IMF and Sri Lanka reach preliminary $2.9bn agreement

Sri Lanka's economy is expected to contract by 8.7 per cent in 2022 and inflation recently exceeded 60 per cent

A closed fuel station in Colombo. Sri Lanka faces its worst economic crisis since independence in 1948. AFP

The International Monetary Fund and Sri Lanka reached a preliminary $2.9 billion agreement to restore the stability of the economy and help the country manage its debt as it presses forward with structural reforms.

Debt relief from Sri Lanka’s creditors and additional financing from multilateral partners will be required to help ensure debt sustainability and close financing gaps, the Washington-based lender said.

“Financing assurances to restore debt sustainability, from Sri Lanka’s official creditors, and making a good-faith effort to reach a collaborative agreement with private creditors are crucial before the IMF can provide financial support to Sri Lanka,” the fund said.

The new arrangement is subject to the approval of the fund's management and executive board.

“Sri Lanka has been facing an acute crisis. Vulnerabilities have grown, owing to inadequate external buffers and an unsustainable public debt dynamic,” said the IMF's Peter Breuer and Masahiro Nozaki, who held talks with authorities in Colombo from August 24 to September 1.

“The April debt moratorium led to Sri Lanka defaulting on its external obligations, and a critically low level of foreign reserves has hampered the import of essential goods, including fuel, further impeding economic activity.”

Faced with its worst economic crisis since independence in 1948, as well as dwindling foreign currency reserves and a shortage of fuel and medicine, the island nation of 22 million people said in April that it was defaulting $51bn of external debt for the first time and missed interest payments on some of its sovereign bonds.

In 2021, Sri Lanka’s foreign debt was equal to 64.2 per cent of its gross domestic product and total debt was equal to 119 per cent of the country's GDP.

Sri Lanka's economy is expected to contract by 8.7 per cent in 2022. Inflation recently exceeded 60 per cent, affecting mostly the poor and vulnerable, according to the fund.

“The authorities’ programme, supported by the fund, would aim to stabilise the economy, protect the livelihoods of the Sri Lankan people and prepare the ground for economic recovery and [the promotion of] sustainable and inclusive growth,” the fund's officials said.

Sri Lankan authorities will need to raising fiscal revenue and consolidate their finances. The IMF programme mandates that the country put in place major tax reforms that will help to reduce income inequality.

A rallying cry among protesters is that Sri Lanka’s extremely low tax rates and tax exemptions, which primarily benefitted the wealthiest in the country, contributed to the economic crisis.

Under the IMF programme, the reforms include broadening tax base for corporate income tax and VAT, which will help the country to reach a primary surplus of 2.3 per cent of GDP by 2024, according to the fund's estimates.

Another element of the fund's programme is the introduction of cost-recovery based pricing for fuel and electricity to minimise fiscal risks arising from state-owned enterprises.

The government needs to boost social spending and improve the coverage of social safety nets to reduce the impact of the economic crisis on the poor and vulnerable.

About 5.7 million people in Sri Lanka need humanitarian assistance, with 4.9 million — 22 per cent of the population — being food insecure, according to the UN.

The government and central bank need to restore price stability through data-driven monetary policy action and fiscal consolidation, the fund said.

This requires phasing out financing from the central bank and boosting its independence, which will allow it to pursue a flexible strategy to bring inflation under control. A new Central Bank Act is a cornerstone of this strategy, the IMF said.

Under the fund's programme, Sri Lanka's central bank will need to rebuild its foreign reserves and restore a market-determined and flexible exchange rate.

Lenders need to be adequately capitalised and financial sector safety nets and regulatory standards must be enhanced by the revised Banking Act, the IMF said.

Authorities will need to reduce corruption, a major catalyst for the country's economic meltdown.

The IMF said authorities need to improve fiscal transparency and public financial management by introducing a stronger anti-corruption legal framework and conducting an in-depth governance assessment, supported by the IMF's technical team.

Sri Lanka had a score of a 37 on Transparency International's 2021 Corruption Perception Index, a scale on which zero denotes that a country is “highly corrupt” while a score of 100 indicates a country is “highly clean”.

When ranked by score, Sri Lanka ranks 102 among the 180 countries in the Index, where the country ranked number one is perceived to have the most honest public sector, according to the index.

About 79 per cent of people in the country think government corruption is a big problem.

The IMF team held meetings with President and Finance Minister Ranil Wickremesinghe, Prime Minister Dinesh Gunawardena, Central Bank of Sri Lanka Governor P. Nandalal Weerasinghe, Secretary to the Treasury K M Mahinda Siriwardana and other senior government and central bank officials.

It also met with parliamentarians, representatives from the private sector, civil society organisations and development partners.

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Sri Lankans battle to maintain basic living standards — in pictures

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