Press Release No. 01/16

Press Release: IMF Approves US$253 Million Stand-By Arrangement For Sri Lanka

April 20, 2001

The Executive Board of the International Monetary Fund (IMF) today approved a 14-month stand-by credit for SDR 200 million (about US$253 million) for Sri Lanka to support the government's economic program for 2001-02. The decision will enable Sri Lanka to draw SDR 103 million (about US$131 million) from the IMF immediately.

In commenting on the Executive Board's decision, Shigemitsu Sugisaki, Deputy Managing Director and Acting Chairman, said:

"The program aims to restore macroeconomic stability through an improvement in the financial position of the public sector and the rebuilding of official reserves, supported by a flexible exchange rate. The program should also lay the foundation for a move to a higher sustainable growth path. To support these objectives, the government has strengthened macroeconomic policies and is developing a structural reform agenda that emphasizes fiscal consolidation, improvements in public administration, public enterprise restructuring, and improvements in the functioning of labor markets.

"Fiscal consolidation will be a key component of the program. Under the 2001 budget, the overall government deficit will be reduced from 9.8 percent of GDP in 2000 to 8.5 percent of GDP, with further reductions over the medium term to 5 percent. The budget target is to be achieved through increased tax revenue by widening the tax base and increasing tax rates, as well as lower security-related spending and strict expenditure controls. In addition, administered prices for petroleum products, public transportation, and utilities, have been adjusted to reflect changes in international oil prices, in order to reverse the buildup of losses in energy related public enterprises.

"The authorities adopted a floating exchange rate regime on January 23, 2001, and the rupee has since stabilized. To support its flexible exchange rate policy, the Central Bank of Sri Lanka has relaxed the regulations that were introduced temporarily to prevent unduly large fluctuations. Maintaining a flexible market-determined exchange rate is an important feature of the government's program. Continued progress with structural reform will be necessary to attract private investment, achieve high growth, and alleviate poverty over the medium term. In addition, there is an urgent need to accelerate privatization, strengthen the integrity of the banking sector and improve public administration, the financial position of public enterprises, and the labor market.

"The financing of the program will involve substantial contributions from the international financial institutions, official bilateral creditors, and the private sector. Financing from the World Bank and the Asian Development Bank will be used to support structural reform. The successful implementation of the program and the finalization of major structural reform plans, as well as progress in developing a poverty reduction strategy, could establish medium-term financial support from the Fund under the Poverty Reduction and Growth Facility," Mr. Sugisaki said.

ANNEX

Program Summary

After slowing in the aftermath of the Asian crisis, economic activity picked up from mid-1999 to the third quarter of 2000 (with annualized growth increasing to about 7 percent) because of recovery in Sri Lanka's main export markets, particularly for textiles, garments, and tea. Growth subsequently slackened, however, as poor monsoons affected agricultural output and the business environment worsened.

From the fourth quarter of 1999, macroeconomic problems emerged, and the rupee came under considerable pressure. Although exports grew strongly, the higher cost of oil imports, and increased military imports caused by an escalation of the civil conflict, resulted in a sharp increase in the external current account deficit in 2000. As a result, gross official reserves dropped to less than 1½ months of imports. Domestically, there was a substantial expansion in the fiscal deficit, which was accompanied by a sharp increase in interest rates of about 7 percentage points in 2000.

In light of these developments, the authorities have framed an economic program focused on fiscal consolidation and the rebuilding of reserves, supported by a restrained monetary policy and a flexible exchange rate.

Fiscal policy is aimed at reducing the overall deficit (before grants) by 1¼ percentage points to 8½ percent of GDP in 2001, mainly by means of increased revenue. The increased revenue would be generated largely from increased taxes on turnover, corporate income, and imports, as well as improved tax administration. Total expenditure is targeted to increase slightly as a substantial increase in spending on priority capital projects is expected to more than offset reductions in current expenditure. The reduction in current expenditure reflects lower security-related expenditure, a civil service wage constraint and hiring freeze, and strict expenditure controls. The 2002 budget would lower the deficit further, to 6¾ percent of GDP, based on a further widening of the tax base and continued improvements in tax administration, as well as reduced security-related expenditure.

Monetary policy restraint will be maintained in order to bring inflation down to single digits by the end of 2001, while rebuilding gross official reserves to about $1.5 billion. However, some reduction of interest rates could be expected in the latter part of the year as the impact of administered price increases and exchange rate depreciation diminishes. In support of the new floating exchange rate regime, the central bank will intervene in the foreign exchange market only to meet its reserve targets and to prevent undue fluctuations in the rate.

Structural reforms will be focused on improving the performance of the state sector through privatization and restructuring of public enterprises, enhancement of tax administration and improving the performance of GST for government revenue over the medium term. Other key reforms include improvements in the operations of the two state banks, rationalization of the civil service, reform of the civil service pension system, improvements in the functioning of labor markets, and the removal of remaining limits on inward foreign direct investment.

Sri Lanka joined the IMF on August 29, 1950, and its quota¹ is SDR 413.4 million (about US$524 million). Its outstanding use of IMF financing currently totals SDR 112 million (about US$142 million).