## Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Sri Lanka _IMF News, November 13, 2006_ ## Source details **Canonical URL:** [Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Sri Lanka](https://www.imf.org/en/news/articles/2015/09/28/04/53/pn06132) ## Other formats - [Markdown version](/en/news/articles/2015/09/28/04/53/pn06132/index.md) - [Structured JSON version](/en/news/articles/2015/09/28/04/53/pn06132/index.json) - [Bundle manifest](/en/news/articles/2015/09/28/04/53/pn06132/bundle-manifest.json) ## Bibliographic details - Published: November 13, 2006 --- ### Background and recent macro developments - Real GDP increased by 6 percent in 2005 and by a further 8 percent in the first quarter of 2006. - Growth drivers: domestic demand, improved agricultural performance, strong tsunami-reconstruction efforts, and robust service sector growth. - Inflation developments: - Declined from 18 percent in January 2005 to 3.5 percent at end-2005. - Has risen since early 2006 due to fast credit growth, pass-through of higher oil prices, and increases in wages and pension payments. - Security and political risks: - Recent escalation of hostilities and deterioration in the security situation following unsuccessful June peace talks. - Weakening in confidence could affect investment going forward. - Government and main opposition party (UNP) signed a Memorandum of Understanding on five key policy areas (the ethnic conflict, electoral reform, good governance, social development, and structure for collaboration). ### Fiscal position and public debt - Fiscal outcomes: - 2005 fiscal deficit widened to 8.7 percent of GDP, larger than budgeted, mainly because of tsunami-related spending. - Excluding tsunami-related flows, the 2005 budget deficit was 7.5 percent of GDP (compared to 8.2 percent of GDP in 2004). - First half of 2006: fiscal deficit contained through adjustment of capital expenditures; tax revenue grew 23 percent (below the 27 percent budget target). - Sizable overruns on recurrent expenditure from oil subsidies, pensions, and additional security and humanitarian spending. - Debt dynamics: - Total public debt declined by 11 percent of GDP (to 94 percent of GDP) in 2005. - Sri Lanka received a Fitch rating of BB- in December 2005; outlook revised from stable to negative amid renewed security concerns. - Government put planned global bond issuance on hold and mobilized resources from domestic investors during April-September 2006. - Fiscal targets endorsed by Directors: - Adhering to the 2006 budget target and reducing the fiscal deficit target to 7½ percent of GDP in 2007. - Plan to bring the fiscal deficit down to 5 percent by 2010, to be achieved through revenue enhancing policies and rationalization of current spending. - Recommendation to limit further recourse to commercial borrowing for budgetary purposes. ### External sector and reserves - Current account and balances: - Current account deficit narrowed in 2005 but projected to increase by end-2006 due to higher oil prices and strong demand for non-oil imports. - Tsunami-related inflows slowed in 2006 while the debt service burden rose. - Reserves and exchange rate: - Gross official reserves hovering around $2.4 billion, equivalent to 2.4 months of imports and 86 percent of short-term debt. - Rupee-dollar exchange rate weakened somewhat since the second half of 2005. - Real effective exchange rate (REER) appreciated by 2 percent during the same period (reflecting high domestic inflation relative to trading partners). - Board recommendations: - Limit intervention in the foreign exchange market and allow greater flexibility in the exchange rate to help safeguard external reserves and maintain competitiveness. ### Monetary policy, credit growth, and financial sector soundness - Monetary tightening: - Central bank raised its policy rate five times (cumulative 2 percentage points) during November 2004-December 2005, and by another 1 percentage point recently. - Interest rates of government securities increased by about 1¼ percentage points since September 2006. - Reserve money growth reduced to 16 percent in August 2006 (from 21 percent in April 2006). - Credit and banking: - Credit growth to the private sector (including housing loans) about 23 percent in August 2006, contributing to demand pressures. - NPL ratios of state-owned banks declined from 18 percent in 2003 to 8 percent in June 2006, reaching similar levels to domestic banks. - Capital adequacy ratios improved (to 8 percent of total assets). - Concerns remain about fast credit growth and credit quality. - Regulatory progress: - Steps taken to further enhance the regulatory and supervisory framework, including plans to adopt the Basel II capital accord by 2008. - Directors welcomed an FSAP update planned for 2007 and encouraged timely implementation of the Basel Core Principles. ### Structural priorities and sectoral issues - Infrastructure: - Priority on power and roads; emphasis on restoring financial viability of the power sector and expanding generation capacity using more cost-efficient sources (including coal power). - Development forum planned for early 2007. - Energy sector: - Encourage efforts to reduce quasi fiscal losses of energy companies through electricity tariff adjustments, balance sheet restructuring, and enhanced operational efficiency. - Need for safety nets to protect low-income households and strengthened regulatory guidelines to broaden investor base for long-term energy financing. - Trade and taxation: - Directors encouraged an open trade regime with minimum distortions; curtail the cess regime and integrate fees in the tariff structure. - A single low tariff structure could help maximize efficiency. - Importance of further tax system reform and financial sector reforms to raise growth and reduce vulnerability. - Social policy: - Commended improvements in social indicators over the last decade and emphasis on reducing rural poverty and narrowing rural-urban income inequality. - Welcomed extensive consultations with stakeholders to build consensus for the national development strategy. - Data and governance: - Encouraged improved quality and coverage of fiscal statistics and resolution of remaining issues to meet SDDS requirements. - Welcomed passage of anti-money laundering legislation in 2006. ### Executive Board assessment — policy guidance - Near-term policy focus: - Reduce inflation and external vulnerabilities. - Further monetary tightening may be needed to contain credit growth and anchor inflation expectations. - Fiscal consolidation: - Strong fiscal adjustment critical to avoid adverse debt dynamics and preserve ability to meet poverty reduction and Millennium Development Goals. - Develop a well-defined medium-term fiscal policy framework and improvements to debt management. - Financial stability: - Further strengthen prudential standards and monitoring of systemic risks. - Further restructuring of two large public banks should focus on improving lending practices and strengthening capital adequacy. ### Selected economic indicators (key figures) - Real GDP growth (percent): 2002: 4.0; 2003: 6.0; 2004: 5.4; 2005: 7.0; 2006 Proj.: ... - Inflation (percent, end of period, Sri Lanka consumer price index): 2002: 6.6; 2003: 1.0; 2004: 16.8; 2005: 3.6; 2006 Proj.: 12.0 - National savings (percent of GDP): 2002: 19.5; 2003: 21.6; 2004: 23.7; 2005: 22.6 - Gross investment (percent of GDP): 2002: 21.2; 2003: 22.1; 2004: 25.0; 2005: 26.5; 2006 Proj.: 27.3 - Revenue (percent of GDP): 2002: 16.5; 2003: 15.7; 2004: 15.3; 2005: 16.1; 2006 Proj.: 17.0 - Expenditure (percent of GDP): 2002: 25.4; 2003: 24.0; 2004: 23.5; 2005: 24.7; 2006 Proj.: 26.0 - Overall deficit (percent of GDP) 2/ (Excluding grants and privatization receipts): 2002: -8.9; 2003: -8.3; 2004: -8.2; 2005: -8.7; 2006 Proj.: -9.1 - Total government debt (percent of GDP): 2002: 105.6; 2003: 105.8; 2004: 105.4; 2005: 93.9; 2006 Proj.: 89.6 - Exports (in millions of U.S. dollars): 2002: 4,699; 2003: 5,133; 2004: 5,757; 2005: 6,347; 2006 Proj.: 6,950 - Imports (in millions of U.S. dollars): 2002: 6,105; 2003: 6,673; 2004: 7,999; 2005: 8,863; 2006 Proj.: 10,501 - Current account balance (in millions of U.S. dollars): 2002: -236; 2003: -74; 2004: -646; 2005: -650; 2006 Proj.: -1,281 - Current account balance (in percent of GDP): 2002: -1.4; 2003: -0.4; 2004: -3.2; 2005: -2.8; 2006 Proj.: -4.7 - Capital and financial account balance (in millions of U.S. dollars): 2002: 444; 2003: 722; 2004: 632; 2005: 1,224; 2006 Proj.: 1,556 - Of which, direct investment 3/ (in millions of U.S. dollars): 2002: 186; 2003: 201; 2004: 227; 2005: 234; 2006 Proj.: 324 - Gross official reserves (excluding ACU balances, in millions of U.S. dollars): 2002: 1,560; 2003: 2,146; 2004: 1,833; 2005: 2,458; 2006 Proj.: 2,662 - Gross official reserves (in months of prospective imports): 2002: 2.4; 2003: 2.8; 2004: 2.2; 2005: 2.5 - Real effective exchange rate (percent change, period average) 4/: 2002: 0.1; 2003: -4.9; 2004: -5.1; 2005: 8.8 - External debt (in percent of GDP): 2002: 62.6; 2003: 64.1; 2004: 63.9; 2005: 55.4; 2006 Proj.: 49.2 - Debt service (in percent of goods and services exports) 5/: 2002: 12.3; 2003: 10.9; 2004: 10.1; 2005: 7.4; 2006 Proj.: 10.4 - Broad money growth (annual percent change) 6/: 2002: 13.4; 2003: 19.6; 2004: 19.1 - Of which, net credit to government: 2002: -4.2; 2003: 25.1; 2004: 11.9 - Of which, credit to the private sector: 2002: 16.9; 2003: 21.5; 2004: 20.7 - Interest rate (percent, end of period) 7/ (Three-month treasury bill rate): 2002: 9.9; 2003: 7.3; 2004: 11.8 *Public Information Notice (PIN) No. 06/132 — November 13, 2006. Executive Board concluded the Article IV consultation with Sri Lanka on October 25, 2006.* --- ## References - [Sri Lanka and the IMF](http://www.imf.org/external/country/LKA/index.htm) - [Public Information Notices](https://www.imf.org/en/news/searchnews) - [https://www.imf.org/en/home](https://www.imf.org/en/home) _Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/pn06132_