Sri Lanka- IMF Agreement

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Recently, the International Monetary Fund announced a staff-level agreement with the crisis ridden island nation of Sri Lanka. This announcement comes after the country’s economic situation worsened into one of its most serious since its independence in 1948.

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What is the current situation in Sri Lanka?

Even though the changes in the government has brought in some relief, there are everyday problems still plaguing the Sri Lankans:
- Sri Lankan families are skipping meals and also trying to keep up with the rapid inflation
- Kerosene prices rose from LKR 87 to LKR 340/ litre last month.
- Essential commodities, including medicines, are still in short supply.
- Doctors are raising concern about malnutrition among the children and the pregnant women’s inability to afford nutrition.
Several international organizations, including the UN, have launched initiatives to ensure food security in the country. Schools and colleges have reopened.
Over the last month, the fuel and LPG supply has improved after the government decided to repurpose the available funds (from the World Bank) for purchasing essential fuel and ration supply using a QR-code system.
Despite the temporary relief with respect to essential supplies, the crisis is still ongoing and shows no sign of letting up. According to the country’s central bank governor, the economic meltdown could lead to a record contraction of 8% in 2022.
Sri Lanka owes over $51 billion in foreign debt. Of this, $28 billion is to be repaid by 2028.
The IMF expects the country’s economy to shrink by 8.7% in 2022 while its inflation rises to over 60%.

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What has Sri Lanka’s done to address the situation?

The Sri Lankan President has put forth a budget aimed at:
- Boosting government revenue to 15% of GDP by 2025
- Reducing public sector debt
- Reigning in inflation
Other measures that the country is expected to adopt (according to the budget):
- Privatization of some 50 state-owned enterprises, including Ceylon Electricity Board, Ceylon Petroleum Corporation, and Sri Lankan Airlines
- Restructuring of the Board of Investment, now renamed as National Agency for Public Private Partnership
- Increasing VAT to 15% (currently 12%)
- Compulsory tax registration for people aged 18 years and above to increase the income tax collections
- Lowering of retirement age in government and semi-government organizations from 62-65 years to 60 years. Those above the age of 60 years and still working are to be retired by the year end.
- On the welfare side, the budget has increased payments to farmers, the elderly, the disabled and some categories of patients.
The country has already taken some significant steps:
- Floated the LKR (increased flexibility in exchange rate)
- Increased the interest rates
- Increased electricity tariffs
- Increased fuel prices
- Restored tax cuts introduced by previous government

What are the highlights of the staff level agreement?

The staff-level agreement is a formal arrangement between the IMF staff and the Sri Lankan authorities for a $2.9-billion package. This is to support the country’s economic policies with a 48-month arrangement under EFF (Extended Fund Facility).
This agreement is only a preliminary step i.e. still requires approval from the IMF management and its executive board.
The EFF is also conditional i.e. the country is required to take several immediate measures, deemed necessary by the IMF, for addressing the fiscal lapses and structural weaknesses.
Some of the required domestic policy measures include:
- Increasing fiscal revenue
- Safeguarding financial stability
- Reducing corruption vulnerabilities
Sri Lanka is also required to restructure its debt with its lenders. The IMF financial support will go through only after the country’s many official creditors give financing assurances on debt sustainability and after the government concludes a collaborative agreement with its private creditors.
Sri Lanka has many international creditors- like multilateral agencies, banks and asset managers- and also bilateral creditors- like India, Japan and China. These creditors need to agree to debt restructuring for the IMF package to come through.

How far will these funds help?

The IMF package, to be released in tranches over the next 4 years, is short of the $3 to $4 billion that Sri Lanka requires. It is less than what India has lent to Sri Lanka over the past 4 months.
Even if this package were to be released swiftly, subject to the country’s success with the ‘prior actions’ criteria, it cannot completely bailout the country’s economy.
However, the IMF loan is expected to improve the country’s credit ratings and improve creditors’ and investors’ confidence– which would help cater to the gaps between the tranches.
Some hold that the ‘prior actions’ requirement attached to the package will push the government to take necessary policy actions to increase revenue, reduce state spending and address corruption.

What is the way ahead?

The provisional agreement hasn’t come a day too soon, even as it awaits a final nod from the IMF Board and the even more difficult task of persuading the country’s creditors to agree to debt restructuring.
Japan, one of Sri Lanka’s creditors, has offered to initiate and organize multilateral negotiations on debt restructuring, on the country’s behalf. However, Beijing, the world’s largest bilateral lender, is expected to go it alone.
India, as another one of the creditors, has already demanded ‘creditor equality’ and ‘transparency’ in the process- seen as a veiled caution against preferential treatment of China.
The country’s creditors need to approach these negotiations with a cooperative spirit.
The country is also looking at more pain with regards to domestic economic measures– as required by the IMF. This is the 16^th such intervention by the agency in the island nation’s economy.
While it is possible to turn the economic meltdown into an opportunity to correct flawed model of economic development, short-term fixes with so much hardship are unlikely to be an ideal solution.
There are several structural issue in sectors like financial services, electricity, petroleum and telecom that need addressing. While some sectors are already witnessing some deregulation, it could do with a faster pace. The banks could also do with major recapitalization.
The country’s President has said that it will be atleast 2024 before the Sri Lankan economy gets back to its 2018 prosperity levels.
However, the government is responsible for building the economy’s fiscal strength and resilience. For this, it needs to introspect its high import reliance, the state of domestic production, prospects for improving exports and addressing wealth and income inequality.

Conclusion:

The IMF package, following final green flag, wouldn’t be able to address all of Sri Lanka’s money troubles. However, it could help boost creditor and investor confidence, which could in turn improve the country’s access to more funds. Meanwhile, policy measures being undertaken as part of ‘prior action’ is expected to see resistance and hardship, given the already dire straits the country is currently swimming in. Sri Lanka is looking at a long and hard road ahead before it can stand steadily on its feet.