Public Information Notice: IMF Concludes 2002 Article IV Consultation with Sri Lanka

IMF News, September 11, 2002

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Bibliographic details

• Published: September 11, 2002

Background and recent macroeconomic developments

• The Executive Board concluded the Article IV consultation with Sri Lanka on September 3, 2002; the Public Information Notice is dated September 11, 2002.
• Over the last two decades Sri Lanka:
  • experienced steady growth despite a civil conflict ongoing for over 19 years;
  • liberalized financial markets, increased outward orientation, and diversified exports;
  • faced large fiscal imbalances that averaged more than 9 percent of GDP during this period, leading to prolonged periods of public dissaving.
• Policy actions and outcomes:
  • The Central Bank of Sri Lanka (CBSL) floated the exchange rate on January 23, 2001 and implemented a stabilization program supported by a Stand-By Arrangement approved April 20, 2001.
  • By end-June 2001 the program had met all its key objectives, including a narrowed current account deficit and rebuilt net international reserves with a broadly stable exchange rate.
  • Political developments and delayed corrective policies in the second half of 2001 weakened program implementation.
• 2001 shocks and effects:
  • GDP contracted by about 1½ percent in 2001—the first contraction since independence in 1948.
  • Agricultural output declined more than 3 percent due to drought; low reservoir levels caused widespread power cuts.
  • The official Colombo Consumer Price Index (food items account for 65 percent of the CCPI basket) increased 10¾ percent in the 12 months to December 2001.
  • External and domestic shocks and delays in external financing led private capital flows (including privatization receipts) to fall below expectations.
• Fiscal and monetary outcomes in 2001:
  • The fiscal deficit rose in 2001 by 1 percentage point to almost 11 percent of GDP.
  • Revenue fell due to slower growth, election-related tax cuts, and lack of tax administration reform; politically sensitive spending on Samurdhi and subsidies was not tackled.
  • Program target on borrowing by public corporations was exceeded due to large losses by the Ceylon Electricity Board (CEB).
  • The CBSL progressively reduced policy rates during the last three quarters of 2001; by end-2001 the reverse repo rate was 900 basis points lower than its rate in January 2001.
  • Broad money growth slightly exceeded the 2001 target of 13½ percent.
• Political and policy shifts in 2002:
  • After the December elections, the United National Front (UNF) government committed to fiscal consolidation and structural reforms; a strong budget was presented in March 2002.
  • Substantial macro stabilization progress occurred in first half of 2002: headline inflation in the range 8-9 percent for the 12 months to August (consistent with the year-end target), GDP growth bottomed out in Q1, the rupee remained broadly stable, fiscal consolidation began, and public corporations’ financial positions stabilized January–June 2002.
  • A permanent ceasefire was in operation and peace talks were expected to commence in Thailand in September.

Economic prospects and projections

• Growth and inflation outlook for 2002:
  • Modest growth of 3½-4 percent is expected in 2002, reflecting gradual recovery in external demand.
  • Headline inflation through August indicates the annual inflation target of 7-8 percent is achievable.
  • Nominal interest rates are expected to decline during the second half of 2002 as inflation comes down and fiscal consolidation takes hold.
• External sector outlook:
  • Trade developments in early 2002: the trade deficit narrowed significantly during the first four months of 2002 before increasing in May.
  • Official reserves continued to rise steadily through August.
  • Preliminary data suggest improved prospects for portfolio and FDI flows given recent peace progress.
  • Gross official reserves are projected to rise to $1¾ billion, about 2¾ months of imports of goods and services.
• Fiscal outlook:
  • Fiscal data through June suggest the 8½ percent deficit target is achievable.
  • Continued fiscal consolidation is emphasized as central to achieving external and fiscal sustainability.

Executive Board assessment and policy recommendations

• Overall assessment:
  • Sri Lanka is at a critical juncture; despite recent improvements, the macroeconomic situation remains fragile and sustainable high growth requires major adjustments.
  • Resolution of the civil conflict is closely intertwined with the scope for generating growth opportunities.
• Positive notes:
  • The cease-fire is already providing an economic boost via lower security spending and renewed activity in the North and East.
  • The government achieved key macro objectives under the Stand-By Arrangement: reserves rebuilt, fiscal consolidation begun, and several structural reforms initiated, especially in the public sector.
• Risks identified by Directors:
  • Risks of drought and long-term electricity shortages remain major concerns.
  • Political uncertainty could slow peace momentum and undermine the fiscal position.
• Fiscal policy guidance:
  • Directors welcomed the authorities’ intention to press ahead with fiscal consolidation.
  • They welcomed the introduction of the new VAT and stressed continued reform of the tax system and administration.
  • To contain current spending, the government should stand firm on disciplined wage and recruitment policies and defense spending; the Defense Spending Monitoring Committee was welcomed.
  • Authorities should avoid having subsidies and transfers exceed budget provisions and should resist further broad cost-of-living relief measures, including tax cuts and administered price adjustments, that could undermine fiscal and public corporation viability.
  • If needed, authorities should be ready to take additional measures to ensure that broad fiscal goals are achieved.
  • The 2003 budget will need to continue fiscal consolidation, with a focus on controlling current expenditures; Directors urged extending VAT to the retail level and removing exemptions.
  • The proposed unified revenue authority is expected to enhance tax administration.
• Monetary and exchange rate guidance:
  • Firm fiscal consolidation would enable the CBSL to maintain a prudent monetary stance while providing sufficient and affordable bank credit to the private sector.
  • Directors urged the CBSL to avoid further significant easing until fiscal consolidation has taken hold.
  • Directors endorsed the authorities’ current exchange rate policy and agreed that CBSL intervention should continue to aim primarily at realizing the net foreign asset path of the monetary program, with only limited smoothing of short-term exchange rate volatility.
• Financial sector and structural reform guidance:
  • Directors emphasized the need to strengthen the banking system and CBSL’s supervisory function to support a gradual and sequenced capital account liberalization.
  • They welcomed decisions to tackle problems at Peoples Bank and to improve Bank of Ceylon performance, with IMF and World Bank technical assistance.
  • Authorities were encouraged to finalize the draft law on anti-money laundering in light of FSAP recommendations.
  • Directors endorsed the authorities’ structural reform agenda and encouraged deeper structural reforms, including:
  • Restructuring the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) and inviting private participation under an appropriate regulatory framework.
  • More ambitious privatization to provide resources for government debt reduction and to support long-term growth and private sector development.
  • Medium-term measures: further public expenditure and financial sector reform, restructuring public sector institutions, strengthening tax collection agencies, and labor market reforms to improve public sector effectiveness and promote private sector growth.
• Data and dissemination:
  • Directors noted that data quality and timeliness are satisfactory for surveillance and looked forward to Sri Lanka subscribing to the Special Data Dissemination Standard (SDDS).

Key statistics (selected indicators as presented)

• Domestic economy (Change in real GDP, percent):
  • 1995: 5.5
  • 1996: 3.8
  • 1997: 6.4
  • 1998: 4.7
  • 1999: 4.3
  • 2000: 6.0
  • 2001: -1.4
• Change in CCPI (percent, end of period):
  • 1995: 11.5
  • 1996: 16.8
  • 1997: 10.7
  • 1998: 3.7
  • 1999: 4.0
  • 2000: 10.8
  • 2001: (value not listed in table)
• National savings (percent of GDP):
  • 1995: 19.5
  • 1996: 19.0
  • 1997: 21.5
  • 1998: 23.4
  • 1999: 23.5
  • 2000: (not listed)
• Gross investment (percent of GDP):
  • 1995: 25.7
  • 1996: 24.2
  • 1997: 24.4
  • 1998: 25.1
  • 1999: 27.3
  • 2000: 28.0
  • 2001: 22.0
• Fiscal position (percent of GDP):
  • Overall deficit (excluding grants and privatization receipts):
  • 1995: -10.1
  • 1996: -9.4
  • 1997: -7.9
  • 1998: -9.2
  • 1999: -7.5
  • 2000: -9.9
  • 2001: -10.9
• External economy (in millions of U.S. dollars):
  • Exports:
  • 1995: 3,807
  • 1996: 4,095
  • 1997: 4,639
  • 1998: 4,798
  • 1999: 4,610
  • 2000: 5,522
  • 2001: 4,817
  • Imports:
  • 1995: 5,311
  • 1996: 5,439
  • 1997: 5,864
  • 1998: 5,889
  • 1999: 5,979
  • 2000: 7,320
  • 2001: 5,974
  • Current account balance (excl. official transfers, in millions of U.S. dollars):
  • 1995: -847
  • 1996: -727
  • 1997: -437
  • 1998: -278
  • 1999: -586
  • 2000: -1,090
  • 2001: -391
  • Current account balance (in percent of GDP):
  • 1995: -6.5
  • 1996: -5.2
  • 1997: -2.9
  • 1998: -1.8
  • 1999: -3.7
  • 2000: -6.6
  • 2001: -2.5
  • Capital and financial account balance:
  • 1995: 704
  • 1996: 457
  • 1997: 600
  • 1998: 414
  • 1999: 372
  • 2000: 445
  • 2001: 536
  • Of which, direct investment:
  • 1995: 57
  • 1996: 119
  • 1997: 430
  • 1998: 193
  • 1999: 177
  • 2000: 176
  • 2001: 172
  • Gross official reserves (less ACU balances):
  • 1995: 1,989
  • 1996: 1,855
  • 1997: 1,922
  • 1998: 1,892
  • 1999: 1,530
  • 2000: 911
  • 2001: 1,182
  • Change in the real effective exchange rate (annual percent change):
  • 1995: -1.1
  • 1996: 10.4
  • 1997: 13.4
  • 1998: -10.5
  • 1999: -1.2
  • 2000: 0.6
• External debt and debt service:
  • External debt (in percent of GDP):
  • 1995: 75.0
  • 1996: 68.6
  • 1997: 62.3
  • 1998: 61.0
  • 1999: 63.2
  • 2000: 60.8
  • 2001: 61.8
  • Debt service (in percent of goods and services exports):
  • 1995: 15.3
  • 1996: 13.3
  • 1997: 15.2
  • 1998: 14.7
• Financial variables:
  • Broad money growth (annual percent change, including foreign currency banking units):
  • 1995: 21.1
  • 1996: 11.3
  • 1997: 15.6
  • 1998: 13.2
  • 1999: 12.9
  • 2000: 13.6
  • 2001: (table shows 13.6 for 2000 and a blank for 2001)
  • Interest rate (in percent; e.o.p., three-month treasury bill rate):
  • 1995: 19.3
  • 1996: 17.5
  • 1997: 10.2
  • 1998: 12.0
  • 1999: 11.8
  • 2000: 18.0

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Sri Lanka (September 11, 2002).

References

• Sri Lanka and the IMF
• Public Information Notices
• Article IV
• https://www.imf.org/en/home