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Apr 26, 2016 7:45 EDT

Will the IMF Facility Be a Turning Point in the Economy?

iCrowdNewswire - Apr 26, 2016

Will the IMF Facility Be a Turning Point in the Economy?


In as much as the loan is vital for getting the country out of the current critical balance of payments crisis, the commitment to the suggested economic reform program is essential to stabilise the economy and lay the foundation for a high trajectory of economic growth. The suggested corrective measures by ensuring fiscal discipline and prudent fiscal and monetary policies could get the country out of the current crisis, restore economic stability and provide the conditions for rapid economic growth.

Econ-Cartoon3-300x186IMF statement
The IMF statement of April 11th points towards the IMF granting a facility of US$ 1.5 billion with agreement on an economic program supported by the IMF. While the IMF agreement on the Extended Fund Facility (EFF) is not a fait accompli, the tenor and thrust of the statement leaves little doubt that it will be granted after the on going Annual Spring Meetings of the IMF Board and the discussions that are currently taking place in Washington D.C. between the IMF and the Sri Lankan authorities.

Economic recovery
The loan facility and the concomitant economic reform program could usher an economic recovery. The government must however have the political resolve to implement the associated economic reforms that are vital to strengthen the fiscal position, foreign exchange reserves and balance of payments.

The broad objectives of the proposed economic program, according to the IMF, is to achieve “high and sustained levels of inclusive economic growth, restore discipline to macroeconomic and financial policies, and rebuild fiscal and reserve buffers.” The IMF identifies the key objectives underlying the reform agenda as improving revenue administration and tax policy; strengthening public financial management; reform of state enterprises; and structural reforms to enable a more outward-looking economy, deepen foreign exchange markets, and strengthen financial sector supervision.

Tax reform
One of the weakest features of the Sri Lankan economy is the low collection of government revenue. The revenue to GDP ratio has declined over the years from around 20 per cent of GDP to only 12 per cent, despite average annual GDP growth of around 7 per cent in recent years. This tax to GDP ratio is too low for the country’s level of per capita income. Countries with similar per capita incomes gather more than 20 per cent of GDP as revenue.

The low revenue collection results in high fiscal deficits and accumulation of public debt and leaves inadequate fiscal space for education, health and infrastructure development. The foreign funded high cost of infrastructure development in 2010-2014 has been the main reason for doubling of foreign indebtedness.

The reduction of the fiscal deficit is vital for economic stability. The IMF economic reform program lays considerable emphasis on fiscal consolidation. Its objective is “A durable reduction of the fiscal deficit and public debt through a growth-friendly emphasis on revenue generation.”

The cabinet has, according to the IMF statement, decided to reduce the 2016 fiscal deficit to 5.4 per cent of GDP. Although this is inadequate, it may be a realistic target. The government should take steps to achieve a fiscal deficit of 3.5 per cent of GDP in 2020 as targeted in the Prime Minister’s Economic Policy Statement of November 2015.

The IMF strategy to increase revenue consists of broadening the tax base by reducing tax exemptions and introduction of a new Inland Revenue Act. The medium term revenue effort will be based on further reform of tax and expenditure policies, modernizing revenue administration and public financial management by implementation of key IT systems.

Pragmatic tax measures
Tax exemptions, tax avoidance and tax evasion are widespread endemic features. An effective tax system must take into account the inefficiency and corruption that prevails. The IMF proposals are essentially medium term and based on the assumption of an effective administration. New tax measures should be unavoidable and certain of collection such as withholding taxes and license fees. Otherwise the good intentions of curtailing tax evasion and tax avoidance would remain a delusion. Tax exemptions are easier to remove if the government is determined to not permit discretionary exemptions.

State enterprises
The other important economic reform that has been mooted is “a clear strategy to define and address outstanding obligations of state enterprises”. The colossal losses of state enterprises have been a heavy burden on the public finances. The reform of these enterprises is vital to redeeming the public finances. Drastic reforms, including the privatisation or part privatisation of some state owned enterprises are imperative. Will the government have the political will and courage to implement a privatisation program as was done by Chandrika Bandaranaike‘s government.

The IMF loan facility will strengthen the country’s diminished reserves and add considerable international confidence in the Sri Lankan economy. The enhanced international confidence in the Sri Lankan economy would stem capital outflows and reduce the cost of international borrowing. As the Governor of the Central Bank, Arjuna Mahendran has stated “Depending on the success of the Extended Fund Facility with the IMF on which discussions are currently underway in Washington D.C. other global lending agencies will look at us much more favourably in the coming months.” He also said that the People’s Bank of China has given authorization to issue bonds in China in renminbi the official Chinese currency and that all these would enable the raising of US$ 3 billion at lower interest rates quite easy.

Concluding reflections
The expected IMF facility of US$ 1.5 billion will replenish the reserves and add confidence in the economy. This would have a beneficial impact on capital inflows. The corrective measures by the IMF of ensuring fiscal discipline and prudent fiscal and monetary policies are essential to get out of the crisis and restore economic stability and create conditions for higher investment and rapid growth.

This story was originally published by The Sunday Times, Sri Lanka

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Editor, Sunday Times, Sri Lanka

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