This supplement updates the Staff Report that was issued to the Executive Board on June 28. It does not alter the thrust of the staff appraisal.
1. The new Inland Revenue Act (IRA)—consistent with staff recommendations—was submitted to parliament in early July, meeting a prior action of the second review. The new IRA will support fiscal consolidation by making the tax system more efficient and equitable. Its implementation will be assisted by further IMF TA as needed.
2. Efforts are continuing to recover from the severe floods in May 2017, caused by heavy monsoon rainfall across southwestern regions of the country. Development partners and emergency humanitarian funds have provided financial and in-kind support. While it is too early to assess the economic impact of the floods, the government will soon conduct a Rapid Impact and Needs Assessment, supported by the United Nations and the World Bank. At the same time, the northern part of the country is still recovering from the 2016 drought.
3. Latest data and information releases are broadly consistent with staff projections:
GDP and credit growth. The Sri Lankan economy grew by 3.8 percent (year-on-year) in 2017Q1, as agriculture contracted by 3.2 percent due to the lingering effects of the 2016 drought. However, industry (construction in particular) and services grew by 6.3 and 3.4 percent respectively in Q1. Private sector credit growth slowed somewhat but remained high at 20 percent in April 2017, despite rising lending rates.
Inflation. Headline inflation declined to 6.1 percent (year-on-year) in June 2017 from its March peak of 7.3 percent. However, food inflation has been persistently higher at about 9 percent during March-June, reflecting supply disruptions caused by the late-2016 drought and the May-2017 floods. The 3-month average inflation in June (6.3 percent) remained within the inner band under the Monetary Policy Consultation Clause.
Current account and reserves. The current account deficit was US$708 million (0.8 percent of annual GDP) in 2017Q1 compared to a surplus of US$35 million one year ago, with oil imports rising due to the drought-induced demand for more thermal power generation. Nevertheless, the efforts to rebuild reserves continued after the authorities overperformed on the committed corrective action in March and April 2017. During May–June, the CBSL made additional net FX purchases of about US$280 million and the exchange rate depreciated by about 1 percent against the US dollar.
Fiscal developments. Over January–April 2017, the primary surplus was Rs 9 billion, comparing favorably with the program floor of Rs −8 billion for the January–June period. This was underpinned by strong revenue performance over January–April as tax revenues increased by 26 percent (year-on-year).
Monetary policy. The Monetary Board meeting in late June kept the policy interest rates unchanged on the anticipation of further deceleration in private sector credit growth and moderation of inflation as weather-related supply disruptions dissipate.