## _cr05335 ## Source details **Canonical URL:** [_cr05335](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05335.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05335.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05335.pdf.json) --- ### Executive summary — macroeconomic stance and immediate impacts - Expansionary monetary and fiscal policies in 2004 supported growth but added to inflationary pressures. - Fiscal and monetary outcomes: - Fiscal deficit reached 8.2 percent of GDP in 2004, or 1½ percent higher than budgeted. - Net domestic financing reached 6 percent of GDP in 2004. - Government issued $250 million (1¼ percent of GDP) in dollar denominated bonds in the domestic market. - Government debt remained at 105 percent of GDP (end-2004). - Central bank provided significant government financing, contributing to monetary aggregate growth. - Inflation and external position: - Annual inflation reached 16.8 percent (SLCPI; end-of-period) in 2004. - External current account deficit increased to 3 percent of GDP in 2004. - Official international reserves declined by $313 million to 2 months of import coverage (gross official reserves fell to $1.8 billion, equivalent to 2.1 months of imports). - Tsunami impact and reconstruction outlook: - December 26 tsunami damaged nearly two thirds of Sri Lanka’s coastline and led to extensive loss of life. - Reconstruction and a quick rebound in tourism should maintain growth momentum. - Demand pressures and fuel price adjustments are expected to keep inflation in double digits. - Imports of oil and construction materials projected to increase external current account deficit to 5½ percent of GDP in 2005, expected to be financed by international assistance on concessional terms. - Near-term policy challenge and priorities: - Avoiding the 2004 policy slippages is critical. - Monitor aid flows and ensure accountability in their use. - Fiscal policy needs to reduce demand pressures by enhancing revenue, reducing subsidies, and cutting development spending in lower priority areas. - Authorities have taken steps to tighten monetary policy; further tightening recommended to contain inflationary pressures. ### Political background and policy orientation - Political context: - Ceasefire continues but peace talks stalled for two years; April 2004 elections formed a coalition including the JVP, constraining reforms. - December 2004 tsunami added to political frictions; JVP withdrew from coalition in June 2005. - On June 24, the government signed the Post-Tsunami Operational Management Structure (P-TOMS) with the LTTE. - Government economic strategy: - Emphasis on rural development and a stronger public sector role. - Expansion of civil service and halt of privatization plans for several strategic enterprises; restructuring under Strategic Enterprise Management Agency (SEMA). - Donors pledged on the order of $3 billion in assistance over the next 3–4 years (May development forum). - Strategy focuses on public sector financial management, public service delivery, small and medium enterprises, and rural development. - Donors urged attention to incentives for private sector development; development strategy unclear in areas such as agricultural policies and labor market regulations. ### Developments in 2004 — growth, fiscal, monetary, external, sectoral - Growth and inflation: - Growth above 5 percent in 2004 supported by accommodative policies. - Annual inflation 16.8 percent (SLCPI; end-of-period). - Fiscal performance: - Fiscal deficit 8.2 percent of GDP in 2004. - Revenues fell short owing to late income tax amendments and lower profit transfers from the central bank. - Expenditure overruns driven by higher subsidies (mostly for fuel). - Monetary and credit: - Broad money increased by 20 percent in 2004 (compared with 15 percent in 2003 and 14 percent envisaged). - Private credit growth 22 percent. - Despite a 50 basis points policy rate increase in November, real interest rates remained negative. - External and reserves: - Balance of payments shifted to a deficit of $205 million in 2004, from a surplus of $502 million in 2003. - By end-2004, the rupee had lost 8 percent of its value against the dollar (y/y). - Gross official reserves fell to $1.8 billion (2.1 months of imports). - Public enterprises and quasi-fiscal costs: - Direct subsidies from the budget to Ceylon Petroleum Corporation (CPC) amounted to 1 percent of GDP in 2004, and ½ percent of GDP so far in 2005. - Ceylon Electricity Board (CEB) operational inefficiencies led to losses estimated at ¾ percent of GDP in 2004; accumulated debt and arrears about 4 percent of GDP. - Post-tsunami stabilization (early 2005): - Rupee appreciated 5 percent against the U.S. dollar through end-May on expectations of aid inflows. - Gross reserves increased by about $240 million reflecting IMF emergency assistance and other donor disbursements. - Monetary aggregates continued to exceed official targets; SLCPI 15 percent y/y as of April 2005. - Fuel prices adjusted twice in 2005 but remain below cost recovery levels. - Stock prices up by about 25 percent so far in 2005. ### Fiscal policy and the 2005 budget (excluding tsunami) - Budget targets and revisions: - 2005 budget targeted a deficit of 7½ percent of GDP; official projections revised to around 8 percent of GDP. - Revenue measures: - Unified VAT rate 15 percent introduced in 2004; supplementary rates 5 percent on essential food items and 18 percent on luxury goods; 5 percent surcharge introduced on value of imported goods for VAT purposes. - Excise rates raised on betting and cars (cars raised from 30 percent to a maximum of 115 percent depending on engine capacity). - Custom duty bands reduced from 6 to 5 with a cess of 10–20 percent on more than 300 items. - Budget projected revenue to increase by 1¾ percentage point of GDP to slightly above 17 percent of GDP; authorities lowered projection to 16¼ percent of GDP. - Staff estimates revenue likely to fall short of 16¼ percent target by about ½ percent of GDP. - Expenditure: - Budgeted increase of 1 percent of GDP in expenditure with steep increase in public investment; spending on health and education budgeted to increase by 30 percent. - Subsidies projected to decline by more than 1 percentage point of GDP following price adjustments; provisions for fuel subsidies limited to kerosene. - Budget incorporates 2005 effects of two-year 40 percent wage increase for civil servants and new hiring equivalent to 7 percent of existing personnel. - Expenditure increases limited to around ½ percent of GDP after revisions; higher-than-expected subsidy payments to be compensated by reductions in domestically and externally financed capital expenditure (excluding tsunami reconstruction). - Continued high world oil prices imply substantial ongoing subsidy payments, particularly on diesel. ### Near-term macro outlook and tsunami fiscal impact (post-tsunami) - Growth and inflation: - Reconstruction activity and bumper crop expected to support growth at about 5¼ percent in 2005. - Demand pressures from reconstruction and fuel price adjustments likely to keep inflation in double digits. - Fiscal impact and financing: - Government spending on reconstruction and relief will amount to 1½ percentage points of GDP. - Overruns on oil subsidies projected at ½ percent of GDP (even after further price adjustments). - Authorities plan to keep domestic financing of the 2005 budget at 4½ percent of GDP by reducing locally-financed development projects. - Rs. 20 billion already spent on tsunami relief. - Domestic financing in first five months reached Rs. 50 billion, compared with budget estimate of Rs. 105 billion for the year. - Staff recommended additional near-term revenue measures (examples: reducing prohibitive excise duty on vehicle imports, streamlining tax exemptions, increasing items subject to top VAT rate of 18 percent). - Staff recommended further fuel price adjustments to end diesel subsidies and price adjustments for electricity, railways, and buses. - External sector and oil: - External current account deficit expected to increase by 2½ percentage points to 5½ percent of GDP in 2005. - Total exports increased by 12 percent in first five months of the year; remittances increased by 24 percent in same period. - Oil prices projected at $51 per barrel in 2005 compared with $38 per barrel in 2004 and $29 per barrel in 2003. - Oil imports increased in value terms by about $900 million since 2003. ### Tsunami financing and aid coordination (aggregated figures) - Authorities estimate total post-tsunami relief and reconstruction costs around $2.1 billion. - Table I.1 financing of tsunami relief and reconstruction spending (in millions of U.S. dollars): - Total reconstruction spending: 2005: 600; 2006: 600; 2007: 600; 2008: 300; Total: 2,100. - Financing: 2005: 746; 2006: 518; 2007: 501; 2008: 224; Total: 1,990. - Private/NGO financing total: 674. - Donors total: 1,257 (Grants total: 697; Loans total: 560). - Debt rescheduling (net) total: 59. - Financing surplus/gap total: -110. - Table I.2 government coordinated spending plan (in billions of Sri Lankan rupees): - Total Expenditure: 2005: 51; 2006: 50; 2007: 50; 2008: 25; Total: 176. - Central government budget: 2005: 33; 2006: 28; 2007: 26; 2008: 14; Total: 101. - Loans: total 56; Grants: total 24; Off-budget grants total: 75. - Aid management steps taken: - Hired an international auditor; imposed information and registration requirements on NGOs; established a database for monitoring aid. - Outstanding coordination gaps: no agreed framework with donors and LTTE for allocating aid across projects and regions. - Recommendation: multi-donor-trust fund and tracking matrix to prevent duplication and reduce transaction costs. ### Public enterprises, pricing, and restructuring - Fiscal risks from public enterprises: - Financial performance of some large public enterprises deteriorated to levels that could threaten economic and financial stability. - CPC subsidies: 1 percent of GDP in 2004; ½ percent of GDP so far in 2005. - CEB losses estimated at ¾ percent of GDP in 2004; accumulated debt and arrears about 4 percent of GDP. - Policy and reform recommendations: - Fuel price adjustments will reduce CPC subsidies; reinstatement of automatic pricing formula once prices reflect international levels recommended. - CEB requires urgent fundamental restructuring; unbundling of production, transmission, and distribution should move forward quickly, supported by ADB and JBIC. - Secure investments to reduce reliance on expensive power sources; more independent regulation of public utilities to avoid political interference. - Creation of SEMA important for monitoring large enterprises that remain public. - Comprehensive monitoring of fiscal risks posed by public enterprises should be a priority. - Privatization and management improvements: - Several enterprises improved performance through privatization or management: Sri Lanka Telecom, Air Lanka, Ports Authority, Bank of Ceylon, People’s Bank (more remains to be done). - Positive experiences could be leveraged to build public consensus for reform. ### Financial sector regulation, banking, and capital markets - Banking system improvements since 2002 FSAP: - Nonperforming assets have come down; provisioning increased; capital positions improved. - Contribution to reducing bank spreads (currently about 4 percent). - Concern that provisioning not required for loans overdue 3–6 months leaves capital somewhat overstated. - Rapid credit growth amid negative real interest rates could lead to future asset quality deterioration. - State banks: - Significant improvements in state-owned banks’ positions; bad loans written off or recovered; provisioning increased; reduced government interference. - People’s Bank still requires substantial restructuring; capital injections should be linked to performance indicators under SEMA. - Capital markets and captive financing: - Corporate bond market underdeveloped. - EPF and NSB assets amount to about 30 percent of GDP and remain captive government financing sources. - Liberalizing investment options for captive sources recommended to foster market-determined rates and capital market development. ### Labor market and structural reforms - Labor market constraints: - High redundancy payments (maximum of four years of salary) undermine efficiency. - Concerns over government initiatives to mandate specific wage increases; staff warned this could damage competitiveness. - Structural reform priorities: - Extend VAT to wholesale and retail sectors; improve tax and customs administration; broaden tax base. - Eliminate most subsidies; improve targeting of welfare benefits; prioritize locally-financed investment projects. - Comprehensive civil service reform to increase average pay, decompress wage structure, and improve efficiency. - Address land and labor market rigidities, improve road infrastructure, and address unreliable and expensive electricity. ### Debt sustainability, scenarios, and policy implications - Debt stock and baseline projections: - Public sector debt: 2004 105.4 percent of GDP; 2005 100.7; 2006 95.3; 2007 91.2; 2008 87.1; 2009 83.0; 2010 78.3; 2015 61.9; 2025 47.9. - NPV of public sector debt: 2005 87.3; 2006 80.0; 2007 74.1; 2008 70.2; 2009 66.6; 2010 62.1; 2015 47.9; 2025 37.6. - Gross financing need (percent of GDP): 2005 36.5; 2006 32.2; 2007 28.5; 2008 28.7; 2009 26.8; 2010 25.1. - Debt service-to-revenue ratio (percent): 2005 104.9; 2006 104.1; 2007 91.2; 2008 90.1; 2009 87.3; 2010 79.8. - Alternative scenarios and risks: - A1 (growth and primary balances at historic averages): NPV debt-to-GDP falls only to 78 percent in 2010 versus 62 percent in baseline; would increase to 104 percent in 2025. - A2 (continuation of 2002–2004 policies): NPV debt-to-GDP increases from 87 percent in 2005 to 89 percent in 2010 and 113 percent in 2025. - External debt baseline: declines from 63 percent of GDP in 2004 to just under 50 percent in 2010; NPV of external debt declines from about 40 percent to 30 percent of GDP. - Bound test B6 (one-time 30 percent depreciation): NPV of external debt rises to about 50 percent of GDP; takes about eight years to return to current level. - Policy implications: - Strengthen fiscal consolidation to preserve favorable debt dynamics. - Broaden revenue base and reorient expenditures toward priority spending. - Improve debt management and plan for possible shift from concessional to commercial financing. ### Monetary and exchange rate policy recommendations - Monetary policy: - Authorities’ program envisages broad money growth of 15 percent in 2005; private sector credit expansion of about 20 percent conditional on targets. - Staff recommended more aggressive tightening to avoid entrenching inflation pressures associated with reconstruction. - Outstanding central bank credit to government declined by about ½ percent of GDP from December to May 2005. - Repo/reverse repo policy corridor increased by 25 basis points in late May and 50 basis points in June 2005. - Recommendations: reduce fiscal dominance, grant more autonomy to CBSL, increase monetary policy transparency (e.g., publish minutes). - Exchange rate: - Authorities committed to a flexible exchange rate regime. - Staff emphasized interventions should be limited to moderating short-term fluctuations or increasing reserves when conditions conducive. - Caution against sustained drop in foreign reserves below current low levels and against protectionist trade policies or exchange controls. ### Statistics, data dissemination, and technical assistance - Data and coverage: - Overall coverage and timeliness adequate for program monitoring, but weaknesses remain. - Authorities participate in GDDS; SDDS subscription intended but substantial work remains. - Outstanding statistical issues and priorities: - Full adoption of GFSM 2001 will take substantial time; priority to reduce lag in monthly expenditure details and improve reporting on extra-budgetary funds and provincial councils. - Multiple consumer price indices exist; a new nationwide CPI covering income deciles is being published and expected to appear in IFS following assessment. - International transactions reporting system (ITRS) issues: large unclassified transactions, inclusion of FCBUs, need for instruction book, and development of international investment position statistics. - Technical assistance: - FAD TA on tax policy/administration; mixed implementation record. - MFD and LEG TA on state bank restructuring, supervision, capital market development, deposit insurance, monetary operations, and legal reform; some delays due to political uncertainty and tsunami. - CBSL revisions in Central Bank Act expected to be approved in 2006. ### Executive Board conclusions and recommended actions (summary) - Commended prompt relief after tsunami; key challenges are efficient and transparent reconstruction, mobilizing donor assistance, and maintaining macroeconomic stability. - Fiscal policy: - Stronger fiscal consolidation needed; improve debt management; curtail central bank financing in context of medium-term budget framework. - Additional measures may be required to achieve revised 2005 revenue targets; comprehensive tax reform and improved tax/customs administration urged. - Expenditure-side adjustment: shift spending toward priority infrastructure and poverty-related projects; cut fuel subsidies to cost-recovery levels; civil service reform needed to contain wage bill. - Monetary and exchange rate policy: - Additional appropriately paced monetary tightening recommended; greater central bank independence supported by some Directors. - Flexible exchange rate regime supported; limited smoothing appropriate given aid inflows; avoid protracted intervention to prevent depreciation. - Structural and financial sector reforms: - Restructure key public enterprises; monitor quasi-fiscal costs of CEB and CPC; recapitalize People’s Bank linked to performance targets; promote greater competition and commercialization of state-owned banks. - Statistics: - Improvements adequate for surveillance but further work needed to meet SDDS requirements and improve fiscal statistics. *Source: _cr05335 (IMF staff report and annexes contained in the referenced document)._ ### Executive Summary ...................................................................................................... ### _cr05335 - Executive Summary ### Executive summary — macroeconomic stance and immediate impacts - Expansionary monetary and fiscal policies in 2004 supported growth but added to inflationary pressures. - Fiscal outcome and monetary expansion: - The fiscal deficit exceeded budget targets. - A significant amount of government financing was provided by the central bank, contributing to growth in monetary aggregates. - Inflation and external position: - Annual inflation reached 16.8 percent (SLCPI; end-of-period). - The external current account deficit increased to 3 percent of GDP. - Official international reserves declined by $313 million to 2 months of import coverage. - Tsunami impact and reconstruction outlook: - The December 26 tsunami led to extensive loss of life and damaged nearly two thirds of Sri Lanka’s coastline. - Reconstruction and a quick rebound in tourism should maintain growth momentum, but demand pressures and fuel price adjustments are expected to keep inflation in double digits. - A significant increase in imports of oil and construction materials are projected to increase the external current account deficit to 5½ percent of GDP, but this is expected to be financed by international assistance on concessional terms. - Near-term policy challenge: - Avoiding the 2004 policy slippages is critical. - Monitoring aid flows and ensuring accountability in their use will be a key priority in mobilizing external financing for tsunami reconstruction. - Fiscal policy will need to reduce demand pressures by enhancing revenue, reducing subsidies, and cutting development spending in lower priority areas. - The authorities have taken steps to tighten monetary policy and more will be needed to keep inflationary pressures in check. ### Political background and policy orientation - Political developments and implications: - Political constraints and uncertainties have affected policy implementation since the last Article IV consultation. - The ceasefire continues to hold, but peace talks have been stalled for two years. - The April 2004 elections produced a coalition including the Marxist People’s Liberation Front (JVP); difficulties in building consensus constrained reforms. - The December 2004 tsunami added to political frictions; a parliamentary majority established earlier lasted only until June 2005 when the JVP withdrew from the government coalition. - On June 24, the government signed the Post-Tsunami Operational Management Structure (P-TOMS) with the LTTE. - Government economic strategy: - Greater emphasis on rural development and a stronger role for the public sector as a driver of growth. - Expansion of the civil service and halt of privatization plans for several strategic enterprises in favor of restructuring under the Strategic Enterprise Management Agency (SEMA). - Donors pledged on the order of $3 billion in assistance over the next 3–4 years at a development forum on tsunami reconstruction (May 16–17). - Strategy focuses on enhancing public sector financial management and public service delivery, and promoting small and medium enterprises and rural development. - Donors urged attention to incentives for private sector development and noted that the development strategy remained unclear in areas such as agricultural policies and labor market regulations. ### Developments in 2004 — fiscal, monetary, external, and sectoral - Growth and inflation: - Accommodative fiscal and monetary policies helped support growth above 5 percent in 2004. - Annual inflation reached 16.8 percent (SLCPI; end-of-period), reflecting demand pressures and higher food and oil prices. - Fiscal performance and debt: - The fiscal deficit reached 8.2 percent of GDP in 2004, or 1½ percent higher than budgeted. - Revenues fell short of the budget target owing to late enactment of income tax amendments and lower-than-expected profit transfers from the central bank. - Expenditure overruns were driven by higher subsidies (mostly for fuel). - Net domestic financing reached 6 percent of GDP. - Government issued $250 million (1¼ percent of GDP) in dollar denominated bonds in the domestic market. - Government debt remained at 105 percent of GDP. - Monetary and credit developments: - With the central bank purchasing large amounts of treasury bills, ample liquidity was available for private credit and money growth increased significantly. - Broad money increased by 20 percent, compared with 15 percent in 2003 and 14 percent envisaged under the authorities’ monetary program. - Private credit growth was 22 percent. - Despite a 50 basis points policy rate increase in November, real interest rates remained negative. - Monetary expansion in 2004 was accounted for by an expansion of net domestic assets. - Balance of payments and reserves: - The balance of payments shifted to a deficit of $205 million in 2004, from a surplus of $502 million in 2003. - The current account moved to a deficit of 3 percent of GDP. - By end-2004, the rupee had lost 8 percent of its value against the dollar (y/y), despite central bank intervention. - Gross official reserves had fallen to $1.8 billion (equivalent to 2.1 months of imports). - Public enterprises and quasi-fiscal costs: - Financial costs in key public enterprises increased significantly. - Direct subsidies from the budget to the Ceylon Petroleum Corporation (CPC) amounted to 1 percent of GDP in 2004, and ½ percent of GDP so far in 2005. - Operational inefficiencies in the Ceylon Electricity Board (CEB) led to substantial losses estimated at ¾ percent of GDP in 2004; accumulated debt and arrears amount to about 4 percent of GDP. - Deadlines for reforming CEB have been postponed repeatedly. - Stabilization since the tsunami: - The rupee appreciated 5 percent against the U.S. dollar through end-May on expectations of aid inflows. - Gross reserves increased by about $240 million reflecting the Fund’s emergency assistance and other donor disbursements. - Monetary aggregates continued to exceed official targets and inflation remained in double digits (15 percent y/y in the SLCPI as of April). - Fuel prices have been adjusted twice so far in 2005 but remain below cost recovery levels. - Stock prices are up by about 25 percent so far this year. ### Fiscal policy and the 2005 budget (excluding tsunami) - Budget targets and revisions: - The 2005 budget targeted a deficit of 7½ percent of GDP, a contraction of some 0.7 percentage points over the previous year. - Since the budget was approved, official projections have been revised to forecast a deficit of around 8 percent of GDP. - Revenue measures and projections: - The unified VAT rate of 15 percent introduced in 2004 was supplemented with rates of 5 percent on essential food items and 18 percent on luxury goods; a 5 percent surcharge was introduced on the value of imported goods for VAT purposes. - Excise tax base broadened and excise rates raised on betting and cars (taxes on cars raised from 30 percent to a maximum of 115 percent, depending on engine capacity). - Broadening of the corporate income tax base was coupled with a reduction in personal income tax (PIT) rates; deductibility of certain business expenses was restricted. - Custom duty bands were reduced from 6 to 5 with a cess (surcharge) of 10–20 percent imposed on more than 300 items. - The budget projected revenue to increase by 1¾ percentage point of GDP to slightly above 17 percent of GDP. - The authorities lowered their revenue projection to 16¼ percent of GDP. - Staff estimates that revenue is likely to fall short of the 16¼ percent target by about ½ percent of GDP. - Privatization receipts are also likely to fall short of budget estimates. - Expenditure measures and outcomes: - Expenditure was budgeted to increase by 1 percent of GDP, with a steep increase in public investment more than offsetting cuts in current outlays. - Spending on health and education was budgeted to increase by 30 percent. - Subsidies were projected to decline by more than 1 percentage point of GDP following adjustments in prices of oil, wheat, and public services; provisions for fuel subsidies were limited to kerosene. - The budget incorporated the 2005 effects of the two-year 40 percent wage increase for civil servants and new hiring equivalent to 7 percent of existing personnel. - Expenditure increases will now be limited to around ½ percent of GDP; higher than expected subsidy payments will be more than compensated for by reductions in domestically and externally financed capital expenditure (excluding tsunami reconstruction). - Continued high world oil prices mean maintenance of administered oil prices requires substantial ongoing subsidy payments, particularly on diesel. ### Structural reforms, public enterprise restructuring, and financial sector - Structural reform progress: - Some progress in structural reforms by end-2004, notably in revenue administration and financial sector restructuring. - The cabinet approved creation of a revenue board in June 2004 to coordinate revenue departments; restructuring of the Inland Revenue Department remains to be done. - ADB program loan approved in support of restructuring People’s Bank; performance indicators of People’s Bank have improved. - Public enterprise reform and fiscal burden: - Restructuring of public enterprises remains an important priority. - Tariff adjustments and restructuring are needed to reduce the fiscal burden of the Ceylon Petroleum Corporation and the Ceylon Electricity Board. - Financial sector supervision: - Noticeable improvements in the overall regulation and supervision of the financial system. - Changes to provisioning rules and firmer enforcement of regulations have contributed to improvements in financial indicators in the banking system. - State-owned banks’ financial performance improved; privatization plans abandoned but restructuring continues under SEMA. ### Medium-term outlook, risks, and policy priorities - Medium-term determinants: - The medium-term outlook depends on fiscal consolidation, implementation of structural reforms, and revival of the peace process. - High levels of public debt constrain growth prospects and affect expectations of macroeconomic stability. - Debt sustainability and policy requirements: - Progress toward a meaningful path of consolidation has been elusive; debt sustainability is a concern. - Addressing debt sustainability will require stronger efforts to improve revenue, rationalize expenditure, and improve overall debt management. - Labor, capital markets, and infrastructure: - Inefficiencies in labor and capital markets and poor infrastructure will need to be addressed to enhance growth. - Trade policy: - Sri Lanka’s commitment to an open trade regime needs to be maintained to benefit from strong global and regional growth. _Executive Summary, _cr05335 - Executive Summary_._ ### 10. The near-term outlook is to a large extent influenced by the post-tsunami ### _cr05335 - 10. The near-term outlook is to a large extent influenced by the post-tsunami ### Near-term macroeconomic outlook: growth, inflation, and reconstruction - Reconstruction will have a significant financial impact on the government’s budget and the balance of payments. - Growth drivers and risks: - Devastation of the fisheries sector will adversely affect growth. - Tourist arrivals rebounded after sharp declines in January and February; for the first five months of the year, arrivals and earnings increased by 8 percent compared with the previous year. - Reconstruction activity and a bumper crop earlier this year are expected to support growth at about 5¼ percent in 2005, broadly in line with last year. - Inflation and demand pressures: - Demand pressures from tsunami reconstruction and fuel price adjustments are likely to keep inflation in double digits. ### Fiscal impact and government financing - Tsunami-related fiscal effects and financing plans: - Government spending on reconstruction and relief will amount to 1½ percentage points of GDP. - Authorities intend to finance additional tsunami-related spending through international support. - Overruns on oil subsidies are projected to amount to ½ percent of GDP (even after assuming further price adjustments are made). - Authorities plan to reduce locally-financed development projects (compared with budget estimates) to keep domestic financing of the 2005 budget at 4½ percent of GDP. - Fiscal developments to date in 2005: - Rs. 20 billion has already been spent on tsunami relief. - Domestic financing of the budget in the first five months reached Rs. 50 billion, compared with the budget estimate of Rs. 105 billion for the year. - Staff recommended consideration of additional near-term revenue measures (examples noted by staff: reducing prohibitive excise duty on vehicle imports, streamlining tax exemptions, increasing number of items subject to the top VAT rate of 18 percent). - For expenditure, staff argued there is no feasible alternative to further adjustment in domestic prices to end subsidies for diesel; scope exists for cutting back the size of the kerosene subsidy. - Authorities plan to implement further fuel price adjustments to eliminate the subsidy for diesel and price adjustments for electricity, railways, and buses. ### External sector: current account, exports, remittances, and oil - External current account and trade: - The external current account deficit is expected to increase by 2½ percentage points to 5½ percent of GDP in 2005, reflecting higher imports for tsunami reconstruction, slow growth in garment exports, and a steep oil price increase. - Total exports increased by 12 percent in the first five months of the year. - Remittances increased by 24 percent in the same period. - Garment industry: - Coming off growth of 9 percent in 2004, garment exports increased by 6 percent in the first quarter of 2005. - Industry is concerned about weaker orders for coming months, but staff judged the overall adverse impact should be contained. - Oil price effects: - Oil prices are projected at $51 per barrel in 2005 compared with $38 per barrel in 2004 and $29 per barrel in 2003. - As a result, oil imports have increased in value terms by about $900 million since 2003. ### Textile quota removal (Box 3): vulnerability and adjustment - Context: - Quotas under the WTO Agreement on Textiles and Clothing were removed on January 1, 2005. - Producers have shifted production to China and India to take advantage of low cost labor. - Sector structure and adjustment: - Large companies represent only 12 percent of total firms but generate more than 70 percent of the total value of textile exports. - Medium sized exporters account for roughly 25 percent of exports; small companies account for only 5 percent of exports but small- and medium-sized companies employ 38 percent of sector workers. - Policies and business strategies have led to a gradual shift to out-of-quota goods; U.S. quota utilization rate fell from 85 percent in 2000 to about 67 percent in 2003. - Overall, quota-based exports declined from more than 60 percent in the 1990s to about 50 percent in 2003. - Staff assessment and projections: - Staff assesses the impact of quota removal on Sri Lanka’s external position to be limited. - The global price effect of quota removal is estimated at negative 10 percent over a three-year period. - In the medium term, the volume of textile exports is projected to rise by a modest 2 percent per year. ### Downside risks to the near-term outlook - Key risks identified: - Need for additional measures to meet fiscal objectives (including further domestic fuel price adjustments) which may prove politically difficult. - Capacity constraints in the construction sector could negatively affect inflation and limit the effectiveness of aid inflows. - Shortfalls or delays in mobilizing external assistance could lead to inflationary budget financing, recourse to nonconcessional foreign currency bonds, and pressures on the exchange rate. - Further increases in international oil prices would worsen growth and inflation prospects and amplify external vulnerabilities. ### Medium-term priorities, targets, and structural reforms - Medium-term objectives and targets: - Authorities target growth at 6–7 percent annually to support poverty reduction. - Economic strategies aim to reduce the overall fiscal deficit to 4½ percent of GDP by 2008, with adjustment predicated on improving revenue performance. - Sound monetary policy aimed at lowering inflation to single digits. - Promote exports through rationalization of tariff and trade policies, enhanced trade facilitation, and investment arrangements with partner countries. - Policy actions and structural reforms: - Develop the government’s strategy into a comprehensive Poverty Reduction Strategy. - Scope for significant gains in agriculture productivity and further development of tourism and telecommunication services; untapped growth potential in the North and East. - Need to ease land and labor market rigidities, improve road infrastructure, and address unreliable and expensive electricity. - Credible progress toward fiscal consolidation is needed to improve investor confidence and end financial repression constraining capital market development. - Fiscal consolidation specifics: - Staff emphasized revenue enhancement as the key priority. - Authorities’ medium-term framework relies on revenue projections rising from 15 percent of GDP in 2004 to 19½ percent in 2008; staff argued these are very ambitious and recommended basing the medium-term framework on lower revenue targets until progress is demonstrated. - Suggested medium-term revenue measures: extension of the VAT to wholesale and retail sectors, continued improvements in tax and customs administration, and other base-broadening measures. - Expenditure reforms needed: elimination of most subsidies, improved administration and targeting of welfare benefits, and better debt management. - A comprehensive civil service reform plan is needed to increase average pay levels, decompress the wage structure, and improve efficiency. - Poverty and social indicators: - Sri Lanka has traditionally had strong social indicators and progress toward many Millennium Development Goals has been recorded (examples cited: primary enrollment, infant and maternal mortality). - Despite per capita GDP growth of 3.5 percent during the 1990s, incidence of poverty fell modestly by 3 percentage points to 22.7 percent in 2002 (excluding the North and East), compared with the MDG target to reduce poverty to 13 percent by 2015. - Persistent poverty in rural areas and the North and East underscores need to upgrade infrastructure and improve agricultural performance. ### Debt sustainability and debt management concerns - Debt levels and risks: - Public debt is over 100 percent of GDP, making debt sustainability a serious concern. - Scenarios in Annex II indicate debt outlook would be sustainable if the FMRA is in place and credible steps are taken to meet legislative targets by 2008; failure to improve fiscal performance or address structural problems would rapidly worsen the outlook. - Debt management issues: - Recent developments (terms of Paris Club debt moratorium and issuance of domestic bonds at high coupon rates) will increase debt service costs in the future. - Because of high interest rates, purchasers pay more than face value for bonds with receipts above face value recorded as negative interest payments in the current year (amounting to ½ percent of GDP in 2005), which lowers interest payments in the current year at the expense of higher interest payments in future years. - Authorities have expressed interest in extending the Paris Club debt service moratorium to help finance tsunami reconstruction but wish to maintain future access to commercial credit and are considering requesting an international sovereign rating. - Fiscal monitoring and transparency: - Priority should be given to more comprehensive monitoring of fiscal risks (including losses of CEB) and systematically accounting for implicit and contingent liabilities in both the short and medium-term and through analysis of the overall public sector debt burden. ### Monetary and exchange rate policy - Monetary stance and recommendations: - Authorities’ monetary program envisages broad money growth of 15 percent in 2005. - Given a modest increase in net international reserves, and provided the government meets its domestic financing target, expansion of private sector credit would remain at about 20 percent. - Staff welcomed central bank efforts to reduce liquidity and recommended a more aggressive tightening of monetary policy to avoid entrenching inflation pressures associated with tsunami reconstruction. - Outstanding credit to the government by the central bank declined by about ½ percent of GDP from December to May—a reversal from 2004. - In late May and June, the repo/reverse repo policy corridor was increased by 25 basis points and 50 basis points, respectively. - Staff stressed importance of reducing fiscal dominance, granting more autonomy to the CBSL, and increasing monetary policy transparency (for example, publishing minutes of Monetary Board meetings). - Exchange rate policy: - Authorities reiterated commitment to a flexible exchange rate regime. - Staff emphasized that interventions should be limited to moderating short-term fluctuations or increasing reserves when market conditions are conducive. - Given possible differences in timing of tsunami-related aid flows and import needs, exchange rate volatility could increase; central bank could intervene during inflows to provide scope for later foreign exchange sales to finance corresponding imports. - Staff cautioned against allowing a sustained drop in foreign reserves below current low levels and advised against protectionist trade policies or exchange control measures to stem downward pressure on the currency. *Source: _cr05335 - 10. The near-term outlook is to a large extent influenced by the post-tsunami* ### 25. The financial performance of some large public enterprises has deteriorated to ### _cr05335 - 25. The financial performance of some large public enterprises has deteriorated to ### Public enterprises, pricing, and restructuring - Financial performance of some large public enterprises has deteriorated to the point where they could threaten economic and financial stability. - Fuel price adjustments will reduce government subsidies to the CPC, and once prices have been adjusted to reflect prevailing international levels, reinstatement of the automatic pricing formula would prevent the problem from recurring in the future. - For CEB, there is a more urgent need for fundamental restructuring; unbundling of production, transmission, and distribution should move forward as quickly as possible, being supported by the ADB and Japan Bank for International Cooperation (JBIC). - Need to secure necessary investments to reduce reliance on expensive sources of power. - More independent regulation of public utilities is important to avoid political interference. - Similar fiscal risks (but on a much smaller scale) exist in the operations of railways, buses, and other utilities. - Authorities committed to: - bring in another foreign investor to increase competition in the distribution of oil products, - press forward with CEB reforms. - At the time this report is being issued, the government was still negotiating with labor unions on CEB restructuring. - Creation of the Strategic Enterprise Management Agency (SEMA) is an important step in monitoring performance of large enterprises expected to remain in the public sector. - Further tariff adjustments and restructuring are needed to improve financial positions and reduce fiscal burden of CEB and CPC. - A more comprehensive monitoring of fiscal risks posed by public enterprises should be a priority. ### Privatization and management improvements - Several enterprises showed performance improvement through privatization or improved management: Sri Lanka Telecom, Air Lanka, the Ports Authority, Bank of Ceylon, and People’s Bank (although much more remains to be done). - Strong management teams and increased commercial autonomy can contribute to significant performance improvements. - Positive experiences could be leveraged to build public consensus for reform. ### Financial sector regulation and banking system - Improvements since the FSAP in 2002: - Nonperforming assets (NPAs) have come down. - Provisioning increased. - Capital positions improved across the entire banking system (Table 6). - These changes should help reduce bank spreads between deposit and lending rates which at about 4 percent are relatively high. - Contributing factors: changes in prudential regulations that reduced the value of collateral consistent with more realistic recovery rates, enhanced supervisory efforts, improved procedures for collection and recovery of bad debts. - Concern: not requiring provisioning against loans overdue between 3–6 months leaves capital somewhat overstated. - Concern: current rapid growth in lending—in a context of negative real interest rates—could lead to deterioration of asset quality in the future. - On deposit insurance: staff noted the need to ensure necessary preconditions are satisfied, including strengthening legal and financial institutions. - CBSL has addressed all recommendations of the full Safeguards Assessment of June 2003, including through revisions in the Central Bank Act that are expected to be approved in 2006. - Significant improvements in financial position and operation of the two large state-owned banks: - Bad loans have been written off and/or recovered. - Provisioning increased. - Government interference declined. - Better credit risk practices installed. - People’s Bank still has a long way to go before it could be considered a financially sound entity. - To avoid repeating past recapitalization mistakes, capital injections should be directly linked with performance indicators as envisaged under the restructuring plan agreed with SEMA. - Continued vigilance needed as recent rapid growth in lending could lead to asset-quality deterioration. - Monitor large state banks to ensure restructuring continues and any capital injections are directly linked with performance indicators. - Reforms in the banking system should contribute to reduced interest rate spreads and improved monetary transmission. - Improving government debt market functioning, including liberalizing investment options for captive sources (e.g., the EPF), will lead to more market-determined interest rates and contribute to capital market development. ### Trade policy, regional integration, and capital markets - Sri Lanka’s commitment to an open trade regime needs to be maintained to benefit from strong global and regional growth. - Recent ad hoc changes in import surcharges and fees have complicated the system and send mixed signals; staff argued these should be rationalized into the current tariff structure and the remaining 10 percent surcharge on imports removed once revenue improvements have been secured. - Authorities indicated intention to further rationalize the tariff structure; various fees (cesses) are earmarked to fund export promotion and development activities. - Large trade opportunities exist within the region, especially with the fast growing Indian economy; exports to India have picked up substantially since 2001. - The Comprehensive Economic Partnership Agreement with India and other regional initiatives provide basis for further expansion. - To capture benefits of regional integration, progress should be made in moving to a low uniform tariff structure to minimize distortions from preferential agreements. - Capital market concerns: - Corporate bond market remains underdeveloped. - The Employee Provident Fund (EPF) and National Savings Bank (NSB), with assets amounting to about 30 percent of GDP, remain important captive sources of government financing. - Very little movement yet toward EPF/NSB seeking alternative investments. - Captive sources have enabled government to access financing at rates below the prevailing inflation rate, but this financial repression constrains broader banking and capital market development. ### Labor market issues - High redundancy payments for private sector workers undermine labor market efficiency: maximum of four years of salary makes Sri Lanka one of the most generous schemes in the world. - Private sector concerned with a recent government initiative to mandate specific wage increases; staff noted such interference in wage setting was unwarranted and could damage competitiveness. - Authorities emphasized strength of labor unions and protections provided to workers, and stressed need for strategic partnerships between government, private sector, and unions. - Regional comparison data (from Doing Business / staff estimates) cited firing index and estimated firing costs (weeks of wages) with specific country values presented in source figures. ### PRGF/Extended Arrangements and Fund engagement - Authorities indicated desire to resume discussions on a Fund-supported program in the near future and requested continued policy advice and technical assistance. - Authorities recognized usefulness of a formal financial framework with the Fund to underpin macroeconomic discipline, coordinate donors, and support domestic reform, but stressed importance of ownership and more time to generate domestic consensus. - Staff agreed credibility of reform program is essential given slippages in implementation of the current program (Table 9). - Authorities expressed interest in further technical assistance from the Fund in deposit insurance, revenue administration, and debt management. - A staff visit is envisaged in September to review progress and discuss the framework for the 2006 budget. - For illustrative purposes, the balance of payments scenario presented in Table 4 assumes a one-year extension of the current PRGF/EFF arrangements until April 2007. ### Tsunami reconstruction and aid coordination - Coordinating tsunami reconstruction and aid use will be a considerable challenge. - Staff advised spending priorities and final decisions on distributing aid should be determined by the government, which should coordinate official assistance and oversee arrangements to manage and monitor private aid flows. - Government intends a significant portion of reconstruction—especially for schools and hospitals—to be executed directly by donors (outside central government’s budget); given administrative capacity burden, this approach can be justified. - Coordination mechanisms: Task Force for Reconstruction of the Nation (TAFREN), MOUs to monitor and coordinate implementation, external auditor hired, and a database for monitoring aid being established. - Government committed to implement reconstruction strategy with full transparency and accountability and improve communication and community participation. - Staff emphasized need for frequent public and donor reports on aid use and specific audit procedures to ensure accountability. ### Macroeconomic outlook and policy recommendations - Near-term prospects for economic growth remain positive, but inflation pressures are likely to be sustained. - Contributing factors to inflation: expected decline in some agricultural prices, fuel price adjustments, and high growth in monetary aggregates; inflation expected to remain in double digits. - Reconstruction activity and pressure on domestic wages and prices likely to perpetuate inflation into 2006. - High public debt exerts a toll on sustainable growth and macroeconomic expectations; insufficient fiscal adjustment could lead to adverse debt dynamics and compromise poverty reduction and MDG attainment. - Government debt at end-2004 remained above 105 percent of GDP. - Improvements in overall debt management within a medium-term budget framework geared toward consolidation are needed. - Revenue: after declining, tax revenue increased by one percentage point of GDP in 2004; measures in second half of 2004 helped limit central government deficit increase and set stage for improved revenue in 2005. - Despite improvement, 2005 budget targets for revenue are unlikely to be achieved; additional near-term policy measures should be considered to strengthen tax collections given uncertain outlook for privatization receipts. - Medium-term revenue priorities: extend the VAT to wholesale and retail sectors, continue improvements in tax and customs administration, and broaden the tax base. - Expenditure reforms needed: - In short term, no feasible alternative to price adjustments to end fuel subsidies for petrol and diesel while reducing subsidies for kerosene. - Careful prioritization of locally-financed investment projects to limit pressure on domestic resources while using available foreign financing for tsunami reconstruction. - Improved administration and targeting of welfare benefits. - Transportation infrastructure needs improvement to enhance private sector investment environment. - Control wage bill and promote better public services via a comprehensive civil service reform plan to increase average pay levels, decompress wage structure, and improve efficiency. - Monetary policy: - Prevailing high inflation and continued high growth in monetary and credit aggregates imply monetary policy should be tightened further. - Central bank commended for intensifying open market operations, but stronger efforts needed to reduce reserve money growth; interest rates should be free to adjust as necessary to meet monetary targets. - A further increase in the interest rate policy corridor would signal determination to reduce inflation and help reduce inflationary expectations. - More central bank autonomy is needed to enhance credibility of monetary policy. - Exchange rate policy: - Flexible exchange rate regime important for adjustment after external and domestic shocks in 2004–05. - Loss of official reserves in 2004 underscores risks of avoiding depreciation through protracted intervention. - Given prospects for large aid inflows and import needs, some intervention to smooth short-run adjustments is justified, but a drop in foreign exchange reserves below current levels should be avoided. - Exchange rate should be allowed to depreciate if downward pressures emerge. - Protectionist trade policies or reversing liberal exchange policies to temporarily reduce exchange rate pressures would be counterproductive and should be avoided. - Over the medium term, international reserves should be increased to a more comfortable level. - Medium-term outlook hinges critically on fiscal consolidation, structural reforms, and revival of the peace process. - Constraints to growth: complex tax system, labor market rigidities, unreliable and expensive electricity, poor infrastructure, and underdeveloped capital markets. - Capital market development, including liberalizing investment options for captive government financing sources, is necessary to support future growth. ### Economic statistics and data dissemination - Improvements in economic statistics have been made in a number of areas, but weaknesses remain. - Full adoption of the GFSM 2001 methodology will take substantial time; priority improvements include: - reducing lag in producing monthly expenditure details, - improving reporting on extra budgetary funds and provincial councils, - revising budgetary classifications and accounting structure. - Staff encouraged authorities to address remaining issues needed to meet SDDS requirements, including compiling and disseminating prescribed data on general government operations, international reserves and foreign currency liquidity, and the international investment position. - CBSL revisions in the Central Bank Act are expected to be approved in 2006. *Source: _cr05335 - 25. The financial performance of some large public enterprises has deteriorated to (IMF staff report).* ### 46. Sri Lanka’s commitment to an open trade regime needs to be maintained to ### _cr05335 - 46. Sri Lanka’s commitment to an open trade regime needs to be maintained to ### Trade policy and regional integration - Sri Lanka’s commitment to an open trade regime needs to be maintained to benefit from strong global and regional growth. - In conjunction with efforts to promote regional trade, progress also should be made in moving to a low uniform tariff structure to minimize distortions and inefficiencies than can result from preferential agreements. ### Restoration of reform credibility and fiscal statistics - Staff urges the authorities to re-establish the credibility of their reform program to provide a basis for the resumption of Fund program support. - The authorities are also encouraged to improve the quality and coverage of fiscal statistics and address the remaining issues needed to meet SDDS requirements. * _cr05335 - 46. Sri Lanka’s commitment to an open trade regime needs to be maintained to* ### 48. It is recommended that the next Article IV consultation with Sri Lanka be held in ### _cr05335 - 48. It is recommended that the next Article IV consultation with Sri Lanka be held in ### Recommendation - It is recommended that the next Article IV consultation with Sri Lanka be held in accordance with the provisions of Board Decision No. 12794-(02/76) approved on July 15, 2002. ### Real sector: growth and inflation - GDP growth eased in early 2004; poor agricultural performance, due to drought, contributed to the slowdown in growth. - Inflation picked up sharply in 2004; inflation indicators shown: - Real GDP growth (Table 1): 2004: 5.4; 2005 Est./Proj.: 5.3 (annual percent change figures presented as "Real GDP growth-1.54.06.05.45.3" in source). - Key headline statistics (2004 unless noted): - Nominal GDP (2004): US$20.0 billion - Population (2004): 19.3 million - GDP per capita (2004): US$1,029 ### Fiscal sector: deficits, revenues, and debt - Fiscal adjustment remained elusive; domestic deficit financing increased in 2004. - While interest payments decreased somewhat, the debt stock remains very high. - Selected fiscal indicators (percent of GDP, Table 1 / Table 2): - Revenue (2004): 15.3; 2005: 15.7 - Expenditure (2004): 23.5; 2005: 23.9 - Primary balance (excluding grants, 2004): -2.2; 2005: -3.1 - Overall balance (excluding grants, 2004): -8.2; 2005: -8.2 - Overall balance (including grants, 2004): -7.7; 2005: -7.4 - Domestic financing (2004): 5.8; 2005: 4.4 - Government debt (domestic and external) (2004): 105.4; 2005: 100.7 - Central government operations (Table 2, percent of GDP): - Total revenue (2004 est.): 15.3; 2005 IMF projections: 16.0–16.3 (multiple columns shown) - Total expenditure and net lending (2004 est.): 23.5; 2005 projection: 23.9 - Interest payments (2004): 5.9; 2005 (various columns): 5.6–5.1 (presented in table) - Overall balance (including grants) (2004 est.): -7.7; 2005 IMF projection: -7.4 ### Monetary sector: monetary growth and credit - Monetary growth accelerated in 2004, reflecting a substantial increase in net domestic assets (NDA). - Monetary aggregates (Table 3, annual percent change / levels): - Reserve money (percent change, end of period): 2004: 20.9; 2005 projected: 15.0 - Broad money (percent change): 2004: 19.6; 2005 projected: 15.0 - Domestic credit (percent change): 2004: 22.4; 2005 projected: 13.2 - Private sector credit (percent change): 2004: 22.1; 2005 projected: 21.0 - 91-day T-bill rate (end of period): 2004: 7.3; 2005: 10.0 - Monetary accounts (Table 3, selected levels in billions of Sri Lankan rupees): - Reserve money (end-2004 act.): 171; end-2005 staff proj.: 197 (table contains series across quarters and projections) ### Financial sector and interest rates - Short-term nominal interest rates rose by much less than the increase in inflation; the steepening of the yield curve suggests increased inflation expectations. - Nominal interest rates (Figure 2): repo, reverse repo, 3-month T-bill series shown; yield curve comparisons for May 2005 and December 2003 indicate steepening. - Stock market recovered dramatically since late 2003, driven by strong corporate earnings and dearth of investment opportunities (Colombo stock exchange index, January 2002=100 series shown). ### External sector: trade, reserves, exchange rate, and balance of payments - Higher oil prices and robust demand for non-oil imports caused the trade deficit to widen. - External trade (Table 1 / Figure 2): - Exports (2004): 5,757; 2005: 6,098 (in millions of U.S. dollars) - Imports (2004): 8,000; 2005: 9,171 (in millions of U.S. dollars) - Trade balance (2004): -2,242; (2005): -3,073 (in millions of U.S. dollars) - Current account balance (2004): -648; (2005): -1,257 (in millions of U.S. dollars) - Current account balance (percent of GDP): 2004: -3.2; 2005: -5.6 - Reserves and exchange rates: - Gross official reserves (end of period, Table 1): In millions of U.S. dollars: 2002: 1,183; 2003: 1,560; 2004: 2,146; 2005: 1,833; 2005 staff proj.: 2,083 - Gross official reserves (Table 4 / Table 5 series): 2004: 2,146; 2005: 1,833; medium-term projections: 2006: 2,147; 2007: 2,376; 2008: 2,453; 2009: 2,606 (in millions of U.S. dollars) - Despite heavy central bank intervention, the rupee depreciated considerably vis-à-vis the U.S. dollar in 2004 before appreciating on expectations of post-Tsunami aid flows (exchange rate and NEER/REER indices presented; rupees per U.S. dollar series with January 2002=100 reference). - Balance of payments (Table 4, selected flows, in millions of U.S. dollars): - Current account (2003): -74; 2004: -648; 2005: -968 (tsunami-adjusted series shows -1,257 for 2005 in another column) - Services receipts (2004): 1,609; transfers (2004): 1,717; private transfers (net, 2004): 1,617 - Capital and financial account (2004): 1,132; financial account (2004): 958 - Gross reserves (net of ACU balances, Table 4): 2004: 2,146; 2005: 1,833; projections through 2009 provided. ### Projections, medium-term framework, and vulnerabilities - Medium-term macroeconomic framework (Table 5, selected projections, 2005–2009): - Real GDP (annual percent change): 2005: 5.3; 2006–2009: 6.0 each year in the presented table ("Real GDP 5.45.36.06.06.06.0") - Inflation (Sri Lanka CPI; average): 2005: 14.0; 2006: 9.5; 2007: 7.5; 2008: 6.0; 2009: 5.0 - Overall balance (excluding grants, percent of GDP): 2005: -8.2; 2006: -7.8; 2007: -6.8; 2008: -5.7; 2009: -4.6 - Total government debt (percent of GDP): 2005: 100.7 (Table 1); Table 5 projects: 2005: 100.7 (prov.), 2006: 95.3; 2007: 91.2; 2008: 87.1; 2009: 83.0 - Balance of payments medium-term (Table 4 & Table 5): - Current account (percent of GDP) projections: 2005: -5.6; 2006: -5.4; 2007: -4.5; 2008: -3.2; 2009: -2.2 - Trade balance (percent of GDP): 2005: -13.6; 2006: -13.6; 2007: -12.7; 2008: -11.0; 2009: -9.5 - Vulnerability indicators (Table 6, selected): - Nonperforming loans (as percent of total loans, 2004): State-owned commercial banks: 14.2; Domestic private banks: 10.5; Foreign banks: 3.3 - Risk-based capital asset ratio (2004): State-owned commercial banks: 5.5; Domestic private banks: 11.1; Foreign banks: 12.4 - Stock market index (ASPI; 2004): 1,507 - Exports (annual percent change): 2004: 12.2; Imports (annual percent change): 2004: 19.9 ### IMF program-related and Fund obligations - Projected payments to the Fund (Table 7, in millions of SDRs): - Disbursements (2005): 103.4; 2006: 177.2; 2007: 177.2; 2008–2009: 0.00 (table labeled "Disbursements 1/103.4177.2177.20.00.0") - Repayments (2005): 25.8; 2006: 74.2; 2007: 31.9; 2008: 46.0; 2009: 62.8 - Charges/interest (2005): 5.3; 2006: 9.1; 2007: 7.1; 2008: 6.2; 2009: 4.3 - Stock of outstanding use of Fund resources (2005): 266.8; 2006: 369.8; 2007: 515.1; 2008: 469.0; 2009: 406.2 ### Social and development indicators - Millennium Development Goals and social indicators (Table 8, selected series): - Poverty headcount, national (percent of population; 1994/1997/2003 entries): 1994: 20.0; 1997: …; 2003: 25.0 (table shows series with some missing entries) - Net primary enrollment ratio (percent of relevant age group): 1990: 89.9; 2003: 97.0 - Under 5 mortality rate (per 1,000): 1990: 32.0; 2003: 15.0 - Infant mortality rate (per 1,000 live births): 1990: 26.0; 2003: 13.0 - Immunization, measles (percent of children under 12 months): Series includes 80.0, 84.0, 94.0, 99.0, 99.0 - Access to improved water source (percent of population): 1990: 68.0; 2003: 78.0 - Fixed line and mobile telephones (per 1,000 people): 1990: 7.4; 1994: 12.2; 1997: 25.5; 2000: 64.9; 2003: 121.7 _Italic: Sources: Data provided by the Sri Lankan authorities; CEIC Data Company Ltd.; Central Bank of Sri Lanka; Fund staff estimates and projections (as presented in the source content)._ ### 1. Budget ### 1. Budget ### Structural policy actions and implementation status - Extension of the VAT to the wholesale and retail sectors - Deadline: January 31, 2004 - Status: Not met. Plan abandoned by new government - Rationalization/streamlining of tax incentives 1/ - Deadline: January 31, 2004 - Status: No progress made. 2/ - Reduce import surcharge to 10 percent from 20 percent - Deadline: January 31, 2004 - Status: Met on time (January 2004) - Tax administration and tax policy reform - Deadline: June 30, 2003 - Financial sector reform - Deadlines: June 30, 2003; June 30, 2003 - External evaluation of assets and liabilities of People's Bank - Deadline: September 15, 2003 - Status: Not met. External consultants have not been re-engaged. - Complete the restructuring of People's Bank 1/ - Deadline: March 31, 2004 - Public enterprise reform - Deadline: December 31, 2003 - Labor market reform - Deadline: April 30, 2003 - Implementation of the binding redundancy compensation formula - Status: Not met. While the formula was gazetted in March 2005, implementation is contingent on the creation of an unemployment insurance scheme. - Presentation to parliament of a new Revenue Authority Act and preparation of detailed implementation plan - Status: Not met. Plans for Revenue Authority were abandoned by new government. - Complete the sale of 8.5 percent of the government shares in Sri Lanka Telecom (SLT) and bring to a point of sale the shares held by the government in Hilton Colombo 2/ - Status: Not met. New government has abandoned privatization strategy, but has approved business development plan, including public recapitalization. - Presentation to parliament of the Asset Management Company (AMC) law - Status: Not met. Government open in principle to share sales of non-strategic SOEs. Decisions on SLT and Hilton are still pending. - Presentation to parliament of the amended banking laws and the new Exchange Management Act - Status: Met with delay (November 2003). The law, however, has not been approved. - Status update: Partly met with delay (November 2003). Banking Laws were approved in December 2004; but Exchange Management Act has been dropped from the legislative agenda. Notes from source: - 1/ Was to be given more specificity in the context of the first review. - 2/ Most measures planned for 2004 were never enacted after the change in government. In the 2005 budget, new incentives outnumber the elimination of existing incentives. ### Tsunami: social and economic impact — key findings - Geographical and human impact - The tsunami struck a coastal area stretching over 625 miles, or two thirds of the country’s coastline. - Close to 40,000 people are dead or missing. - 1,000 children are left without parents. - About 1 million people have been affected (5 percent of the population). - The ADB estimates that an additional 250,000 people may fall into poverty. - Some 60 percent of the damage was sustained by the war-ravaged North-East. - Sectoral impacts and offsets - Fishing industry: accounts for about 2 percent of GDP and exports very little; thousands of fishermen died; 65 percent of the boat fleet was either damaged or destroyed; 11 fisheries harbors sustained severe damage. - Tourism and related services: account for an estimated 2 percent of GDP and more than 8 percent of exports of goods and services; affected areas account for only 25 percent of Sri Lanka’s hotel room capacity. - Construction sector: accounts for 7 percent of GDP and is likely to offset most of the contraction in the fishing and tourism sectors. - Macro implications - Tsunami reconstruction and financing will lead to higher import and financing needs compared with the previous baseline. - The authorities currently estimate total post-tsunami relief and reconstruction costs to be around $2.1 billion. - An additional $250 million of debt rescheduling/relief has been secured in 2005 from the Paris Club and other bilateral creditors, which eased the immediate cash flow constraints of tsunami relief and the early stages of reconstruction. ### Financing estimates and aggregated figures (as presented) - Table I.1. Sri Lanka: Financing of Tsunami Relief and Reconstruction Spending (In millions of U.S. dollars) - Total reconstruction spending: 2005: 600; 2006: 600; 2007: 600; 2008: 300; Total: 2,100 - Financing: 2005: 746; 2006: 518; 2007: 501; 2008: 224; Total: 1,990 - Private/NGO financing: 2005: 196; 2006: 180; 2007: 198; 2008: 100; Total: 674 - Donors: 2005: 297; 2006: 380; 2007: 380; 2008: 200; Total: 1,257 - Grants: 2005: 177; 2006: 200; 2007: 200; 2008: 120; Total: 697 - Loans: 2005: 120; 2006: 180; 2007: 180; 2008: 80; Total: 560 - Debt rescheduling (net): 2005: 253; 2006: -42; 2007: -77; 2008: -76; Total: 59 - Financing surplus/gap: 2005: 146; 2006: -82; 2007: -99; 2008: -76; Total: -110 - Memorandum item — Government spending plan: 2005: 510; 2006: 500; 2007: 500; 2008: 250; Total: 1,760 - Sources: Ministry of Finance and Planning; Central Bank of Sri Lanka; Asian Development Bank; World Bank; bilateral donors; and Fund staff estimates and calculations. - Table I.2. Sri Lanka: Financing of Government Coordinated Spending Plan (In billions of Sri Lankan rupees) - Total Expenditure: 2005: 51; 2006: 50; 2007: 50; 2008: 25; Total: 176 - Central government budget: 2005: 33; 2006: 28; 2007: 26; 2008: 14; Total: 101 - Loans: 2005: 12; 2006: 18; 2007: 18; 2008: 8; Total: 56 - Grants: 2005: 10; 2006: 6; 2007: 6; 2008: 2; Total: 24 - Debt rescheduling (net): 2005: 2 5-4-8-8 6 (as presented) - Domestic financing: -14810811 (as presented) - Off-budget grants: 2005: 18; 2006: 22; 2007: 24; 2008: 11; Total: 75 - Sources: Ministry of Finance and Planning; Central Bank of Sri Lanka; Asian Development Bank; World Bank; bilateral donors; and Fund staff estimates and calculations. ### External accounts and medium-term effects - Post-tsunami activities increase the external current account deficit. - Tsunami-related import spending of $440 million in 2005 pushes the current account deficit up by about 1 percent of GDP. - Imports for tsunami-related spending increase to $475 million in 2006 and decline thereafter. - Accumulation of net international reserves declines with the expiry of debt relief and the need to repay the rescheduled debt. - Debt relief in 2005 helped compensate the financing gap arising from tsunami-related spending and allowed the government to address relief and reconstruction through the budget. ### Recommendations and governance for expenditure management - Effective and transparent management of tsunami-related expenditure requires a comprehensive database of all expenditures and financing. - Clear coordination structures, such as TAFREN, will assist in this task. - When the authorities seek necessary approvals for expenditure through the central government budget, they should provide information to parliament on all planned expenditure under the recovery and reconstruction plan. *Source: _cr05335 - 1. Budget* ### 9. The government is making efforts to ensure the effective use of aid. It has hired an ### _cr05335 - 9. The government is making efforts to ensure the effective use of aid. It has hired an ### Aid management and coordination - The government has: - hired an international auditor, - imposed information and registration requirements on NGOs, - established a database for monitoring aid. - Outstanding coordination gaps: - The government, donors, and the LTTE have yet to agree on a framework for allocating aid across projects and regions. - A multi-donor-trust fund and the tracking matrix—currently under discussion with donors—would help prevent duplication of aid and reduce the government’s transaction costs in dealing with a huge number of donors. ### Tsunami inflows and outflows (Table I.3: Sri Lanka: Tsunami Inflows and Outflows in the Balance of Payments; In millions of U.S. dollars) - Impact on current account (by year and total): - Total outflows: 2005 550, 2006 475, 2007 470, 2008 240, Total 1,735 - Imports of goods: 2005 400, 2006 430, 2007 430, 2008 220, Total 1,480 - Imports of aervices: 2005 40, 2006 45, 2007 40, 2008 20, Total 145 - Tourism: 2005 110, 2006 0, 2007 0, 2008 0, Total 110 - Financing (by year and total): - Total financing: 2005 548, 2006 590, 2007 578, 2008 300, Total 2,016 - Official sector: 2005 297, 2006 380, 2007 380, 2008 200, Total 1,257 - Grants: 2005 177, 2006 200, 2007 200, 2008 120, Total 697 - Project loans: 2005 120, 2006 180, 2007 180, 2008 80, Total 560 - Private sector: 2005 251, 2006 210, 2007 198, 2008 100, Total 759 - NGO grants: 2005 196, 2006 180, 2007 198, 2008 100, Total 674 - Loans: 2005 40, 2006 20, 2007 0, 2008 60 - FDI: 2005 15, 2006 10, 2007 0, 2008 25 - Tsunami related financing gap: 2005 2, 2006 -1, 2007 15, 2008 -10, Total -60-281 (note: entry appears as "2-115-108-60-281" in source) - Debt rescheduling: 2005 253, 2006 -42, 2007 -77, 2008 -76, Total 59 - Tsunami related change in NIR ( (- = increase) ): - -251 -73 -3116 -340 (preserve exact sequence as in source) ### Central government debt sustainability — baseline scenario (Table II.1 and narrative) - Baseline fiscal scenario outcomes: - Central government debt falls linearly from 105 percent of GDP in 2004 to 78 percent of GDP in 2010 and 48 percent in 2025. - NPV indicators of debt and debt-to-revenue and the debt-service to revenue ratio perform similarly. - The debt service-to-revenue ratio will continue to exceed the indicative threshold (40 percent) through 2010. - Main driver: - Continued interest rate/growth differential; projected real growth of 6 percent through the period exceeds projected real interest rates on domestic and foreign debt. ### Downside risks and alternative scenarios (Table II.2 and narrative) - Alternative scenario A1 (growth and primary balances at historic averages): - NPV of the debt-to-GDP ratio would fall to only 78 percent of GDP in 2010 versus 62 percent in the baseline and would eventually increase to 104 percent of GDP in 2025. - Alternative scenario A2 (continuation of recent 2002–2004 policies): - Assumptions: primary deficit of 1.2 percent of GDP, average real interest rate of 2.6 percent, asset changes and off-budget activities equal to 3.2 percent of GDP, real growth of 5 percent. - Outcome: NPV of debt-to-GDP increases from 87 percent in 2005 to 89 percent in 2010 and 113 percent of GDP in 2025. - Most extreme stress test: - The most extreme stress test is of continued lower-than-average growth. ### External debt sustainability (Tables II.3–II.4 and narrative) - Key assumption: - Sri Lanka will graduate from low-income country status; export growth assumed at 6 percent per year; competitive tourism sector; higher demand for imported consumer goods over time. - Baseline outcomes: - External debt declines from 63 percent of GDP in 2004 to just under 50 percent of GDP in 2010. - In NPV terms external debt declines from about 40 percent to 30 percent of GDP. - Debt service ratio increases to about 12 percent for public debt, and 17 percent for total external debt as external financing shifts to commercial terms. - Vulnerabilities: - Exchange rate sensitivity: a one-time 30 percent depreciation would bring the NPV of external debt to about 50 percent of GDP; it would take about eight years to return to its current level. ### Selected numeric indicators and projections (preserve figures as in source) - Public sector debt (percent of GDP) historical/projections (Table II.1 excerpt): - Public sector debt: 2002 105.5, 2003 105.8, 2004 105.4, 2005 100.7, 2006 95.3, 2007 91.2, 2008 87.1, 2009 83.0, 2010 78.3, 2015 61.9, 2025 47.9 - Foreign-currency denominated: 2002 55.1, 2003 55.4, 2004 54.8, 2005 53.4, 2006 50.8, 2007 49.5, 2008 46.6, 2009 43.8, 2010 41.4, 2015 31.0, 2025 18.6 - Change in public sector debt (percent of GDP): 2002 2.3, 2003 0.3, 2004 -0.4, 2005 -4.7, 2006 -5.4, 2007 -4.1, 2008 -4.1, 2009 -4.1, 2010 -4.7, 2015 -2.5, 2025 -0.9 - Identified debt-creating flows and components (percent of GDP, selected entries): - Primary deficit: 2002 1.1, 2003 0.7, 2004 1.8, 2005 2.1, 2006 1.2, 2007 2.3, 2008 1.0, 2009 0.7, 2010 -0.1, 2015 -1.0, 2025 -1.7 - Revenue and grants (percent of GDP): 2002 17.0, 2003 16.2, 2004 15.8, 2005 16.5, 2006 17.0, 2007 17.5, 2008 17.9, 2009 18.2, 2010 18.5, 2015 18.7, 2025 19.0 - Primary (noninterest) expenditure (percent of GDP): 2002 18.1, 2003 16.9, 2004 17.6, 2005 18.8, 2006 18.0, 2007 18.1, 2008 17.8, 2009 17.2, 2010 16.9, 2015 17.8, 2025 18.3 - NPV of public sector debt (selected projection row): - NPV of public sector debt: 2005 87.3, 2006 80.0, 2007 74.1, 2008 70.2, 2009 66.6, 2010 62.1, 2015 47.9, 2025 37.6 - Gross financing need (percent of GDP): 2005 36.5, 2006 32.2, 2007 28.5, 2008 28.7, 2009 26.8, 2010 25.1, 2015 23.4, 2025 21.4, 2011–25 average 19.2, 2025 15.1 - Debt service-to-revenue ratio (percent): 2005 104.9, 2006 104.1, 2007 91.2, 2008 90.1, 2009 87.3, 2010 79.8, 2015 74.3, 2025 69.2, 2011–25 average 61.7, 2025 50.5, later 48.9 - Key macro assumptions (selected): - Real GDP growth (in percent): 2002 4.0, 2003 6.0, 2004 5.4, 2005 4.5, 2006 2.3, 2007 5.3, 2008 6.0, 2009 6.0, 2010 6.0, 2011–25 average 6.0 - Average nominal interest rate on forex debt (in percent): 2002 1.4, 2003 1.3, 2004 1.4, 2005 1.5, 2006 0.1, 2007 0.7, 2008 1.4, 2009 1.5, 2010 1.4 - Average real interest rate on domestic currency debt (in percent): 2002 6.4, 2003 8.8, 2004 2.3, 2005 6.2, 2006 2.6, 2007 1.0, 2008 3.1, 2009 4.2, 2010 5.6 - Inflation rate (GDP deflator, in percent): 2002 8.2, 2003 5.0, 2004 9.4, 2005 8.6, 2006 2.7, 2007 9.7, 2008 10.0, 2009 8.0, 2010 6.5 ### Sensitivity and stress-test outcomes (Table II.2, Table II.4 excerpts) - NPV of debt-to-GDP ratio — baseline and alternatives (selected): - Baseline NPV of debt-to-GDP ratio: 2005 87, 2006 80, 2007 74, 2008 70, 2009 67, 2010 62, 2015 48, 2025 38 - A1 (historical averages): 2005 87, 2010 78, 2025 100 - A2 (2002–2004 averages): 2005 87, 2010 89, 2025 113 - A3 (permanently lower GDP growth): 2005 87, 2010 65, 2025 57 - External debt NPV-to-GDP baseline (Table II.3 and II.4): - NPV of external debt (baseline): 2005 35, 2006 35, 2007 34, 2008 33, 2009 31, 2010 30, 2015 20, 2025 11 - Bound test B6 (one-time 30 percent nominal depreciation in 2006): NPV of external debt reaches 49 in 2006 under B6 (Table II.4). ### Policy implications and recommendations (implied by analysis) - Strengthen aid coordination mechanisms: - Finalize framework for allocating aid across projects and regions with donors and LTTE. - Implement a multi-donor-trust fund and tracking matrix to reduce duplication and transaction costs. - Maintain fiscal consolidation to preserve favorable debt dynamics: - Sustain reforms to keep central government debt on the projected downward path. - Broaden the revenue base and reorient expenditures toward priority spending to reduce downside fiscal risk. - Monitor and manage external vulnerabilities: - Prepare for exchange rate shocks given sensitivity of external debt to depreciation. - Anticipate a shift from concessional to commercial external financing and plan for higher debt service ratios. - Prioritize growth-supporting policies: - Emphasize policies that sustain real GDP growth at or near 6 percent to secure baseline debt outcomes. *Source: _cr05335 - 9. The government is making efforts to ensure the effective use of aid. It has hired an (extracted from IMF staff report content provided).* ### 21.1 percent; and relief and rehabilitation, 7.4 percent. ### _cr05335 - 21.1 percent; and relief and rehabilitation, 7.4 percent. ### Staff assessment — statistical coverage and timeliness - Overall coverage and timeliness of available data in Sri Lanka are adequate for program monitoring and surveillance purposes. - Authorities supply key data to the Fund on a timely basis; Government regularly publishes economic information and data. - Daily information on stock, money, and foreign exchange market developments is readily available through electronic media. - Sri Lanka is a participant in the General Data Dissemination System (GDDS); metadata were posted on the Fund’s DSBB in July 2000. - Quarterly national accounts and monthly monetary and fiscal revenue data are published regularly. - Authorities appointed an SDDS coordinator in February 2003 and have expressed intention to subscribe to the Special Data Dissemination Standard (SDDS), but substantial work remains to meet all SDDS requirements and prepare necessary metadata. ### Implementation of ROSC recommendations and dissemination - Most data ROSC recommendations have been implemented; others are expected to be implemented in the near future. - Most data are now being disseminated on the Census and Statistics and central bank websites. - A census of industries is underway; a Census of Agriculture (including the North and East) has been finalized. - A labor force survey is being conducted on a quarterly basis. - The CBSL has issued an advance release calendar and designated a contact person to assist data users. ### Outstanding statistical issues — Real sector - Multiple consumer price indices exist: - Colombo Consumer Price Index (CCPI) by Department of Census and Statistics (DCS) is the official measure but uses an outdated consumption basket and weighting system. - Greater Colombo Price Index (GCPI) published by DCS includes Colombo city and suburbs. - Central Bank of Sri Lanka (CBSL) produces a Colombo District CPI (CDCPI) and a Wholesale cum-Producer Price Index (WPI/PPI). - STA (October 1998) recommended producing 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 an assessment of its quality. - STA data ROSC mission (June 2001) identified deficiencies in national accounts: - Lack of sufficient data sources and undeveloped statistical techniques. - No periodic comprehensive benchmarks and no system for conducting regular annual surveys of establishments. - Absence of a statistical business register, resulting in poor sample frames for surveys. - Detailed data needed to measure both output and intermediate consumption are mostly unavailable or not collected. - Estimates of gross value added rely on outdated fixed ratios established from the base year 1996, often with outdated studies or ad hoc assumptions. - Quarterly indicators are used for compiling quarterly value added estimates; methodology for deriving GDP at constant prices is not satisfactory. - Expenditure estimates are available only annually and rely mostly on commodity flow techniques. ### Outstanding statistical issues — Fiscal sector - STA GFS mission (May 2003) followed up on ROSC recommendation to develop a migration path to GFSM 2001. - Authorities agreed to revise from end–2003 the budgetary classifications and accounting structure to match GFSM 2001 classifications and to apply that chart of accounts to all general government units. - Data regularly provided for publication in the GFS Yearbook cover only the budgetary accounts of central government; no data on the four extra-budgetary funds or the provincial and local governments are provided. - No sub-annual data are provided for publication in IFS. - Authorities plan to reduce the lag in producing monthly expenditure details on budgetary central government operations to 45 days and to revise presentation to conform to GFSM 2001. - Process to compile current and historical data on budgetary operations of Provincial Councils has begun. - Full adoption of GFSM 2001 system is expected to take a substantial period of time. ### Outstanding statistical issues — Monetary sector - 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. - Authorities started reporting adjusted monetary data to STA from January 1999. - STA monetary statistics mission (June 2003) clarified methodology for treatment of Fund accounts; recommended repos be treated as collateralized loans rather than on a change of ownership basis; resolved discrepancies between data reported to STA and to APD related to valuation of Fund accounts and methodological treatments. ### Outstanding statistical issues — External sector - STA mission (December 2004) identified high-priority issues in the international transactions reporting system (ITRS): - Address large values of unclassified transactions. - Include FCBUs in data. - Provide an instruction book to assist ITRS reporters with classifications and coding accuracy. - Mission advised development of a comprehensive survey to implement a medium-term plan to introduce international investment position statistics. - CBSL provides gross and net official reserves and intervention data in U.S. dollar terms on a weekly basis. ### Table summary — Common Indicators Required for Surveillance (as of June 20, 2005) - Exchange rates: Latest observation 6/20/2005; Date received 6/20/2005; Frequency of data D; Frequency of reporting D; Frequency of publication D. - International reserve assets and reserve liabilities of the Monetary Authorities: Latest observation 6/17/2005; Date received 6/20/2005; Frequency D; Frequency of reporting W; Frequency of publication W. - Reserve/base money: Latest observation 6/16/2005; Date received 6/17/2005; Frequency W; Frequency of reporting W; Frequency of publication W. - Broad money: Latest observation 4/29/2005; Date received 6/15/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - Central bank balance sheet: Latest observation 5/31/2005; Date received 6/15/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - Consolidated balance sheet of the banking system: Latest observation 4/29/2005; Date received 6/15/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - Interest rates: Latest observation 6/17/2005; Date received 6/17/2005; Frequency W; Frequency of reporting W; Frequency of publication W. - Consumer price index (SLCPI): Latest observation 4/2005; Date received 6/1/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - Revenue, expenditure, balance and composition of financing—central government: Latest observation 4/2005; Date received 6/15/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - Stocks of central government and central government-guaranteed debt: Latest observation 3/2005; Date received 6/1/2005; Frequency M; Frequency of reporting M; Frequency of publication M. - External current account balance: Latest observation Q4/2004; Date received 3/31/2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q. - Exports and imports of goods and services: Latest observation Q4/2004; Date received 3/31/2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q. - GDP/GNP: Latest observation Q4/2004; Date received 3/31/2005; Frequency Q; Frequency of reporting Q; Frequency of publication Q. - Gross external debt: Latest observation 12/2004; Date received 4/29/2005; Frequency A; Frequency of reporting A; Frequency of publication A. ### Technical assistance (Annex VII) — fiscal, monetary, and statistical TA highlights - Fiscal sector FAD TA focused on tax policy and administration: - 2001 report proposed agenda: introduction of a single-rate VAT, repeal of ad hoc taxes, limiting tax exemptions/incentives, broadening tax bases. - TA missions in 2002 and 2003 advised on design of a revenue authority and modernization of revenue departments. - Early 2004: resident expert for five months provided operational support to the Large Taxpayer Unit (LTU). - Implementation record mixed: - Many ad hoc taxes repealed; a VAT established and Economic Service Charge implemented. - Key recommendations such as coverage and rate of VAT and limiting of tax exemptions were not fully implemented. - Disappointing progress in establishing a single Taxpayer Identification Number and modernizing Inland Revenue Department structure/processes. - Monetary and financial sector TA (MFD and LEG) focused on: - State bank restructuring, bank supervision, capital market development, legal reform, deposit insurance, monetary operations, banking and central banking laws, AML/CFT legislation. - Implementation affected by political uncertainties (2004 elections) and the tsunami. - Positive outcomes: improved performance of two state-owned banks; strengthened provisioning requirements; increased actual provisioning across banking sector; short selling of government securities permitted to enhance capital markets. - Delays: new central bank law and banking law delayed; Parliamentary approval not expected before end-2006. - STA TA areas: General Data Dissemination System; Price indices; Government Finance Statistics; Monetary and Financial Statistics; International investment position (missions in June–July 1997, February–March 2000; October 1998; April/May 2003; May/June 2003; August 2003). ### Statement by IMF Staff Representative (July 15, 2005) — recent developments - Political situation remains difficult; President ruled out calling parliamentary elections; main opposition demands Presidential election. - Post-Tsunami Operations Management Structure (P-TOMS) taking shape with representatives from government, LTTE and Muslim community; P-TOMS to approve reconstruction projects for North and East. - Funding channeled through a Trust Fund with World Bank as custodian; about $100 million pledged so far to that Trust Fund. - Staff estimates Sri Lanka has received $300–350 million in aid for reconstruction from official donors, NGOs/private sources, and year-to-date impact of the debt moratorium. - In addition: $158 million in emergency assistance from the IMF and about $65 million in humanitarian assistance by UN agencies. - Financial markets stable despite political uncertainty: - Exchange rate hovered around Rs. 100/US$ since end-May. - Reserves remained at $2.1 billion (about 2.4 months of imports) as of July 6. - Equity prices about same level as in May. - Yields on the 3-month treasury bill rose to about 9 percent, close to 200 basis points above end-2004, due to increases in policy rates and open market operations. - GDP growth Q1: 4.8 percent (y/y); tsunami slowed services and fisheries contracted by 65 percent; tourism arrivals decreased by 5 percent y/y in Q1 but April-May arrivals were well above last year’s levels. - Sectoral notes: - Good paddy harvest and rebound in electricity value added helped offset tsunami impact. - Apparel sector growth rate of 7 percent. - Inflation: Sri Lanka CPI about 13 percent (y/y) in May; Colombo CPI fell in June to below 10 percent; inflationary pressures remain a concern for second half of year. - Fiscal: Mid-Year Fiscal Position Report estimates overall fiscal deficit in first four months at about 3 percent of annual GDP. - Latest revenue figures: 20 percent growth y/y through May. - Staff estimates that at current oil prices, additional subsidies of around ⅓ percent of GDP would be required unless fuel and diesel prices are adjusted by more than envisaged in the staff report. - Monetary: reserve money growth at end-June about 19 percent (y/y), compared to 21 percent at end-2004; Monetary Board left interest rates unchanged at its monthly meeting earlier that week. - Ceylon Electricity Board (CEB): negotiations with unions ongoing; main issues unresolved (unbundling); increase in fixed charges for electricity announced. ### Public Information Notice (PIN) No. 05/102 — Executive Board conclusions (August 2, 2005) - Executive Board concluded the 2005 Article IV consultation with Sri Lanka on July 15, 2005. - Background observations: - Real GDP increased by 5.4 percent in 2004, compared with 6.0 percent in 2003. - Annual inflation reached 16.8 percent (end-of-period) in 2004. - Fiscal deficit reached 8¼ percent of GDP in 2004. - Net domestic financing reached 6 percent of GDP in 2004. - Government issued $250 million (1¼ percent of GDP) in dollar denominated bonds in the domestic market to help bridge financing gap. - Broad money increased by 20 percent in 2004; private credit growth of 22 percent. - Balance of payments shifted to a deficit of $205 million in 2004 from a surplus of $502 million in 2003; current account deficit of 3 percent of GDP in 2004. - By end-2004, rupee lost 8 percent (y/y) against the dollar; gross official reserves fell to $1.8 billion (2.1 months of imports). - 2005 budget aims to reduce deficit to 7½ percent of GDP; budget measures include phasing out numerous subsidies, increasing spending on health and education, and meeting Fiscal Management (Responsibility) Act targets on a delayed timetable. - Structural reform progress mixed: - Cabinet approved listing of various revenue departments under a revenue board (June 2004); much remains to be done on Inland Revenue Department restructuring. - ADB approved program loan in support of restructuring of People’s Bank. - Fiscal and quasi-fiscal costs from CPC and CEB in 2004-05: direct subsidies from budget amounting to 1 percent of GDP in 2004 and ½ percent of GDP so far in 2005; CEB accumulated debt and arrears about 4 percent of GDP. - Post-tsunami stabilization: - Rupee appreciated 5 percent against U.S. dollar through mid-July; gross reserves increased by more than $300 million reflecting IMF emergency assistance and donor disbursements. - Monetary aggregates continued to grow rapidly; inflation remained high despite central bank absorption efforts and policy rate increases in May and June of 25 and 50 basis points respectively. - Fuel prices adjusted twice in 2005; fuel subsidies remain a drag on the budget. - Stock prices up about 25 percent so far in 2005. ### Executive Board assessment — policy guidance and risks - Commended prompt and effective relief implementation after December 2004 tsunami. - Key challenges: manage reconstruction efficiently and transparently, mobilize donor assistance effectively, and maintain macroeconomic stability. - Near-term growth prospects positive due to reconstruction activity and agricultural performance; cautioned that reconstruction bottlenecks could exacerbate inflationary pressures. - Emphasized importance of government coordinating official tsunami assistance and monitoring private aid flows; welcomed Task Force for Reconstruction of the Nation and appointment of an external auditor; called for periodic public reporting and implementation of audit procedures. - Longer-term challenges: fiscal consolidation, structural reforms to enhance investment climate, and reviving peace process. - Fiscal policy: - Noted recent large fiscal deficits and high public debt pose macroeconomic risks. - Called for stronger fiscal consolidation, improved debt management, and curtailment of central bank financing of the budget in context of a medium-term budget framework. - Welcomed improved revenue performance but encouraged additional measures if needed to achieve revised 2005 revenue targets; urged comprehensive tax reform and improvements in tax and customs administration and broadening of the tax base. - Urged expenditure-side adjustment to shift spending toward priority infrastructure and poverty-related projects; urged cutting fuel subsidies (petrol and diesel) by raising prices to cost-recovery levels. - Reiterated need for civil service reform to contain the wage bill and decompress the wage structure; recommended improving targeting of welfare benefits to protect the poor. - Monetary and exchange rate policy: - Commended central bank actions to tighten monetary policy and increase transparency; recommended appropriately paced additional monetary tightening. - Some Directors felt greater central bank independence would help curb inflation and inflationary expectations. - Supported flexible exchange rate regime with some smoothing appropriate given large aid inflows and import needs; cautioned against protracted intervention to avoid depreciation and advised increasing reserves to more comfortable levels over the medium term. - Structural and financial sector reforms: - Encouraged restructuring of key public enterprises and creation of SEMA to monitor enterprises expected to remain in public sector. - Expressed concern over fiscal/quasi-fiscal costs of CEB and CPC; urged further tariff adjustments and restructuring. - Commended improvements in regulation and supervision since 2002 FSAP; warned rapid lending growth could deteriorate asset quality; urged recapitalization of People’s Bank on basis of agreed performance targets and promoted greater competition and commercialization of state-owned banks. - Statistics: - Considered statistical information adequate for surveillance but encouraged improvements in quality and coverage of fiscal statistics and addressing remaining SDDS requirements. ### Selected economic indicators (summary table; values as presented) - Real GDP growth (percent): 2001 -1.5; 2002 4.0; 2003 6.0; 2004 5.4; 2005 Est./Proj. 5.3 - Inflation (percent, 12-month average) 1/: 2001 12.1; 2002 10.2; 2003 2.6; 2004 7.9; 2005 Est./Proj. 14.0 - National savings (percent of GDP): 2001 20.3; 2002 19.5; 2003 21.6; 2004 21.6; 2005 Est./Proj. 22.1 - Gross investment (percent of GDP): 2001 22.0; 2002 21.2; 2003 22.1; 2004 25.0; 2005 Est./Proj. 27.7 - Revenue (percent of GDP): 2001 16.6; 2002 16.5; 2003 15.7; 2004 15.3; 2005 Est./Proj. 15.7 - Expenditure (percent of GDP): 2001 27.5; 2002 25.4; 2003 24.0; 2004 23.5; 2005 Est./Proj. 23.9 - Overall deficit (percent of GDP) 2/: 2001 -10.8; 2002 -8.9; 2003 -8.3; 2004 -8.2; 2005 Est./Proj. -8.2 - Total government debt (percent of GDP): 2001 103.2; 2002 105.6; 2003 105.8; 2004 105.4; 2005 Est./Proj. 100.7 - Exports (in millions of U.S. dollars): 2001 4,817; 2002 4,699; 2003 5,133; 2004 5,757; 2005 Est./Proj. 6,098 - Imports (in millions of U.S. dollars): 2001 5,974; 2002 6,105; 2003 6,673; 2004 8,000; 2005 Est./Proj. 9,171 - Current account balance (in millions of U.S. dollars): 2001 -179; 2002 -236; 2003 -74; 2004 -648; 2005 Est./Proj. -1,257 - Current account balance (in percent of GDP): 2001 -1.1; 2002 -1.4; 2003 -0.4; 2004 -3.2; 2005 Est./Proj. -5.6 - Capital and financial account balance (in millions of U.S. dollars): 2001 535; 2002 444; 2003 722; 2004 635; 2005 Est./Proj. 1,132 - Of which: direct investment 3/ (in millions of U.S. dollars): 2001 172; 2002 186; 2003 201; 2004 227; 2005 Est./Proj. 276 - Gross official reserves (excluding ACU balances, in millions of U.S. dollars): 2001 1,183; 2002 1,560; 2003 2,146; 2004 1,833; 2005 Est./Proj. 2,083 - Gross official reserves (in months of prospective imports): 2001 2.0; 2002 2.4; 2003 2.8; 2004 2.1; 2005 Est./Proj. 2.2 - Real effective exchange rate (percent change, period average): 2001 1.7; 2002 0.1; 2003 -4.9; 2004 -4.7; 2005 Est./Proj. ... - External debt (percent of GDP): 2001 60.8; 2002 62.6; 2003 64.1; 2004 62.8; 2005 Est./Proj. 58.9 - Debt service (in percent of goods and services exports): 2001 14.3; 2002 12.3; 2003 10.9; 2004 9.9; 2005 Est./Proj. 10.2 - Broad money growth (annual percent change) 5/: 2001 13.6; 2002 13.4; 2003 15.3; 2004 19.6; 2005 Est./Proj. 15.0 - Of which: net credit to government: 2001 36.8; 2002 -4.2; 2003 -8.7; 2004 25.1; 2005 Est./Proj. 0.1 - Of which: credit to the private sector: 2001 8.9; 2002 12.0; 2003 16.9; 2004 22.1; 2005 Est./Proj. 21.0 - Interest rate (percent, end of period) 6/: 2001 12.9; 2002 9.9; 2003 7.4; 2004 7.3; 2005 Est./Proj. 10.0 *Source: IMF staff report and annexes contained in the referenced document.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05335.pdf_