Transcript of a Press Conference on Sri Lanka: Eighth Review Under the Stand-By Arrangement
July 23, 2012with Koshy Mathai
Sri Lanka and Maldives
23 July 2012
Mr. Mathai: Thank you for coming. I appreciate your being here. We called this press conference to announce that the IMF program with Sri Lanka was completed on Friday. The Board met to consider the Eighth and final Review of the Stand-By Arrangement, and they considered it positively—they completed the review, and they released $415 million more. That brings the total disbursements up to about $2½ billion, which was the total expected amount.
This is the first time, as the Sri Lankan authorities have emphasized in the past, that Sri Lanka has successfully completed an entire IMF program. And that’s really something to celebrate. There have been some real achievements. Growth has been quite strong for the last few years. Inflation has come down; we’ve had an extended period of single-digit inflation—something we’ve not had for a while. Reserves have been built up quite substantially relative to where they started in 2009. And of course the fiscal deficit and the debt ratio have also come down.
But against that good backdrop, of course, not everything has been smooth. Fiscal policy was looser than expected early on in the program, and then there was a delay in the program while the authorities brought fiscal policy back in line with the original goals that they had laid out. And last year, of course, we saw a delayed adjustment to the current account deficit pressures that were building up. But after that period, we saw earlier this year a very firm policy response to the situation in the economy, and the authorities have now moved to a very flexible policy framework which stands the country in good stead as it moves forward and faces pressures.
There’s no doubt that those policy responses earlier this year have meant short-term pain in the economy. There’s no doubt about that. But looking forward we’re convinced that these sorts of adjustments, and this sort of flexible policy management, will put the economy in a good position to enjoy sustainable growth going forward. We see a future of sustainable progress for Sri Lanka, with this flexible policy framework, and really we’re quite optimistic—as we always have been—about Sri Lanka’s long-term growth prospects.
The next full-fledged mission will be later this year—the precise timing is not certain. The team from Washington will visit to do the so-called Article IV consultation—that is the annual or biannual general economic check-up that the IMF does with all member countries. And at the same time, as the authorities have indicated in their Letter of Intent, which is now—or soon will be—on both the IMF and CBSL websites, there probably will be discussions of a future IMF program to follow this one.
Let me stop there, and I’m happy to take any questions you may have.
Questioner: Koshy, why is the tenor of your loans so very short relative to, say, the World Bank?
Mr. Mathai: That basically speaks to the purpose of the IMF. The IMF is meant to help countries that find themselves facing short-term balance-of-payments problems by lending, helping to strengthen the currency, and providing confidence to the economy. It’s not meant as a long-terms means of support, as in the case of the World Bank, ADB, JICA, or any of these other agencies. They are focused on long-term development and they have lending facilities that match that purpose. But we’re a short-term stabilization agency, and our lending arrangements match that role.
Questioner: Another question, Koshy—how sustainable is this currency appreciation sustained by borrowings?
Mr. Mathai: Currency movements are always going to be affected not only by the trade balance—that is, the flow of goods and services in and out of an economy—but also by capital flows. If there’s a huge flood of capital coming into an economy, there will be pressure on the domestic currency to appreciate. And similarly, if there’s a capital outflow, you’ll see pressure for depreciation. And we’ve seen those pressures here in Sri Lanka over the past few years.
You seem to be asking for a prediction on the rupee, but it’s very hard to make such a call, since it’s very difficult to predict capital flows and their sustainability. We were taught very early in our careers at the IMF not to attempt exchange rate predictions—especially over the short term. You just have to look at the underlying macro policies and hope that they are sustainable to support the economy.
Questioner: Do you have a view on whether the rupee is overvalued?
Mr. Mathai: There are models that economists run—as you know, being an economist yourself—to measure overvaluation, but those models are sometimes a bit difficult to interpret since they don’t account perfectly for capital flows. That’s partly what I was trying to get at in my previous response.
It’s difficult to say with any great degree of certainty whether a currency is overvalued or not. I suppose we would say that last year, the rupee was overvalued to some extent. Now there’s been a correction. Whether it remains overvalued is unclear—I haven’t run the numbers recently enough to relate that to you—but what I can say is very important is that we’ve now got a flexible policy framework at hand, which means that, in a sense, it doesn’t matter what the exchange rate level is right now because there’s a commitment on the part of the authorities to let that rate move to reflect market fundamentals. If the market is judging—whether it’s because there’s a higher demand for imports than expected or lower export performance or weaker or stronger capital inflows—if the market judges that there’s a need for the rupee to move, we now have in place a policy framework that will allow that to happen. And that gives us a lot of confidence, going forward, that we won’t have a repeat of the sort of problems that we’ve seen in the past, with reserves running down in defense of a certain exchange rate level.
Questioner: Doctor, you’ve been emphasizing the importance of deepening the foreign exchange market for a long time, and even in the last statement this was mentioned. Could you elaborate on this? What are the steps that the Central Bank should take?
Mr. Mathai: One thing is that over time, as the financial sector becomes more complex and sophisticated, you’ll see some natural increase in volumes and a deepening of the market. Some of the recent debate has been on these particular measures that were brought in a few months ago, in terms of limiting the banks’ net open positions in foreign exchange and restricting the access of agents in the economy to forward contracts in foreign exchange.
Those kinds of measures have a role in terms of preventing market manipulation. But I think there’s a very fine line between manipulation and speculation. Sometimes we throw these words around as if they’re the same thing. Speculation is not all bad. Speculation is a normal part of a market’s functioning, and it sometimes reflects market participants’ simply expressing their views on the right prices—in this case, the right exchange rate levels.
There’s nothing inherently bad about speculation, but there is something bad about market manipulation. And in our efforts to stamp out manipulation, we should be careful not to introduce measures that protect the level of the exchange rate at the cost of introducing extra volatility in that rate by preventing normal price-discovery mechanisms from working. The Central Bank has already expressed its desire, over time, as conditions become more settled, to remove some of those restrictions and to move toward a more flexible market with more liquidity and less volatility, which would be a better situation for everybody.
Questioner: Could you also elaborate on this Extended Fund Facility that the Central Bank is expecting to discuss with you?
Mr. Mathai: It’s hard to give many more details because we really had only very preliminary discussions of this during the last mission. It’s going to be during the next mission that all the issues—including the precise type of arrangement, its length, the size of the financing, etc.—will be discussed.
But I think that part of the Central Bank’s thinking is that they’ve had a Stand-By Arrangement that has been relatively successful—some bumps along the road, but generally, quite successful. And what they’d like to do now is move to a new type of arrangement—a higher form of engagement—where they’re able to focus on the macroeconomic goals that they already have—building up reserves further, tightening the fiscal deficit further, keeping monetary policy on an even keel—while at the same time giving themselves the space to explore some of the other areas they want to get into more, like revenue administration, public financial management, and state enterprise reform. Some of these could be areas they would address within the context of a program. How exactly that would be done, and what exactly this Extended Fund Facility would look like, is hard to tell right now.
Questioner: Is the peace dividend working, Koshy?
Mr. Mathai: Well, it’s difficult for me as an economist to comment on non-economic things, so let me focus on the economy…
Questioner: I mean is the peace dividend working in terms of FDI?
Mr. Mathai: Well, FDI has gone from $500 million to $1 billion, and this year perhaps to $1½ billion—still very low levels, but there has certainly been growth. Looking beyond FDI, we’ve seen the economy growing quite fast—it will slow down this year, but we’re still talking about relatively decent growth. We’ve seen inflation coming down. We’ve seen reserves built up. These all are manifestations of a peace dividend, in a way, because there wouldn’t have been the space for this sort of focus on macroeconomic policies if there were still this massive issue of the war going on.
Questioner: Do you see the depreciation as hurting lower- and middle-class people in the economy?
Mr. Mathai: Yes, I think it hurts people of all income levels, because certainly there’s a pass-through of the exchange rate to domestic prices. There’s no doubt that a weakening of the rupee could…could, and can, and does increase the cost of living in terms of the prices of imported goods. On the other hand, we would all as consumers like the exchange rate to be one rupee per dollar—that would make the cost of imports very affordable, but you’d almost immediately see reserves at the Central Bank being depleted. You would see a very quick, abrupt, and difficult adjustment if we tried to implement that kind of policy.
So what the Central Bank has done now is to say, look, there is a natural balance in the market between the supply of, and the demand for, dollars. And we’re going to let the price of the dollar—which is essentially what the exchange rate is—reflect the underlying fundamentals. And using that exchange rate as something of a shock absorber allows the economy to respond to shocks from the global economy that much easier.
So yes, there is pain in the short term. And that’s why an earlier and smoother adjustment to these policies would have been more easily digested by people, rather than having to do it all overnight, in one fell swoop. But the important thing is that the authorities have moved in this very decisive way toward a flexible framework. What does this mean? It means that should we have some difficulty—for instance, if European growth slows down dramatically and our exports take a hit—our exchange rate would be able to adjust, and that, over time, would help to boost the economy, since a weaker rupee would give an impetus to exporters. That sort of beneficial shock absorber isn’t there if you keep the exchange rate fixed.
The bottom line is that yes, there are costs, but they are unavoidable costs, and they are costs that help the economy to get stronger and healthier in the long term, which helps to create jobs and improve people’s welfare.
Mr. Mathai: I see lots of cameras but am not hearing questions!
Questioner: OK, I would like to know whether there were any conditions involved in releasing the final tranche.
Mr. Mathai: You’ve seen the Letter of Intent—or you very soon will see it—and all the conditions are laid out there. It’s the same sorts of things that were there throughout the program, where the government says we’re going to build up reserves to a certain level, we’re going to keep the deficit on a certain track, and we’re going to run monetary policy in a certain way. And the most important of those for this review was the reserves target.
Mr. Mathai: Don’t feel shy! Well, if that’s it, I’ll call an end to the press conference. Thanks for coming, and I’m always available for any follow-up questions.