seize assets) judged unconstitutional; authorities exploring options, including legislative means, to prevent undermining debt recovery. ### Financial Soundness Indicators (selected aggregates and trends) - Nonperforming loans (in percent of total loans) — system: 16.6 15.0 17.0 15.7 16.7 17.3 16.4 - State-owned commercial banks: 18.5 15.4 18.2 17.8 19.4 20.7 19.3 - Domestic private banks: 15.9 14.9 15.7 15.0 15.4 15.5 14.9 - Foreign banks: 10.7 12.7 13.2 8.7 7.8 10.3 10.2 - Net nonperforming loans (net of provisions; in percent of total loans): 10.7 10.2 10.1 8.5 9.1 9.9 8.9 - State-owned commercial banks: 9.8 8.8 8.3 8.3 6.3 7.4 8.4 6.5 - Domestic private banks: 13.6 13.5 13.3 11.5 11.7 12.1 11.5 - Foreign banks: 5.3 7.8 6.3 4.1 3.4 5.3 5.4 - Capital adequacy ratio (total capital over risk-weighted assets): 10.6 8.3 7.8 8.1 7.5 7.4 7.9 - State-owned commercial banks: 8.8 4.3 0.1 1.7 1.2 0.9 1.1 - Domestic private banks: 12.2 11.4 10.4 10.8 11.6 11.4 12.2 - Foreign banks: 12.5 12.5 16.0 21.7 18.6 16.7 16.2 - After-tax return on average equity: -10.1 13.1 15.5 22.0 23.8 ... - Overall NPL ratio rose from 15¾ percent in December 2002 to 16½ percent in September 2003, primarily reflecting a tightening of loan classifications. - Stress-test update: banks’ balance sheets sensitive to credit quality, not to interest rate changes; data lacking for exchange rate sensitivity, but existing limits on net open positions contain these risks. ### Bank restructuring and capital markets - Restructuring of state-owned banks underway: - External evaluation of net worth of insolvent People’s Bank expected to be completed by April to launch divestment by June; process expected to be completed by end-October. - NPLs of People’s Bank are about ½ percent of GDP, net of provisions, half of which would be eligible for transfer to the future AMC. - Bank of Ceylon (solvent) met most 2002 restructuring targets (loan recovery, return on assets); branches and staffing need rationalization. - Domestic capital markets remain shallow: - Market capitalization of listed companies is about 15 percent of GDP. - Government issued its first 20-year bond in October to help establish a benchmark yield curve. - Employee Provident Fund (EPF) assets (almost all in Sri Lankan Treasury securities) are around 18 percent of GDP. - Staff advice: broaden EPF’s reference portfolio, consider selectively easing restrictions on investing abroad, and outsource management; authorities working with an investment advisor on a reform strategy to start implementation by late 2004. ### Labor, civil service, and social protection reforms - Labor law amendments standardized mandatory redundancy payments for private sector employees; proposed compensation formula provides 15-30 months of salary based on past service and years remaining until retirement. - Proposed unemployment benefit scheme (largely employer-funded) would provide up to nine months of salary. - Staff concern: generosity of proposed schemes could undermine competitiveness; authorities note compensation package is lower than under the previous system. - Government indicated possibility of raising the limit on redundancy benefit to 50 months under union pressure. - Civil service reform program in 2004 budget: - Three-year program to award a 25 percent increase in the wage structure phased in over 2004-2006, conditional on a 30 percent reduction in employment. - 2004 aim: cut employment by 10 percent through a targeted retirement scheme requiring ⅓ percent of GDP in additional restructuring costs. - Despite wage increases, wage and pension bill expected to remain constant in terms of GDP. - Wages in subsequent years to be raised if prior year’s employment reduction target is met. - Mission and World Bank concern that the scheme could become too costly and risk loss of required skills if not specifically targeted. - Official directive on scheme details (designed with World Bank) expected to be circulated by end-February. ### Trade policy and external balances - Initiatives to promote external trade: - Free-trade agreement with India has benefited both sides; negotiations underway with Egypt, Pakistan, and the United States. - Comprehensive economic treaty signed with India. - European Union reduced tariff for Sri Lankan exports by 5 percent. - Measures intended to cushion adverse impact on textile sector from removal of export quotas in 2005. - Staff analysis: smaller exporters (main quota users) likely to close or merge; larger firms likely to withstand impact. - Anti-dumping legislation being drafted; staff advised strengthening provisions restraining use of anti-dumping measures. - Authorities expect workers’ remittances and tourism to remain important sources of foreign exchange earnings. - Tariff and trade regime notes: - Three new tariff bands introduced in 2003 and elimination of tariff exemptions on more than 1600 commodities, bringing simple average overall tariff rate to 12 percent (compared with 11 percent in 2002). - 2004 budget revised tariff structure further, keeping average tariff rate broadly unchanged but widening dispersion in rates. - Most agricultural imports subject to specific tariffs, frequently adjusted in line with domestic supply. - Export licenses limited to a small number of environmentally sensitive items. ### Poverty, social indicators, and welfare reform - Key social indicators (selected historic series and levels preserved as provided): - Total population, midyear (in millions): 14.6 15.5 16.4 17.5 18.7 2,506 - Population growth rate (in percent annual average for period): 1.3 0.99 1.1 1.2 1.3 1.9 - Urban population (in percent of population): 21.6 21.4 21.4 22.0 23.1 30.8 - Net primary school enrollment rate (in percent of age group) — Total: 103 103 107 109 ... - Life expectancy at birth (years) — Total: 68 69 70 71 73 59 - Physicians (per 1,000 people): 0.14 0.18 ... 0.23 0.37 ... - Source: 2002 World Development Indicators, World Bank. - Poverty dynamics and policy orientation: - Poverty is mainly rural or conflict related; preliminary 2002 household survey indicates income poverty may have declined in the late 1990s but remains concentrated in rural and conflict-affected areas. - Main causes: two-decade conflict, inadequate growth in agriculture, lack of opportunity and isolation of the poor. - PRSP (“Regaining Sri Lanka”) focuses on increasing growth and removing barriers preventing the poor in rural and conflict areas from benefiting from private-sector led development. - Measures include improving access to education, health, transport, telecommunications; reforming land tenure; liberalizing land-use policy; reducing high protection of agricultural goods. - A poverty and social impact analysis (PSIA) of PRSP reforms has been initiated with World Bank and DFID support. - Samurdhi welfare program reforms: - Program had covered more than 40 percent of households by mid-2001 but excluded many truly needy due to inefficiencies and politicization. - Reformed under the 2002 Welfare Benefits Act with clear eligibility and termination criteria; means-tested formula designed; pilot project underway. - Samurdhi transfers tightly controlled in 2003 and budgeted to remain so; need to expand program in conflict-affected North and East. - Authorities designing ways to expand coverage in North and East within the Welfare Benefits Act framework. *Source: Chapter I of the selected issues paper (IMF Country Report PDF).* ### 39. With the current political uncertainty constraining the government’s ability to advance ### _cr0468 - 39. With the current political uncertainty constraining the government’s ability to advance ### Program reviews and structural reform implementation - Completion of the first reviews of the PRGF and Extended Arrangements, originally scheduled for August 2003, will take more time due to political uncertainty. - Except for the end-December performance criterion on net domestic financing, all quantitative performance criteria for June and December under the program are estimated to have been met. - End-December indicative targets likely missed: revenue, the primary balance, banks’ net claims on government, and credit to public corporations. - Structural progress: some progress made, albeit with delays. - Specific delayed structural measures: - Revenue Authority bill (June 2003 performance criterion) cannot be presented to Parliament before the elections; review completion postponed until the bill can be presented. - Restructuring of People’s Bank delayed due to prolonged negotiations to appoint an external advisor. ### Near-term fiscal and monetary policy guidance - Fiscal and monetary policies over the next few months need to be very prudent to safeguard macroeconomic stability under uncertain political circumstances. - A financial program has been set and will be used to measure performance for the first review. - Both fiscal and monetary policies may need to be tightened further during the first half of the year if inflationary pressures rise or investor confidence slackens. - Key structural measures to implement to ensure PRSP objectives: measures related to the Revenue Authority and People’s Bank. - Government’s second-half plans: table new Banking and Central Bank bills to Parliament, initiate reforms to the EPF, advance divestment program (notably SLT and the Hilton Colombo). - Preparations to update the PRSP are underway; a progress report is expected later this year. ### Statistical reporting, AML, and safeguards - Statistical systems: - Sri Lanka’s statistical information is adequate for surveillance and program monitoring, but reporting weaknesses remain. - Migration plan for reporting fiscal data using the GFSM 2001 methodology is underway with IMF technical assistance. - Compilation of monetary statistics is being improved. - Staff advised compiling quarterly GDP data from the expenditure side and retail sales data to aid surveillance and policymaking. - Sri Lanka participates in the GDDS; full compliance with the SDDS is expected by mid–2004. - An update of the fiscal ROSC is planned for this year. - Anti-money laundering: - Anti-money laundering legislation is being drafted and is planned for parliamentary presentation by mid–2004; staff has provided technical assistance on drafting. - Safeguards: - CBSL has made progress implementing recommendations of the 2001 Safeguards Assessment; full Safeguards Assessment in June 2003 (Annex III) noted progress and authorities committed to implement staff recommendations. ### Staff appraisal — macroeconomic outlook, risks, and policy recommendations - Recent performance and risks: - Economic recovery has taken root and external vulnerability has declined. - Gains leveraged from the ceasefire and supportive international community; foreign investor interest revived. - Significant challenges remain: unsettled political situation, unfinished reform agenda, stalled peace talks. - Recovery should strengthen in 2004 provided political uncertainty is resolved early and peace talks resume; risks are substantial. - Upside: faster global recovery could boost external demand. - Downside: extended delay in resolving political impasse and resuming peace talks could depress growth. - Medium-term growth pickup depends on deepening reforms and securing lasting peace. - Tax policy and administration: - Staff supports tax policy measures in the 2004 budget, particularly unification of VAT rates and reduction in VAT and import duty exemptions. - Regret that government reversed some proposed reductions in exemptions, adding to revenue pressures. - Full benefits of tax policy measures depend on fundamental reforms in tax administration (leadership, staffing, incentives). - Establishment of the Revenue Authority delayed due to political uncertainty; weak tax administration is a critical bottleneck—tax revenue “fell last year to its lowest level (in percent of GDP) in over a decade” and needs urgent address. - Government should be ready to take corrective revenue and expenditure measures if tax collection falls below levels required to meet budget targets. - Authorities commended for expenditure control over the last two years; tight control over spending, particularly ahead of the April elections, continues to be needed. - Monetary policy: - Staff commends CBSL for supporting recovery while restraining inflation. - If the current drought continues, inflationary pressures could emerge; if political uncertainty deepens and fiscal pressures rise, pressures could intensify. - CBSL should be ready to tighten monetary policy if needed. - Staff supports continuation of the flexible exchange rate regime. - Monetary transmission could be made more effective by addressing banking sector weaknesses. - Medium-term fiscal sustainability and public sector role: - Key medium-term challenge: restore fiscal sustainability while providing resources for priority spending and post-conflict needs. - Recent revenue shortfalls imply stronger fiscal consolidation than currently envisaged is needed to achieve debt reduction targets set in Regaining Sri Lanka and the FMRA. - Tax regime needs streamlining: broaden the base, simplify, and make more equitable, including further reductions in income tax exemptions and incentives. - Proposed early retirement scheme for civil servants could improve governance and service delivery if properly designed; care needed to avoid excessive cost and undue compression of the wage structure. - Shift public sector role from “player” to “referee”: accelerate unbundling of the state electricity board and identify locations for proposed large generation plants early. - Investment climate improvements require building well-functioning regulatory agencies in line with the multi-sector regulatory bill. - Labor and financial sector reforms: - Staff welcomes labor law amendments to increase labor market flexibility; cautions against changes to mandatory compensation formula that reintroduce discretionary retrenchment packages or increase upper limits that could hurt employment. - Financial sector reforms should improve efficiency; restructuring of state-owned banks, particularly People’s Bank, is critically important and further delay should be avoided. - Staff supports CBSL initiatives to tighten prudential norms and enhance supervision; new banking and monetary acts and forthcoming AMC law expected to strengthen CBSL powers and facilitate mobility and consolidation. - Deepening nonbank financial markets: liberalizing the EPF’s reference portfolio and outsourcing its management would help boost demand for corporate bonds and equities. - Social and poverty-reduction policies: - Staff supports government’s approach in the PRSP to reduce poverty by removing barriers that exclude the poor from private-sector led growth. - Steps needed: increase access of the poor to basic services and markets, liberalize land policy, and speed up reforms to the social welfare program to ensure a well-targeted safety net. - Statistical data gaps reiterated: - Staff welcomes plans to implement GFSM 2001 and to comply fully with SDDS in 2004. - Compilation of quarterly GDP data from the expenditure side and of retail sales data remains pending. - Overall conclusion: - Sri Lanka has great potential for rapid growth and poverty reduction; a political environment conducive to steadfast reform implementation and progress on peace is needed. - Staff regrets that completion of the first reviews under the PRGF and Extended Arrangements will take more time. - Government needs to continue advancing the reform agenda and ensure macroeconomic policies safeguard improvements and investor confidence. - Staff hopes policies and sufficient progress (including enactment of tax measures proposed in the 2004 budget, presentation of the Revenue Authority bill to Parliament, and advances in restructuring People’s Bank) will allow early completion of the first reviews of the PRGF and Extended Arrangements. *Source: IMF staff report excerpt.* ### 56. Staff recommends that the next Article IV consultation be held on a 24-month cycle, ### _cr0468 - 56. Staff recommends that the next Article IV consultation be held on a 24-month cycle, ### Staff recommendation - Staff recommends that the next Article IV consultation be held on a 24-month cycle, subject to the provisions on consultation cycles approved on July 15, 2002. ### Real and external sector developments - GDP growth (percent change from a year ago): shown series for 1999–2003; specific annual datapoints presented in Table 1: - Real GDP growth: -1.5 (2001), 3.9 (2002), 5.5 (2003), 6.0 (2004 proj.) - Inflation (Colombo CPI; period average): - 14.2 (2001), 9.6 (2002), 6.3 (2003), 6.0 (2004 proj.) - Contributions to real GDP growth (change in percent of previous year's GDP): Agriculture, Industry, Services shown in figure (services have contributed most to the recovery; industrial production is also picking up). - Trade and reserves: - Trade balance (in millions of U.S. dollars; Table 1): -1,157 (2001), -1,406 (2002), -1,446 (2003), -1,781 (2004 proj.) - Exports of goods / Imports of goods: time series shown; three-month moving sums used in charts. - Net foreign exchange purchases (year-to-date accumulation; in millions of U.S. dollars): series for 1999–2003 shown. - Gross official reserves (net of ACU balances; in billions of U.S. dollars; Table 1): 1,180 (end-2001), 1,595 (end-2002), 2,084 (end-2003), 2,385 (end-2004 proj.) - Gross reserves (in percent of short-term debt): series depicted; reserves rising steadily and external vulnerability subsiding. ### Monetary and financial developments - Reserve money and broad money (Twelve-month percent change; Figure 2 / Table 3): - Reserve money (annual percent change): 12.3, 12.7, 10.1, 10.6, 11.9, 14.5, 17.2, 16.1, 15.4 (series across periods shown) - Broad money (twelve-month percent change): 13.6, 13.4, 15.3, 13.5 (Table 1 / Table 5 series) - Contributions to reserve money growth: net foreign assets improvement offset by slowing net domestic assets (figure). - Interest rates: - 91-day T-bill rate (percent, end of period; Table 1): 12.9 (2001), 9.9 (2002), 7.4 (2003) - Repo rate and prime lending rate series shown; interest rates have fallen reflecting ample liquidity. - Banking and credit: - Private sector credit (percent change, end of period; Table 1): 6.7 (2001), 8.7 (2002), 12.1 (2003), 11.4 (2004 proj.) - Excess reserves (in percent; 3-month moving average) and private credit enabling growth (Figure 2). - Exchange rate and stock market: - Rupee/US$ (end of period; Table 1): 93.3 (2001), 96.7 (2002), 96.7 (2003) - REER and NEER series shown; mild rupee appreciation reversed in 2003; Colombo stock exchange index series shown (January 2000=100). ### Key macroeconomic indicators and projections (Table 1; Table 5 summary) - Nominal GDP (2002): US$16.5 billion (Table header) - Population (2002): 19 million - GDP per capita (2002): US$868 - Quota: SDR 413 million - Selected indicators (in percent of GDP unless noted): - National savings: 20.3 (2001), 19.6 (2002), 21.9 (2003), 22.0 (2004 proj.) - Gross investment: 22.0 (2001), 21.3 (2002), 22.8 (2003), 24.2 (2004 proj.) - Revenue: 16.6 (2001), 16.5 (2002), 15.4 (2003), 15.8 (2004 proj.) - Expenditure: 27.5 (2001), 25.4 (2002), 23.6 (2003), 23.0 (2004 proj.) - Primary balance: -4.1 (2001), -1.6 (2002), -1.2 (2003), -1.3 (2004 proj.) - Overall balance: -10.8 (2001), -8.9 (2002), -8.1 (2003), -7.2 (2004 proj.) - Government debt (domestic and external): 103.2 (2001), 105.5 (2002), 100.9 (2003), 95.4 (2004 proj.) - Money and credit (percent change, end of period; Table 1): - Reserve money: 7.0 (2001), 12.3 (2002), 11.9 (2003), 15.4 (2004 proj.) - Broad money: 13.6 (2001), 13.4 (2002), 15.3 (2003), 13.5 (2004 proj.) - Domestic credit (percent contribution to M2 growth): 18.4 (2001), 7.5 (2002), 8.3 (2003), 8.5 (2004 proj.) - External sector and balance-of-payments (Table 4 / Table 5): - Current account balance (in millions of U.S. dollars): -243 (2001), -272 (2002), -179 (2003), -459 (2004 proj.) - Current account balance (in percent of GDP): -1.5 (2001), -1.6 (2002), -1.0 (2003), -2.2 (2004 proj.) - Gross official reserves (in millions of U.S. dollars; net of ACU balances): 1,180 (2001), 1,595 (2002), 2,084 (2003), 2,385 (2004 proj.) - Gross reserves in months of imports: 2.0 (2001), 2.4 (2002), 2.9 (2003), 3.1 (2004 proj.) - External debt (public and private): 9.7 (2001, in billions of U.S. dollars), 9.9 (2002), 10.2 (2003), 11.6 (2004 proj.) - External debt as percent of GDP: 61.8 (2001), 59.9 (2002), 55.2 (2003), 52.1 (2004 proj.) ### Fiscal accounts (Table 2a and 2b) - Central government summary (in percent of GDP; Table 2a): - Total revenue: 16.6 (2001), 16.5 (2002), 15.4 (2003 est.), 15.8 (2004 proj.) - Tax revenue: 14.6 (2001), 14.0 (2002), 14.7 (2003 est.), 13.8 (2004 proj.) - Value added tax/GST: 3.3 (2001), 4.2 (2002), 6.7 (2003 budget), 6.0 (2004 proj.) - Interest payments: 6.7 (2001), 7.4 (2002), 7.2 (2003 est.), 6.0 (2004 proj.) - Capital expenditure and net lending: 5.9 (2001), 4.6 (2002), 5.2 (2003 est.), 5.2 (2004 proj.) - Overall balance: -10.8 (2001), -8.9 (2002), -7.5 (2003 budget), -8.1 (2003 est.), -7.2 (2004 proj.) - Financing: 10.8 (2001), 8.9 (2002), 7.5 (2003 budget), 8.1 (2003 est.), 6.8 (2004 proj.) - Net external financing: 1.0 (2001), 0.1 (2002), 2.0 (2003 budget), 2.4 (2003 est.), 2.5 (2004 proj.) - Net domestic financing: 8.8 (2001), 8.0 (2002), 4.1 (2003 budget), 4.7 (2003 est.), 3.2 (2004 proj.) - Central government summary (in billions of rupees; Table 2b) shows detailed revenue and expenditure components and financing flows for 2001–2004. ### Monetary program (Table 3) - Monetary authorities (in billions of rupees; selected items): - Net foreign assets (Monetary authorities): 117 (Dec. 2002), 124 (Mar. 2003), 138 (Jun. 2003), 162 (Sep. 2003), 165 (Dec. 2003) - Net domestic assets (Monetary authorities): 98 (Dec. 2002), -7 (Mar. 2003), -27 (Jun. 2003), -23 (Sep. 2003), -12 (Dec. 2003) - Reserve money (levels): 126 (Dec. 2002), 132 (Mar. 2003), 131 (Jun. 2003), 135 (Sep. 2003), 141 (Dec. 2003) - Monetary survey and broad money (in billions of rupees and percent changes) with projections for 2004 at program exchange rate of 98 Rs / U.S. dollar. - Broad money multiplier and velocity: Broad money multiplier around 4.9–5.0 across periods; velocity of broad money reported as 2.7 in memorandum items. ### Balance of payments and medium-term projections (Table 4; Table 5) - Balance of payments (in millions of U.S. dollars): - Current account: -243 (2001), -272 (2002), -179 (2003), -459 (2004 proj.), and projections through 2008: -618 (2005), -776 (2006), -790 (2007), -832 (2008). - Trade balance: -1,157 (2001), -1,406 (2002), -1,446 (2003), -1,781 (2004 proj.), and projections through 2008 provided. - Exports and imports series with projected increases through 2008 (e.g., exports: 4,817 (2001), 4,699 (2002), 5,139 (2003), 5,582 (2004 proj.); imports: 5,974 (2001), 6,105 (2002), 6,585 (2003), 7,363 (2004 proj.)) - Services receipts and payments, income receipts and payments, and transfers are shown with level series and projections. - Macroeconomic framework (Table 5 projections, in percent of GDP unless noted): - Real GDP (percent change): -1.5 (2001), 3.9 (2002), 5.5 (2003), 6.0 (2004 proj.), and medium-term projections 6.3 (2005), 6.5 (2006), 7.0 (2007), 7.0 (2008). - Average inflation (CCPI; percent change): 14.2 (2001), 9.6 (2002), 6.3 (2003), 6.0 (2004 proj.), and declining to 4.0 (2008 proj.) - Overall balance (central government): -10.8 (2001), -8.9 (2002), -8.1 (2003), -7.2 (2004 proj.), trending to -3.9 (2008 proj.) - Gross official reserves less ACU balance (in billions of U.S. dollars): 1.2 (2001), 1.6 (2002), 2.1 (2003), 2.4 (2004 proj.), 2.8 (2005 proj.), 3.1 (2006 proj.), 3.0 (2007 proj.), 3.1 (2008 proj.) ### Vulnerability indicators and financial sector - Banking sector indicators (Table 6; selected): - Nonperforming loans (as percent of total loans): - State-owned commercial banks: 18.5 (1999), 15.4 (2000), 18.2 (2001), 17.8 (2002), 19.3 (latest) - Domestic private banks: 15.9 (1999), 14.9 (2000), 14.9 (2001), 15.0 (2002), 14.9 (latest) - Foreign banks: 10.7 (1999), 12.7 (2000), 13.2 (2001), 8.7 (2002), 10.2 (latest) - Risk-based capital asset ratio (total capital over risk-weighted assets; weighted averages): - State-owned commercial banks: 8.8 (1999), 4.3 (2000), 0.1 (2001), 1.7 (2002), 1.1 (latest) - Domestic private banks: 12.2 (1999), 11.4 (2000), 10.4 (2001), 10.8 (2002), 12.2 (latest) - Foreign banks: 12.5 (1999), 12.5 (2000), 16.0 (2001), 21.7 (2002), 16.2 (latest) - External vulnerability metrics: - Gross official reserves (millions of US$; excl. ACU balance): 1,530 (1999), 911 (2000), 1,180 (2001), 1,595 (2002), 2,084 (2003) - Reserves as percent of broad money: 25.8 (1999), 15.6 (2000), 20.0 (2001), 26.5 (2002), 30.0 (2003) - As percent of short-term debt: 92.4 (1999), 45.7 (2000), 55.2 (2001), 76.4 (2002), (2003 value shown in series) ### Performance criteria and indicative targets (Table 7) - Performance criteria and indicative target series for June–December 2003 and projections for 2004 include: - Ceiling on change in net domestic financing of central government deficit (cumulative from January 1, 2003): shown values 52, 48, 61, 59, 73, 83 (test dates and updates). - Ceiling on net domestic assets of the CBSL (series with negative and positive values across test dates). - Floor on net international reserves of CBSL (in millions of U.S. dollars): 1,317; 1,452; 1,449; 1,736; 1,435; 1,650; 1,660; 1,663; 1,824; 1,895 (series across test dates and projections). - Ceilings on contracting or guaranteeing of new nonconcessional medium- and long-term external debt by the public sector (cumulative): 510, 352, 510, 466, 510, 466 (selected). - Ceiling on the stock of short-term external debt (in millions of U.S. dollars; cumulative from Jan. 1, 2003): 25, 0, 50, 0, 50, 0 (series); cumulative from Jan. 1, 2004: 50, 50, 50, 50. - Accumulation of external payments arrears: 0 across reported test dates. - Indicative targets: floor on central government revenue (cumulative from Jan. 1, 2003): 145, 137, 222, 203, 304, 275; cumulative from Jan. 1, 2004: 71, 148, 234, 320. - Ceiling on banks' net claims on government and credit to public corporations by the banking system: series in billions of rupees with test-date values (e.g., Ceiling on banks' net claims on government: 192, 181, 176, 169, 175, 177, 177, 175, 166, 157). - Ceiling on reserve money of the CBSL (in billions of rupees): 135, 131, 138, 135, 143, 141, 151, 153, 156, 163. *Source: Data provided by the Sri Lankan authorities; IMF staff estimates, projections, and figures as presented in the source document.* ### 1. Budget ### 1. Budget ### VAT and Tax Incentives: Measures and Status - Extension of the VAT to the wholesale and retail sectors - Classification: Structural Benchmark - Target date: January 31, 2004 - Status: Not met. Expected by July 2004. - Rationalization/Streamlining of tax incentives - Classification: Structural Benchmark - Target date: January 31, 2004 - Status: Modest progress made. - Reduce import surcharge to 10 percent from 20 percent - Classification: Structural Benchmark - Target date: January 31, 2004 - Status: Met on time (January 2004). ### Tax Administration and Tax Policy Reform - Presentation to Parliament of a new Revenue Authority act and preparation of detailed implementation plan - Classification: Performance Criterion - Target date: June 30, 2003 - Status: Not met. Expected by mid-May 2004. ### Financial Sector Reform (Nonfiscal Measures) - Presentation to Parliament of the Asset Management Company (AMC) law - Classification: Structural Benchmark - Target date: June 30, 2003 - Status: Not met. Pending resumption of Parliament. - Presentation to Parliament of the amended Banking laws and the new Exchange Management Act - Classification: Structural Benchmark - Target date: June 30, 2003 - Status: Met with delay (November 2003). - External evaluation of assets and liabilities of People's Bank - Classification: Structural Benchmark - Target date: September 15, 2003 - Status: Not met. Expected by end-March 2004. - Complete the restructuring of People's Bank - Classification: Structural Benchmark - Target date: March 31, 2004 - Status: Likely to be delayed until end-October 2004. ### Public Enterprise Reform - Complete the sale of 8.5 percent of the government shares in Sri Lanka Telecom (SLT) - Classification: Structural Benchmark - Target date: December 31, 2003 - Status: Not met. Expected by end-December and bring to a point of sale the shares held by the government in Hilton Colombo end-September 2004, respectively. ### Labor Market Reform - Implementation of the binding redundancy compensation formula - Classification: Structural Benchmark - Target date: April 30, 2003 - Status: Met with delay (January 2004). ### Notes and Clarifications from Source Footnotes - Structural benchmark was to be given more specificity in the context of the first review. - In late 2003, the government announced that the extension of certain tax holidays beyond their expiration date will be curtailed beyond 2004, and that all registered companies, including those registered with the BOI, will be required to file tax returns from 2004 onwards. ### Implementation of Major Policy Initiatives (2001–04): Key Findings - Deficit reduction and fiscal responsibility: - Central government fiscal deficit is estimated to have been 8 percent of GDP in 2003, down from 8.9 percent of GDP in 2002 and 11 percent of GDP in 2001. - A Fiscal Management (Responsibility) Act (FMRA) was enacted in December 2002, which: - sets strict limits on borrowing from the Central Bank (CBSL), - proposes a medium-term deficit path consistent with reducing the debt stock to 85 percent of GDP by end-2006, - mandates “pre-election budget reports” to discourage pre-election handouts, - required a mid-term review of the budget, which was presented to parliament on June 30. - Tax reform: - NSL was merged into GST with a dual rate VAT (20 percent and 10 percent) in the 2002 Budget. VAT was extended to the financial sector at the 10 percent rate. A unified rate of 15 percent is expected to be introduced by March 2004. - Extension of VAT to the retail sector: No progress. Although announced in the 2003 budget, actual extension has been delayed until July 2004. Discussions have been held with provincial councils on revenue sharing. - Exemptions and incentives: - Some progress: Additional exemptions were created with the introduction of the VAT. Some VAT exemptions were lifted in the 2003 Budget and further exemptions will be removed in 2004. - Some progress on rationalizing incentives: In December 2002, Parliament adopted a new Board of Investment (BOI) law, eliminating BOI’s power to grant tax holidays and incentives outside the regular tax code. However, this law still needs to be enacted. - Civil servants’ income taxation: Limited progress. Under the amended Inland Revenue Act, effective April 2003, civil service emoluments count toward statutory income thresholds for tax purposes. - Fiscal policy and tax administration: - Large Taxpayer Unit (LTU): Significant progress. The LTU was restructured in 2002; administrative functions consolidated under a single commissioner responsible for administering all types of taxes owed by large taxpayers. - Unified Revenue Authority: Some progress. The Revenue Authority bill has been presented to Cabinet, but presentation to Parliament has been delayed (now expected in May 2004). The RA will encompass the departments of Inland Revenue, Customs, Excise and the tax and customs components of the BOI. The selection process for its management is underway. - Expenditure reform: - Better debt management and interest bill containment: Significant progress. Measures to reorganize the debt portfolio, improved instrument mix, and reduced the stock of outstanding expensive overdraft at the 2 state banks. Decision to create a new debt office; the World Bank and the U.S. Treasury are giving TA. - Containing defense spending: Significant progress—helped by the current ceasefire. A Defense Spending Monitoring Committee was established in 2002 to ensure no deviation from the budget in spending or incurring commitments. - Civil service hiring freeze: Significant progress. Hiring freeze in place since the 2002 budget and salary increases have been deferred. - Samurdhi Welfare Benefits scheme: Significant progress. The number of beneficiaries reduced from [text truncated in source]. *Source: _cr0468 - 1. Budget* ### 1.9 million to 1.5 million. The Welfare Benefits Law that was enacted in September 2002—which sets clear and transparent ### _cr0468 - 1.9 million to 1.5 million. The Welfare Benefits Law that was enacted in September 2002—which sets clear and transparent ### Exchange Rate and Monetary Policies - Policy recommendations and actions: - Adopt a flexible exchange rate arrangement. - Enhance the transparency and credibility of the reserve money program. - Enhance greater monetary policy instrument independence for the CBSL. - Implementation and outcomes: - Significant progress: "The rupee was floated on January 23, 2001." - Significant progress: Reserve money (RM) is the nominal anchor; the RM program was put in place at the beginning of the SBA and the CBSL introduced active open market operations in March 2003 to strengthen liquidity management, enhance greater control over RM and reduce volatility of short-term rates. - The CBSL has published on its website the basic monetary policy framework, including objectives, targets and instruments; regularly updates the public on the assessment of the RM program (actuals versus targets) and releases monthly review of monetary policy issues and decisions. - Significant progress: The CBSL’s monetary law act (MLA) was amended in December 2002, giving powers to the CBSL’s Monetary Board to change (by removing statutory limits) and remunerate statutory reserve requirements (SRRs), if necessary. ### Public Expenditure Management and Welfare - Institutional and policy measures: - Welfare Benefits Law enacted in September 2002: sets clear and transparent eligibility criteria, provides guidelines for the termination of the benefits, and penalties to reduce politicization and mistargeting. - World Bank assisting government in establishing the MTEF as part of the public expenditure review (PER). - Progress status: - Little progress on medium-term budget framework (MTEF) establishment; delayed, and to be part of the 2005 Budget. ### Financial Sector Reform — Banking Sector - Policy proposals: - Restructure the two state-owned banks. - Improve mechanism to resolve NPLs. - Improve capital base of banks. - Bring loan classification and provisioning norms more in line with international best practices. - Modernize the banking act and introduce greater competition in the banking system. - Assessment and actions taken: - Some progress: Strategy for restructuring of People’s Bank set out; investment consultant appointed for net worth assessment; key policy actions pending. - Some progress: Bank of Ceylon (BOC) implementing restructuring plan; BOC formulated a VRS to reduce staff costs. - Some progress: An Asset Management Company (AMC) bill finalized and expected to be sent to Parliament by end February; bill aims to facilitate bank restructuring, take over large NPLs and recover bad loans through enhanced powers of collection and enforcement. - Some progress: Minimum CAR raised to 10 percent for all domestic banking units from January 2003 and on a consolidated basis for all domestic and foreign currency banking units effective end-December 2003. - Some progress: CBSL started to enforce regulations and tightened provisioning by discounting collateral value. - Significant progress: Amendments to the Banking Act to enhance CBSL supervision capacity and facilitate entry/exit tabled in Parliament in November 2003; work started on new banking and Central Bank laws. ### Structural Reform — Public Enterprise Reform and Divestment - Policy objectives: - Enhance cost recovery by key public corporations to stem quasi-fiscal losses. - Bolster private sector participation in key public corporations. - Speed up general privatization program. - Actions and outcomes: - Significant progress: Automatic petroleum pricing formula linked to international oil prices established in January 2002; electricity tariffs increased by 35 percent in April 2002. - Significant progress: Large portion of CPC’s distribution and retail functions sold to Indian Oil Company (IOC); preliminary bids for an additional 1/3 of outlets; after parliamentary passage of electricity reform bill, Ceylon Electricity Board being unbundled into six small CEBs to be run by private sector management. - Significant progress: Pelwatte sugar company, Lanka Marine and 12½ percent of Sri Lanka Telecom shares sold in 2002; Sri Lanka Insurance Corporation (SLIC) sold in April 2003; Government disposed of its holding in NDB in July 2003. ### Trade Liberalization - Measures proposed: - Eliminate the import surcharge. - Rationalize tariff structure to a simplified three-band regime. - Progress: - Some progress: Surcharge reduced from 40 percent to 20 percent in the 2002 budget, and reduced further to 10 percent in January 2004; government committed to eliminating it by January 2005. - Some progress: One band eliminated in January 2004, leaving five bands in place; tariff rates were increased at the same time. ### Capital Account Liberalization - Measures proposed: - Ease restrictions on inward foreign direct investment. - Ease restrictions on other private capital flows. - Progress: - Significant progress: Restrictions on inward FDI significantly liberalized, including in the financial sector; limit on foreign ownership of domestically incorporated commercial banks raised to 60 percent in 2002. - Significant progress: Foreign Exchange Management bill tabled in Parliament in November 2003; bill relaxes restrictions on some longer term capital account transactions such as foreign borrowing by the private sector of over five years’ maturity and allows foreigners to invest in government securities, while retaining controls over other short term capital movements. ### Labor Markets - Measure proposed: - Amend the Industrial Disputes Act. - Progress: - Some progress: An amended Industrial Disputes Act with a time-bound rule for settling labor disputes and a new redundancy compensatory formula were enacted in January 2003; bills gazetted in May, implementation delayed to January 2004; preliminary parameters for compensation formula prepared. ### Safeguards for CBSL - Objectives: - Strengthen external audit mechanism, financial reporting framework and internal controls systems of the CBSL. - Progress: - Excellent progress: CBSL implemented almost all recommendations in the 2001 safeguards assessment and initiated recommendations in the 2003 assessment. - Actions: Appointed an external audit firm (Ernst & Young, NZ); appointed an audit committee; Monetary Board adopted resolutions on accounting and auditing; CBSL now prepares accounts on a full IAS basis and strengthened internal controls and internal audit function. ### Debt Sustainability — Central Government (Baseline and Key Projections) - Baseline conclusion: - "The updated baseline scenario continues to show a steady decline in central government debt, but at a slower pace than in the baseline scenario presented in March 2003." - By 2008, debt-to-GDP ratio falls to 77 percent. - Vulnerabilities: - Nearly 50 percent of the debt denominated in foreign currency; large external shocks can sharply raise debt ratios (example: a 30 percent nominal depreciation in 2004 raises central government debt-to-GDP ratio to nearly 120 percent and allows it to fall to only 98 percent by 2008). - Return to pre-SBA policies (1999-2000 averages sustained) is unsustainable: debt-to-GDP ratio would rise to over 110 percent of GDP by 2008. - Selected baseline projections (central government debt and related indicators; values are "in percent of GDP, unless otherwise indicated"): - Central government debt (2003–2008): 100.9, 95.4, 91.2, 86.5, 81.5, 76.8 - Of which: foreign-currency denominated: 46.8, 45.8, 44.6, 45.1, 45.3, 44.1 - Change in central government debt: -4.6, -5.4, -4.3, -4.7, -5.0, -4.7 - Primary deficit (including grants): 0.7, 0.8, -0.2, -0.5, -0.7, -0.6 - Revenue and grants: 15.9, 16.3, 17.3, 17.8, 17.9, 18.2 - Primary (noninterest) expenditure: 16.6, 17.1, 17.1, 17.2, 17.2, 17.6 - Automatic debt dynamics: -4.7, -5.3, -3.2, -3.3, -3.8, -3.7 - Contribution from interest rate/growth differential: -5.1, -6.0, -5.3, -4.7, -4.8, -4.5 - Contribution from exchange rate depreciation: 0.4, 0.6, 2.1, 1.4, 1.0, 0.8 - Privatization receipts (negative): -0.6, -0.8, -0.6, -0.6, -0.3, -0.3 - Residual, including asset changes: 0.0, -0.1, -0.3, -0.2, -0.2, -0.2 - Central government debt-to-revenue ratio: 633.5, 585.5, 526.7, 487.0, 455.2, 421.9 - Gross financing need: 31.7, 29.9, 24.5, 23.2, 20.7, 20.3 - Historical and projected macro-fiscal assumptions (selected): - Real GDP growth (in percent) historical average and projections: 4.6, 2.2, 5.5, 6.0, 6.3, 6.5, 7.0, 7.0 - Average nominal interest rate on public debt (in percent): 7.4, 7.3, 7.4, 6.7, 6.4, 6.0, 5.6, 5.2 - Inflation rate (GDP deflator, in percent): 9.1, 10.5, 7.0, 7.0, 6.0, 5.0, 4.5, 4.0 - Revenue to GDP ratio: 19.0, 17.1, 15.9, 16.3, 17.3, 17.8, 17.9, 18.2 ### Debt Sustainability — External Debt (Baseline and Stress Tests) - Baseline summary: - Under baseline, external debt-to-GDP ratio declines to 50 percent in 2008, compared with 60 percent in 2002. - Financing for reconstruction-related needs in the North and East expected to average 1.3 percent of GDP in 2004-2008, with about half to be met by grants. - Debt-stabilizing noninterest current account deficit estimated at 3½ percent of GDP. - NPV estimates for total external debt are below nominal values, reflecting a grant element of approximately 25 percent on public external debt. - Alternative scenarios and vulnerabilities: - Scenarios A1 and A3 (deceleration or reversal of reforms) lead to unsustainable debt dynamics: debt-to-GDP ratios under A1 and A3 would reach 64 percent and 83 percent, respectively, in 2008, compared with expected 55 percent in 2003. - Scenario A2 (low external demand shock with recovery in 2006): post-shock debt-to-GDP ratio would exceed baseline by 4 percentage points in 2008. - A one-time 30 percent nominal depreciation leads to immediate and persistent large increases in debt ratios (e.g., one test shows debt-to-GDP rising to 120.2 in 2004 under a 30 percent real depreciation scenario). - Selected baseline external projections (values "in percent of GDP, unless otherwise indicated"): - External debt (2003–2008): 55.2, 52.1, 52.8, 51.2, 49.9, 47.9 - Change in external debt: -4.3, -3.0, 0.7, -1.6, -1.3, -2.0 - Identified external debt-creating flows: -6.7, -5.2, -3.1, -2.5, -3.0, -3.3 - Current account deficit, excluding interest payments: -0.1, 1.2, 1.7, 2.2, 2.1, 1.7 - Exports: 35.1, 34.0, 32.7, 32.1, 31.8, 31.1 - Imports: 41.5, 41.2, 40.4, 40.0, 39.2, 38.0 - Net non-debt creating capital inflows: -1.4, -1.5, -1.6, -1.7, -1.7, -1.5 - Automatic debt dynamics: -5.2, -4.9, -3.2, -3.1, -3.5, -3.5 - Contribution from nominal interest rate: 1.0, 1.0, 1.0, 0.9, 0.9, 0.8 - Contribution from real GDP growth: -2.9, -3.0, -3.0, -3.2, -3.3, -3.2 - Contribution from price and exchange rate changes: -3.3, -3.0, -1.2, -0.8, -1.1, -1.1 - Residual, incl. change in gross foreign assets: 2.4, 2.2, 3.8, 1.0, 1.7, 1.4 - External debt-to-exports ratio (in percent): 156.9, 153.1, 161.2, 159.4, 157.1, 153.9 - Gross external financing need (in billions of US dollars): 2.2, 2.5, 2.6, 2.9, 3.0, 3.0 - Selected bound test examples (external debt-to-GDP, 2003 baseline = 55.2): - A1 (10-yr historical averages in 2004-08): 55.2, 57.2, 61.0, 61.7, 63.3, 64.4 - A2 (country-specific shock in 2004): 55.2, 56.4, 53.2, 52.3, 50.5, 48.9 - A3 (1999-2001 historical averages in 2004-08): 55.1, 61.6, 66.4, 71.1, 75.8, 83.1 - B5 (one-time 30 percent nominal depreciation in 2004): 55.2, 73.1, 73.8, 70.8, 68.1, 64.8 ### Fund Relations and Technical Assistance (selected points) - Membership and arrangements: - Joined 8/29/50; accepted Article VIII, Sections 2, 3, and 4, March 1994. - Stand-By arrangements outstanding: 200.0 (SDR Million) drawn 200.00 (Stand-By Apr 20, 2001 Sep 19, 2002). - EFF Apr 18, 2003–Apr 17, 2006: Amount Approved 144.40 (SDR Million), Amount Drawn 20.67. - PRGF Apr 18, 2003–Apr 17, 2006: Amount Approved 269.00 (SDR Million), Amount Drawn 38.39. - Exchange rate arrangement: - Independent float. "The central bank floated the rupee on January 23, 2001." - Safeguards assessment (CBSL): - Full safeguards assessment for PRGF completed July 30, 2003; risk ratings upgraded in four of five areas; priority recommendations include completing full implementation of International Accounting Standards, establishing external audit policy vis-à-vis auditor appointments, and continuing to publish audited financial statements and external audit opinion. - Technical assistance (1997–2003) and FSAP/ROSC participation: - Multiple missions from MFD, STA, FAD, LEG across monetary policy instruments, banking supervision, banking and central banking laws, AML/CFT, data ROSC, GFS, monetary and financial statistics, revenue authority design, public expenditure management, and public debt management. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 20.3 percent and relief and rehabilitation 6.8 percent. ### _cr0468 - 20.3 percent and relief and rehabilitation 6.8 percent. ### Lending by the Asian Development Bank, 1997–2003 (In millions of U.S. dollars) - Commitment: - 1997: 166 - 1998: 190 - 1999: 184 - 2000: 209 - 2001: 100 - 2002: 157 - 2003: 315 - Net resource transfer: - 1997: 719 - 1998: 372 - 1999: 476 - 2000: 512 - 2001: 5 - 2002: n.a. - Disbursement: - 1997: 961 - 1998: 269 - 1999: 976 - 2000: 911 - 2001: 71 - 2002: 225 - Source: AsDB. ### Staff Assessment — Statistical Issues: coverage, timeliness, and outstanding deficiencies - Overall assessment: - Coverage and timeliness: "adequate for program monitoring and surveillance purposes." - Authorities supply key data to the Fund on a timely basis; Government regularly publishes economic information; daily information on stock, money, and foreign exchange market developments available electronically. - Sri Lanka is a participant in the General Data Dissemination System (GDDS); metadata posted on the Fund’s DSBB in July 2000. - Authorities expect full compliance on Special Data Dissemination Standard (SDDS) by mid-2004 (including the data template on international reserves and foreign currency liquidity, and on external debt). - Quarterly national accounts and monthly monetary and fiscal revenue data are published regularly. - Implemented and ongoing ROSC recommendations: - Most data ROSC recommendations implemented; others expected soon. - Most data now disseminated on Census and Statistics and Central bank websites. - Census of industries underway; Census of Agriculture (including the North and East) finalized. - Labor force survey being conducted quarterly. - CBSL issued an advance release calendar and designated a contact person to assist data users. - Real sector issues: - Multiple consumer price indices produced: Colombo Consumer Price Index (CCPI) by DCS (uses an outdated consumption basket and weighting system), Greater Colombo Price Index (GCPI) by DCS, Colombo District CPI (CDCPI) by CBSL, and Wholesale cum-Producer Price Index (WPI/PPI) by CBSL. - STA (October 1998) recommended a single, high quality official CPI covering all households and including a reliable price indicator for rent and owner-occupied housing. - A new nationwide CPI covering the second to eighth income deciles is being published; STA expects to publish this new index in IFS following assessment of quality. Authorities plan to make this index official in 2004. - STA data ROSC mission (June 2001) noted considerable progress toward SDDS; identified deficiencies and planned follow-up TA to assist implementation of the 1993 SNA. - Fiscal sector issues: - STA mission (May 2003) followed up on ROSC recommendation to migrate to GFSM 2001. - Authorities agreed to revise from end–2003 budgetary classifications and accounting structure to match GFSM 2001 categories and apply the chart of accounts to all general government units. - Central government data provided for GFS Yearbook cover only budgetary accounts; exclude four extrabudgetary funds and provincial/local governments. No sub-annual data provided for IFS publication. - Authorities plan to reduce lag in producing monthly expenditure details on budgetary central government operations to 45 days and revise presentation to conform to GFS standards. Compilation of current and historical data on budgetary operations of Provincial Councils has begun. - Monetary sector issues: - Foreign Currency Banking Units (FCBUs) classified as resident institutions in the monetary survey since 1998. - To adjust for nonresident foreign currency deposits (NRFC) actually held by residents, 50 percent of these deposits are reclassified from foreign liabilities to domestic deposits. Adjusted monetary data reported to STA from January 1999. - Monetary statistics mission (June 2003) clarified treatment of Fund accounts; recommended repos be treated as collateralized loans; resolved discrepancies between data reported to STA and APD tied to valuation of Fund accounts and methodological differences. - External sector issues: - Authorities adopted most recommendations of the fifth edition of the Balance of Payments Manual. - Plan to develop data on external debt and international investment position to meet SDDS requirements. - STA mission visited Colombo in late August 2003 to advise on international investment position statistics. - CBSL provides gross and net official reserves and intervention data in U.S. dollar terms on a weekly basis. ### Core Statistical Indicators (As of January 30, 2004) — metadata highlights - Dates of latest observations and data reception include: - International reserves: 1/30/04 (date received 1/30/04) - Exchange rates: 1/23/04 - Central bank balance sheet: 1/29/04 - Broad money, interest rates, CPI: various dates in 2003–2004 as listed in the table. - Frequency and mode of reporting vary across indicators (D, W, M, Q, A; reporting modes include E, C, O). - Notes: - 1/ Refers to net international reserves. - 2/ Overall balance refers to central government balance. - 3/ Refers to public debt service. ### Statement by the IMF Staff Representative — Recent Developments (March 5, 2004) - Political environment: - Political situation more tense in run-up to April 2 elections; several election-related incidents of violence reported; observers concerned about potential for further violence. - Financial markets and reserves: - Rupee nearly reached Rs 100 per U.S. dollar in mid-February; returned to Rs 97–98 per U.S. dollar. - Central bank intervention about $40 million since end–2003. - Official reserves amounted to $2.1 billion at end–February (equivalent to 2¾ months of imports and about 100 percent of short-term debt). - Equity prices have risen by 20 percent since mid-February, after bottoming at two-thirds of their late-October 2003 levels. - Interest rates: 3–month T-bill auction reached 7.7 percent in the most recent auction; interest rates rose about 40 basis points between end-October and end-January and a further 20 basis points since then. - Real sector and banking indicators: - Inflation moderated to 4.4 percent on an annualized basis in February; food prices remained stable despite drought. - Tourism hit a record high in December, growing nearly 40 percent year-on-year. - Banking sector: nonperforming-to-total loan ratio declined during Q4 2003 from 16½ percent to 14 percent (reflecting government's assumption of nonperforming bank debt owed by Cooperative Wholesale Enterprise). ### Policy Implementation (pre-election environment) - Fiscal: - Preliminary January data indicate fiscal performance in line with staff projections. - Total tax revenue in January: Rs 21 billion, roughly 13½ percent higher than one year earlier (driven by higher import duties and VAT). - Government issued a “Pre-election Budgetary Position Report” for 2004 per the Fiscal Management (Responsibility) Act. - Deficit target revised upward to 7.3 percent of GDP, from budgeted 6.8 percent, including election costs and recent cost of living relief; staff projection: 7.2 percent of GDP. - Some outstanding revenue measures implemented (e.g., adjustment in import duties); others adopted by administrative orders (e.g., unification of VAT rates) but require formal enactment. - Public enterprise reform and civil service: - Further delays in commercialization of People’s Bank likely; World Bank-financed investment advisor on-site work postponed until May (off-site work continuing), delaying restructuring timetable. - Finalization of Voluntary Retirement Scheme for civil service postponed until after elections to allow strengthening in line with World Bank recommendations. - Central Bank: - CBSL’s audited financial statements for 2003 published and show substantial progress in implementing safeguards assessment recommendations. ### Public Information Notice No. 04/20 — IMF Concludes 2003 Article IV Consultation with Sri Lanka (March 12, 2004) - Background summary: - Over last 18 months: peace process advanced with interruptions; economic recovery strengthened; external vulnerability declined; reforms progressed. - Donors pledged about US$4.5 billion in aid over the medium term at Tokyo conference (June 2003). - Domestic political uncertainty increased due to impasse between President and Prime Minister’s government over control of certain Ministries. - 2002–2003 macro performance: - GDP growth: 2003 estimated at 5½ percent, up from 4 percent in 2002. - Inflation: fell below 6½ percent from 9½ percent in 2002. - Current account deficit likely contained at 1 percent of GDP. - Gross reserves rose by US$500 million to US$2 billion through end-December 2003, covering roughly 2¾ months of imports and just over 100 percent of short-term debt. - Fiscal deficit: declined from 8¾ percent of GDP in 2002 to 8 percent of GDP in 2003 (budget target 7½ percent of GDP). - Monetary policy: CBSL cut repo rates by 275 basis points since end-2002. - Structural reforms noted: - Fiscal Management (Responsibility) Act (December 2002) limits CBSL borrowing, sets medium-term deficit targets, mandates pre-election budget reports. - Draft Revenue Authority bill presented to Cabinet. - Legislative initiatives in financial sector: amendments to banking law, new Foreign Exchange Management bill, Asset Management Company bill approved by Cabinet. - Public enterprise reforms: divestments completed for several corporations; telecom liberalized; state electricity being unbundled; retail petroleum market opened. - Labor market reforms implemented in January 2004: streamlining settlement of labor disputes, eliminating restrictions on overtime work by women, increasing penalties for child labor; introduction of additional labor courts/tribunals, mandatory compensation formula for retrenched workers, and an unemployment insurance scheme. - Economic prospects (2004 projections and risks): - Growth in 2004 expected at 6 percent (driven by increased investment, higher tourism and exports, and normal monsoon). - Inflation expected to stabilize at around 6 percent. - Current account deficit expected around 2¼ percent of GDP. - Gross reserves expected to reach about US$2.25 billion (covering 3 months of imports and 140 percent of short-term debt). - Upside risks: reduction of power and infrastructure bottlenecks could boost tourism, shipping, and telecommunications. - Downside risks: prolonged impasse in peace process and political instability could hold back private investment, delay donor financing, divert government attention from reforms, depress growth, raise fiscal deficit and domestic financing, and keep reserves vulnerable if donor financing is reduced. - 2004 policy framework: - Government targets fiscal deficit of 6¾ percent of GDP in 2004. - Tax measures: unification of VAT, introduction of a minimum corporate tax, reduction in tax incentives to boost revenue. - Expenditure priorities: post-conflict spending close to 1 percent of GDP; capital spending to increase to 5½ percent of GDP. - Civil service reform: three-year reform targeting significant employment reduction (via voluntary retirement) and increases in public sector wages. - Monetary policy: continue balancing support for recovery and restraining inflation; structural reforms to strengthen financial sector, reduce state commercial role, and improve labor market framework. ### Executive Board Assessment — key conclusions and recommendations - Commendations: - Directors commended government efforts since the ceasefire to sustain growth and reduce poverty; noted returning investor confidence, recovering exports and tourism, strengthened growth, reduced external vulnerability, and falling inflation. - Main risks and policy priorities: - Political uncertainty and peace process instability pose risks to reforms. - Key medium-term challenge: restoring fiscal sustainability while ensuring resources for poverty reduction and post-conflict spending. - Need for improved revenue performance via tax regime simplification and reduction of exemptions to increase compliance and reverse declining tax effort. - Recommendations: - Urgently press forward with tax administration reforms and establishment of the Revenue Authority following April elections. - Maintain tight control over spending and resist further cost-of-living adjustment demands; take corrective revenue and expenditure measures if tax collections fall short. - Stand ready to tighten monetary policy if political situation deteriorates or severe budget pressures materialize; broaden policy instruments for monetary management. - Continue flexible exchange rate regime. - Strengthen banking sector and accelerate restructuring of state-owned banks, notably People’s Bank. - Speed up power sector restructuring; establish high-quality regulatory agencies. - Speed implementation of a well-targeted social safety net, informed by poverty and social impact analysis. - Ensure voluntary retirement scheme for civil service is carefully targeted to avoid undue future budget burden. - Statistics and safeguards: - Directors considered statistical information adequate for surveillance and program monitoring; looked forward to full SDDS compliance in 2004. - Commended progress in implementing safeguards assessment recommendations. - Program review implications: - Political circumstances delaying completion of first reviews under the Poverty Reduction and Growth Facility and Extended arrangements. - Expectation that first reviews can proceed once progress is made on tax measures, presentation of Revenue Authority bill, and restructuring of People’s Bank. - Next Article IV consultation: - Expected on a 24-month cycle, subject to applicable Executive Board decision and discussions with authorities. *Source: IMF staff report and Public Information Notice (March 5 and March 12, 2004).* ### conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the ### _cr0468 - conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the ### Domestic economy - Real GDP growth (percent): 4.3, 6.0, -1.5, 3.9, 5.5, 6.0 - Inflation (percent, 12-month average) 1/: 4.7, 6.2, 14.2, 9.6, 6.3, 6.0 - National savings (percent of GDP): 23.5, 21.5, 20.3, 19.6, 21.9, 22.0 - Gross investment (percent of GDP): 27.3, 28.0, 22.0, 21.3, 22.8, 24.2 ### Fiscal position - Revenue (percent of GDP): 17.7, 16.8, 16.6, 16.5, 15.4, 15.8 - Expenditure (percent of GDP): 25.2, 26.7, 27.5, 25.4, 23.6, 23.0 - Overall deficit (percent of GDP) 2/: -7.5, -9.9, -10.8, -8.9, -8.1, -7.2 - Total government debt (percent of GDP): 95.1, 96.8, 103.2, 105.5, 100.9, 95.4 ### External economy - Exports (in millions of U.S. dollars): 4,610, 5,522, 4,817, 4,699, 5,139, 5,582 - Imports (in millions of U.S. dollars): 5,979, 7,320, 5,974, 6,105, 6,585, 7,363 - Current account balance (in millions of U.S. dollars): -560, -1,065, -243, -272, -179, -459 - (in percent of GDP): -3.6, -6.4, -1.5, -1.6, -1.0, -2.2 - Capital and financial account balance: 372, 445, 514, 509, 589, 639 - Of which: direct investment 3/: 177, 176, 172, 235, 231, 320 - Gross official reserves (less ACU balances, in millions of U.S. dollars): 1,530, 911, 1,180, 1,595, 2,084, 2,385 - (in months of prospective imports): 2.2, 1.5, 2.0, 2.4, 2.9, 3.1 - External debt (in percent of GDP): 63.2, 60.8, 61.8, 59.9, 55.2, 52.1 - Real effective exchange rate (percent change, end of period) 4/: -1.2, 0.6, -0.1, 0.0, -5.8, ... ### Financial variables - Broad money growth (annual percent change) 5/: 13.4, 12.9, 13.6, 13.4, 15.3, 13.5 - Of which: net credit to government: 45.3, 56.8, 36.8, -4.2, -8.7, -8.5 - Of which: credit to the private sector: 10.5, 11.8, 8.9, 12.0, 16.9, 15.8 - Interest rate (percent, end of period) 6/: 11.8, 18.0, 12.9, 9.9, 7.4, ... *Sources: Data Provided by the Sri Lankan authorities, and IMF staff estimates and projections.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0468.pdf_