Key Questions on Sri Lanka

Last Updated: November 18, 2016

On June 3, 2016, the IMF Executive Board approved a request from Sri Lanka for a three-year US$1.5 billion (185 percent of quota) financial arrangement under the Extended Fund Facility (EFF). The IMF program supports the government’s economic reform agenda to reduce the fiscal deficit, rebuild foreign exchange reserves, and introduce a simpler, more equitable tax system.

Q1. Why did Sri Lanka need IMF assistance?

Sri Lanka has gone through a significant political transition amid an increasingly difficult external environment. Two major elections in 2015 brought a new coalition government to the helm with an agenda to bring major constitutional changes and improve governance and transparency. At the same time, Sri Lanka’s economy began to show signs of strain also from internal challenges including low tax revenues.

In this context, the government requested financial assistance from the IMF earlier this year, which was approved by the Executive Board of the IMF in June. The goal of the government’s program, which is supported by IMF assistance, is to restore macroeconomic stability and promote inclusive growth by adopting a reform strategy. One important outcome of the reform would be to increase revenues, which in turn would enable more spending on health, education and social services targeted towards the poor and vulnerable.

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Q2. What type of financial assistance does Sri Lanka have? How does it work?

Sri Lankan authorities requested a three-year Extended Fund Facility (EFF) to support their economic program over 2016–19. In June, the IMF Board approved the request for about US$1.5 billion. About US$170 million were disbursed immediately after the approval in June, and the rest is to be disbursed semi-annually, conditional on the completion of program reviews.

To provide some background, the recently approved EFF is the IMF’s 15th program arrangement with Sri Lanka. The previous arrangement (a Stand-By Arrangement approved in 2009) was initiated at the onset of the global financial crisis and was successful in averting an acute external shock. At this juncture, with the strong focus on the government’s structural reform agenda and intensive technical assistance for capacity building, we believe the EFF is a better suited instrument for Sri Lanka. Given that structural reforms often take time to implement and bear fruit, the engagement under an EFF and its repayment period are longer than most Fund arrangements.

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Q3. What is in the reform program?

The main goal of the government’s reform program is to return the country to a path of strong strong and inclusive growth with macroeconomic stability, by addressing key vulnerabilities such as low revenue and foreign reserves. Achieving the goal will require structural reforms, while strengthening external and fiscal resiliency in a challenging global environment. The program rest on several pillars, explained on this infographic this infographic.

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Q4. Why is tax reform needed?

Sri Lanka’s current tax revenues are among the lowest in the world as a share of income. Low revenues force a government to fund its expenditure needs by borrowing domestically or externally, but Sri Lanka’s government debt is already at a high level. To provide essential services without adding to the debt excessively, the government needs to raise tax revenues from those better able to contribute.

In the past, fiscal consolidation in Sri Lanka was mainly implemented through spending cuts, as revenues consistently fell short of targets and kept declining as a share of income. Breaking from the past, authorities now aim to implement a well-designed fiscal consolidation based on both expenditure efficiency and revenue increase. It will enable the government to devote more resources to health, education, infrastructure and other social spending needed to ensure growth, a steady reduction in poverty, and continuous improvement in social development indicators.

In this context, in March 2016 the cabinet approved a number of measures aimed at putting revenues on an increasing path. VAT rate increases are part of these measures that support spending programs without adding excessively to the debt. Going beyond the immediate needs, the program also includes reform efforts to shift the source of taxation, including by reducing the excessive number of exemptions which erode the tax base. In this regard, ongoing work on redrafting the Inland Revenue Act is critical for creating a more transparent, fair and even-handed taxation.

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Q5. Does the economic program unfairly increase the burden on the poor?

Protecting the poor and vulnerable is an integral part of the program. Firstly, the program aims to increase the revenue so that the government can spend more on social and development programs. Secondly, the program supports transparency measures in publishing lists of tax holidays, exemptions, and rate reductions, as well as non-commercial obligations of state-owned enterprises, for better public understanding of how their taxes are spent. This in turn can help eliminate ineffective public spending. For example, replacing ill-targeted subsidies with cash transfers for the poor. Thirdly, the program supports ongoing automation efforts to help manage government’s resources more efficiently.

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Q6. Would the IMF loan increase Sri Lanka’s already high debt?

One of the main objectives of the program is to reduce the debt burden without unduly large adjustments, and the IMF's advice is anchored in the analysis of a country's capacity to finance its policy agenda. Sri Lanka’s program aims to strengthen the government finances and reduce the need for future borrowing, thereby contributing to the decline of debt relative to the size of the economy. In other words, with sufficiently reduced borrowing needs, debt would grow slower than income, and the debt burden would decline over time and reduce the risk of an economic crisis that could result from a high debt.

In addition, the IMF along with other development partners and multilateral institutions provides extensive training programs and technical assistance to strengthen debt management practices to help make the country's officials more attuned with the fast-changing global environment.

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