ECONOMYNEXT – Sri Lanka has missed the budget deficit and foreign reserves targets in a deal with the International Monetary Fund where in built money and foreign exchange policies triggered a currency collapse and an output shock, which hit state revenues.
“Preliminary data indicate that the primary surplus target under the program supported by the Extended Fund Facility (EFF) was missed by a sizable margin in 2019 with a recorded deficit of 0.3 percent of GDP, due to weak revenue performance and expenditure overruns,” IMF mission chief Manuela Goretti said in a statement.
Sri Lanka’s 2019 budget deficit is now estimated by the IMF at 6.2 percent of GDP up from a revised 5.7 percent. A budget presented to parliament originally planned a deficit of 4.4 percent of GDP.
Sri Lanka’s currency collapsed from 153 to 182 to the US dollar in 2018, whilst being under an IMF program by printing money to target a call money rate, sterilize maturing legacy swaps and to also target a perceived ‘output gap’.
The call money rate was targeted to generate inflation of around 5 percent (a domestic anchor), under a ‘flexible’ inflation targeting which gave wide discretion for authorities to cut rates while inflation was climbing or falling.
At the same time the central was expected to target an exchange rate to build forex reserves (a loose external anchor), creating a policy contradiction (a dual anchor conflict) or a soft-pegged exchange rate regime, which automatically leads to a currency collapse.
Sri Lanka was also more explicitly targeting a real effective exchange rate keeping the peg deliberately weak (a strong side convertibility undertaking), analysts have said.
Money was printed to generate excess liquidity in 2018 both through open market operations and new short term dollar rupee swaps, triggering runs on the currency peg.
The corrective measures to stop a meltdown led to a credit contraction and import collapse, generating an output shock and a downturn in revenues.
The December inflation target, a ‘performance criteria’ under the program was met with 4.8 percent rate.
Around July 2019 Sri Lanka also started fresh injection of money and then engaged in a so-called ‘operation twist’ buying long term bonds in the central bank balance sheet, while selling short term securities, though private credit was weak.
Unless liquidity is withdrawn on a net basis, the central bank’s net foreign assets (monetary reserves) do not go up.
Net foreign reserves also fell 100 million dollars short of the December target, the IMF said.
“Net International Reserves fell short of the end-December target under the EFF-supported program in 2019 by about $100 million amid market pressures after the Presidential elections and announced tax cuts,” the IMF said.
“However, conditions have since stabilized. Renewed efforts are needed to rebuild reserve buffers to safeguard resilience to shocks, under a flexible exchange rate.”
Sri Lanka also missed the structural benchmarks such as electricity pricing and fixing SriLankan Airlines.
In addition, other actions planned during the program including a ‘flexible inflation targeting’ law was also not enacted.
The new administration has indicated that it is not keen to pursue the law.
“Approval of the new Central Bank Law in line with international best practices is a critical step to further strengthen the independence and governance of the CBSL and support the adoption of flexible inflation targeting,” Goretti said.
The revenue of the three year program was due to take place in April, with final December data and indicative March targets.
However there was no mention in the statement that Sri Lanka has requested any waivers.
The new administration has slashed taxes and said they are not in agreement with the so-called ‘revenue based fiscal consolidation’ which added a series of new witholding taxes, carbon and sugar taxes and also raised rates of direct tax. (Colombo/Feb08/2020 – Update II)
