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Sri Lanka: Third Review under the Extended Arrangement under the Extended Fund Facility and Request for Modification of Performance Criterion

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
January 2018
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Background

1. Macro stabilization and two major tax reforms were the key outcomes of the first half of the program. Sri Lanka is pursuing a 3-year reform program with IMF support under the extended arrangement under the Extended Fund Facility (EFF) since June 2016. Performance has been broadly on track regarding fiscal consolidation, revenue mobilization, monetary policy management, and reserves accumulation. The government legislated in 2016 the VAT amendments which increased VAT rates and narrowed exemptions. The program’s landmark reform, the new Inland Revenue Act, was legislated in October 2017 and will be implemented in April 2018. Consistent with the objectives of the EFF-supported program, the authorities announced a new far-reaching economic plan titled Vision 2025 in September 2017.

2. Nonetheless, many challenges lie ahead to sustain the reform momentum. The government faces higher debt repayments starting in 2018 at a time when the economy remains vulnerable to shocks. Progress in several structural areas including SOE reforms remains slow. Sustained efforts are needed to further reduce the fiscal deficit, strengthen external buffers, and promote inclusive growth. Political cohesion of the coalition government may be strained in the run-up to the 2020 national elections.

Recent Developments

3. Weather-related supply shocks dominated growth and inflation developments in 2017. Contracting agriculture—due to the 2016 drought and 2017 floods—pulled down GDP growth to 3.9 percent (y/y) in 2017H1 (Box 1). Services grew modestly and industry expanded strongly (5.8 percent) led by construction, mining and quarry. Headline inflation (y/y) exceeded expectations in October 2017 spiking to 7.8 percent, due to weather-driven food inflation and the base effect of VAT rate hikes in November 2016. However, Core inflation declined in October 2017.

4. Capital inflows strengthened, helping to finance the current account and fiscal deficits and reserves accumulation. The current account deficit widened to 3.5 percent of GDP in 2017H1, driven by weather-related imports of food and fuel. While exports strengthened through August due to improved EU access under GSP plus, workers’ remittances and tourism receipts were weak. Portfolio inflows, however, strengthened in 2017Q2 amid a favorable global market environment, with some US$700 million flowing into government securities on net basis over April–September, helping to keep borrowing costs in check. Gross international reserves (GIR) increased from US$6 billion at end-2016 to US$7.3 billion at end-September (3.3 months of imports of goods and services), reflecting steady foreign exchange (FX) purchases by the central bank (about US$1.6 billion over March-October) and a successful placement of sovereign bonds of US$1.5 billion in May.

5. Market interest rates declined, and credit growth remained high. Treasury bond yields dropped by 250 basis points during March–September 2017, reflecting strong capital inflows and lower domestic financing, reversing the rising trend since early 2015. Sri Lanka’s EMBI spread, at 330 bps in 2017Q3, has remained stable throughout 2017. Bank lending rates have been broadly stable since March. Though slowing down gradually with monetary tightening since 2016, private sector credit growth remained high at 17.5 percent (y/y) in September, about double the annual growth rate of nominal GDP. Despite dampening effects due to tightened loan-to-value (LTV) limits on vehicle loans in January, credit growth remained broad-based with no clear signs of a slowdown in month-on-month terms. Staff analysis suggests that the credit gap has widened to around 7 percent of GDP.

Private Sector Credit Growth

(Percent)

Source: CBSL and IMF staff calculations.

Credit to GDP Ratio and its Cyclical Trend

(Percent of GDP)

Source: CBSL and Staff Calculations

*Credit gaps were computed using the one-sided Hodrick-Prescott filter, with quarterly data and a relatively high smoothing parameter (lambda equal to 400,000). It is well documented that the results are sensitive to the choice of the filter and the smoothing parameter. Various values of lambda were used, all of which gave a positive credit gap.

Outlook and Risks

6. Staff’s baseline envisages the economy normalizing in 2018. Real GDP growth is projected to increase from 4.2 percent in 2017 to 4.6 percent in 2018, as agriculture recovers with the return of normal weather conditions while construction and services remain resilient. Similarly, inflation is projected to revert to around 5 percent in end-2017 and throughout 2018. The current account deficit is projected to shrink from 3 percent of GDP in 2017 to 2.5 percent in 2018. Over the medium term, growth is projected to reach about 5 percent, consistent with staff estimate of potential growth.

7. Downside risks remain significant. Given the high level of public debt and need for further fiscal consolidation, fiscal risks include ineffective implementation of the IRA, further delays in SOE reforms, and failure to provide for weather calamities. Too slow a deceleration in credit growth could add to the financial sector vulnerability, and some upside risks to near-term inflation outlook remain. External risks center around a possible reversal of the sizeable portfolio inflows which could raise domestic borrowing costs at a time when large external payments fall due, and could erode the recent gains in building external buffers if international reserves would again be used to defend the currency.

8. Sri Lanka’s external position remains weaker than implied by fundamentals and desirable policy settings. While the current account gap remains moderate and international reserves have increased, reserve coverage remains low by most adequacy metrics (65 percent of the ARA metric and 86 percent of short-term debt at remaining maturity in September 2017). The real effective exchange rate has depreciated by 5 percent since end-2016, helping to reduce the overvaluation which was estimated to exceed 10 percent at the end of 2016 (CR/17/253). However, these gains could be offset quickly through higher inflation and structurally weak competitiveness (paragraph 26).

9. Risks to public debt sustainability remain elevated (Annex I). Public debt, comprising central government debt, guaranteed debt, and Fund credit outstanding, is expected to rise slightly to 87 percent of GDP in 2017 due to the still large fiscal deficit and the weaker exchange rate.1 Moreover, the government faces large amortization payments in 2018, along with repayments on its international sovereign bonds starting in 2019. Gross financing needs (amortization payments plus overall deficit) are projected to reach 20 percent of GDP in 2018. Targeting an overall deficit of 3.5 percent of GDP by 2020 will reduce the risk of debt distress by lowering the debt ratio to 81 percent of GDP by 2020 and 75 percent by 2022. SOE liabilities also constitute a major fiscal risk, although they decreased from 13.7 percent of GDP in 2015 to 11.9 percent of GDP in 2016. External debt remains sustainable, though with high currency risks.

Sources IMF Fiscal Monitor database; Sri Lankan authorities; and IMF staff estimates.

Program Performance

10. Quantitative targets. End-June quantitative performance criteria (QPC) on central government primary balance and net international reserves and indicative targets (IT) for June and September were all met. The continuous PC (no new external arrears) has also been met. The monetary policy consultation clause has not been triggered as inflation remained within the target band.

Sri Lanka: EFF-Supported Program: Performance Against Quantitative Targets 1/
June 2017September 2017 (IT)
TargetActualMet?TargetActualMet?
Quantitative performance criteria
Central government primary balance (floor, in billion rupees)−816−416
Program net official international reserves (floor, in million US$)1,8742,0492,0572,568
Continuous performance criteria
New external payment arrears by the nonfinancial public sector and the CBSL (ceiling, in million US$)0000
Indicative targets
Central government tax revenue (floor, in billion rupees)8038191,2321,240
Reserve money of the CBSL (ceiling, stock, in billion rupees)905892935909

Cumulative from the beginning of the year, except for reserve money.

Cumulative from the beginning of the year, except for reserve money.

11. Structural benchmarks (SBs). Four out of 5 SBs slated for completion by November 2017 were implemented (Table 2 attached to the Memorandum of Economic and Financial Policies (MEFP)).

Table 1.Sri Lanka: Selected Economic Indicators, 2015–22
20152016201720182019202020212022
CR/17/253Proj.Proj.
GDP and inflation (in percent)
Real GDP growth4.84.44.74.24.64.74.84.95.0
Inflation (average)2.24.06.06.04.85.05.05.05.0
Inflation (end-of-period)4.64.55.15.15.05.05.05.05.0
Core inflation (end-of-period)6.75.84.64.64.64.64.64.64.6
Savings and investment (in percent of GDP)
National savings26.129.029.328.729.129.429.830.230.7
Government−2.2−0.5−0.4−0.9−0.30.81.21.51.7
Private28.329.629.729.729.428.728.528.828.9
National Investment28.431.531.831.731.631.631.932.432.8
Government5.57.86.46.36.06.05.96.06.1
Private22.923.725.425.425.625.726.126.426.7
Savings-Investment balance−2.4−2.4−2.5−3.0−2.5−2.2−2.2−2.2−2.1
Government−7.7−8.3−6.7−7.1−6.3−5.2−4.6−4.5−4.4
Private5.45.94.34.23.83.02.42.42.3
Public finances (in percent of GDP)
Revenue and grants13.314.314.514.215.016.116.616.716.8
Expenditure20.419.719.719.920.020.020.020.220.3
Primary balance−2.2−0.20.0−0.21.02.02.52.42.3
Central government balance−7.0−5.4−5.2−5.7−5.0−4.0−3.5−3.5−3.5
Central government net domestic financing4.32.83.43.42.93.22.82.72.6
Central government debt78.580.179.681.680.377.674.772.169.6
Money and credit (percent change, end of period)
Reserve money16.527.113.013.013.312.612.712.512.0
Broad money17.818.415.918.915.014.112.812.412.0
Domestic credit23.516.410.813.212.111.410.410.210.1
Credit to private sector25.121.913.716.314.813.312.912.412.1
Credit to government21.38.16.18.07.37.75.25.35.4
Balance of payments (in millions of U.S. dollars)
Exports10,54710,31011,23911,24411,86112,49013,08813,75114,518
Imports−18,935−19,400−20,517−21,040−21,932−22,953−24,197−25,396−26,716
Current account balance−1,882−1,943−2,094−2,461−2,180−2,046−2,172−2,331−2,457
Current account balance (in percent of GDP)−2.4−2.4−2.5−3.0−2.5−2.2−2.2−2.2−2.1
Export value growth (percent)−5.2−2.29.09.15.55.34.85.15.6
Import value growth (percent)−2.52.55.88.54.24.75.45.05.2
Gross official reserves (end of period)
In millions of U.S. dollars7,3046,0197,2467,5058,0148,7889,62410,28310,864
In months of imports3.72.83.33.43.43.63.83.83.9
External debt (public and private)
In billions of U.S. dollars44.846.047.448.349.552.754.957.360.3
As a percent of GDP56.457.156.858.257.456.855.153.452.2
Memorandum items:
Nominal GDP (in billions of rupees)10,95211,83913,09813,02714,27115,69017,26719,02120,972
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Table 2a.Sri Lanka: Summary of Central Government Operations, 2015–22(In billions of rupee)
20152016201720182019202020212022
CR/17/253Proj.Proj.
Total revenue and grants1,4611,6941,8941,8542,1462,5232,8583,1753,523
Total revenue1,4551,6861,8841,8462,1362,5122,8463,1623,508
Tax revenue1,3561,4641,7181,6801,9542,3122,6262,9203,241
Income taxes263259328272323402443488538
VAT2202833724355457509411,1031,279
Excise taxes498455513476538575615660708
Other trade taxes184212213214228243259276295
Other191254293283321342368393422
Nontax revenue99222166166182200220242267
Grants671081011121315
Total expenditure and net lending2,2292,3342,5812,5972,8543,1433,4613,8424,250
Current expenditure1,7021,7581,9441,9732,1892,4022,6462,8993,159
Civil service wages and salaries323334348346365399439483533
Other civilian goods and services135869696105116127140155
Security expenditure297307335331355385423466514
Subsidies and transfers419419481480515566623686757
Interest payments5276116837208499371,0341,1231,201
Capital expenditure and net lending5275766376246657418159421,091
Overall balance−768−640−687−742−707−620−602−666−727
Financing768640687742707620602666727
Net external financing292307240302293121118147171
Net domestic financing476333447440414499484520556
Memorandum items:
Central government primary balance−241−29−3−23141317431457474
Nonfinancial SOE balance 1/−2334
Ceylon Electricity Board21−14
Ceylon Petroleum Corporation−1870
Sri Lankan Airlines−18−30
Other−81
Central government debt8,5959,47910,43010,63011,46012,18012,90513,71414,589
Domestic currency4,6865,1215,3545,4935,9586,5527,1187,7348,277
Foreign currency3,9094,3585,0765,1365,5025,6295,7875,9806,312
Publicly guaranteed debt408524
Financial obligations of nonfinancial SOEs 2/1,5011,414
Fund credit outstanding11083114119208256259255234
Nominal GDP (in billion of rupees)10,95211,83913,09813,02714,27115,69017,26719,02120,972
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.

For 42 nonfinancial SOEs reported in MOF Annual Reports.

The figure does not cover all nonfinancial SOEs. It covers financial obligations of Ceylon Electricity Board, Ceylon Petroleum Corporation, Road Development Authority, Sri Lanka Ports Authority, Sri Lankan Airlines, and other SOEs.

Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.

For 42 nonfinancial SOEs reported in MOF Annual Reports.

The figure does not cover all nonfinancial SOEs. It covers financial obligations of Ceylon Electricity Board, Ceylon Petroleum Corporation, Road Development Authority, Sri Lanka Ports Authority, Sri Lankan Airlines, and other SOEs.

Table 2b.Sri Lanka: Summary of Central Government Operations, 2015–22(In percent of GDP)
20152016201720182019202020212022
CR/17/253Proj.Proj.
Total revenue and grants13.314.314.514.215.016.116.616.716.8
Total revenue13.314.214.414.215.016.016.516.616.7
Tax revenue12.412.413.112.913.714.715.215.315.5
Income taxes2.42.22.52.12.32.62.62.62.6
VAT2.02.42.83.33.84.85.55.86.1
Excise taxes4.53.83.93.73.83.73.63.53.4
Other trade taxes1.71.81.61.61.61.51.51.51.4
Other1.72.12.22.22.22.22.12.12.0
Nontax revenue0.91.91.31.31.31.31.31.31.3
Grants0.10.10.10.10.10.10.10.10.1
Total expenditure and net lending20.419.719.719.920.020.020.020.220.3
Current expenditure15.514.814.815.115.315.315.315.215.1
Civil service wages and salaries3.02.82.72.72.62.52.52.52.5
Other civilian goods and services1.20.70.70.70.70.70.70.70.7
Security expenditure2.72.62.62.52.52.52.52.52.5
Subsidies and transfers3.83.53.73.73.63.63.63.63.6
Interest payments4.85.25.25.55.96.06.05.95.7
Capital expenditure and net lending4.84.94.94.84.74.74.75.05.2
Overall balance−7.0−5.4−5.2−5.7−5.0−4.0−3.5−3.5−3.5
Financing7.05.45.25.75.04.03.53.53.5
Net external financing2.72.61.82.32.10.80.70.80.8
Net domestic financing4.32.83.43.42.93.22.82.72.6
Memorandum items:
Central government primary balance−2.2−0.20.0−0.21.02.02.52.42.3
Nonfinancial SOE balance 1/−0.20.3
Ceylon Electricity Board0.2−0.1
Ceylon Petroleum Corporation−0.20.6
Sri Lankan Airlines−0.2−0.3
Other−81
Central government debt78.580.179.681.680.377.674.772.169.6
Domestic currency42.843.340.942.241.741.841.240.739.5
Foreign currency35.736.838.839.438.635.933.531.430.1
Publicly guaranteed debt3.74.4
Financial obligations of nonfinancial SOEs 2/13.711.9
Fund credit outstanding1.00.70.90.91.51.61.51.31.1
Nominal GDP (in billion of rupees)10,95211,83913,09813,02714,27115,69017,26719,02120,972
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.

For 42 nonfinancial SOEs reported in MOF Annual Reports.

The figure does not cover all nonfinancial SOEs. It covers financial obligations of Ceylon Electricity Board, Ceylon Petroleum Corporation, Sri Lanka Ports Authority, Road Development Authority, Sri Lankan Airlines, and other SOEs.

Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.

For 42 nonfinancial SOEs reported in MOF Annual Reports.

The figure does not cover all nonfinancial SOEs. It covers financial obligations of Ceylon Electricity Board, Ceylon Petroleum Corporation, Sri Lanka Ports Authority, Road Development Authority, Sri Lankan Airlines, and other SOEs.

Table 2c.Sri Lanka: Summary of Central Government Operations, 2017–18(In billions of rupees)
2017Q12017Q22017Q32017Q42018Q12018Q22018Q32018Q4
Est.Est.Est.Proj.
Total revenue and grants437441453524485517554590
Total revenue436440452518484516550586
Tax revenue415404421440447476514516
Income taxes636183655963100100
VAT111108105111119142142142
Excise taxes115119116126135135135135
Other trade taxes5849505657575757
Other6966668278808082
Nontax revenue2136317837403669
Grants11161144
Total expenditure and net lending636574680707697676763718
Current expenditure484434520535551514598526
Civil service wages and salaries8786888690909393
Other civilian goods and services1319174724252730
Security expenditure71787810384889192
Subsidies and transfers103112110155126124133132
Interest payments209140227144227188253180
Capital expenditure and net lending152140160172146161165192
Capital expenditure147139160171145160164191
Net lending51011111
Overall balance−200−133−227−183−212−158−209−128
Primary balance970−3815304551
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
  • On November 9, the authorities submitted to Parliament the 2018 budget consistent with the program targets and staff recommendations, meeting the prior action for the third review2. In addition, the 2018 budget includes a tax expenditure statement, a plan to rationalize tax expenditures, and the estimated cost of SOEs’ non-commercial obligations (SB, November 2017).

  • A report outlining the cost of non-commercial obligations for fuel and electricity (SB, September 2017) was published in November as an annex to the 2018 budget.

  • A diagnostic review of the VAT system (SB, June 2017) was completed in November.

  • The authorities have opted to postpone designing compliance strategies for income taxes (SB, June 2017) until the new IRA is fully operational in 2018.

  • The Monetary Board of the Central Bank of Sri Lanka (CBSL) approved a roadmap for flexible inflation targeting and flexible exchange rate regime (SB, October 2017).

Policy Discussions

The authorities pledged to target a primary surplus of 1 percent of GDP in 2018, while requesting a small adjustment of the end-2017 fiscal target due to the weather calamities. The authorities pledged to build up net international reserves by about US$700 million in 2018, and undertake energy pricing reforms.

A. Fiscal Consolidation Needs to Continue

12. Revenue mobilization continues. Tax revenues increased by 9.3 percent (y/y) in real terms in January–September 2017, driven by a 56.6 percent surge in VAT collections following the VAT amendment in November 2016. The projected 2017 outturn implies a tax to GDP ratio of 12.9 percent, 1 percentage point higher than in 2015 (excluding one-off factors). When implemented, the new IRA is expected to boost revenues further by about ½ percent of GDP (annualized) largely through removal of tax exemptions. Revenue mobilization has also been supported by tax administration reforms, including roll-out of the RAMIS IT system and VAT compliance strategies.3 Nevertheless, tax revenues are projected to fall short of the 2017 IT by 0.3 percent of GDP, reflecting temporary factors related to the weather calamities and the delay in implementing the new IRA.

Sri Lanka: Tax Revenue

(In percent of GDP)

Source: IMF staff calculations.

Note: The collection of the super gains tax in 2015 is excluded.

Sri Lanka: Tax Revenue

(In percent of GDP)

Source: IMF staff calculations.

Note: The collection of the super gains tax in 2015 is excluded.

13. The authorities requested relaxing the 2017 fiscal targets due to the exceptionally severe weather events. Between the protracted effects of the 2016 nationwide drought and the devastating 2017 floods in the southwest (Box 1), the spending needs exceeded the space that could be generated by mid-year budget reallocation and spending rationalization. As a result, the authorities requested lowering the QPC ceiling on primary deficit by Rs 20 billion to Rs 23 billion (0.2 percent of GDP) and the tax revenue IT floor by about 40 billion (0.3 percent of GDP) for end-2017. This temporary adjustment is smaller than the Rs 68 billion overperformance in the 2016 primary balance QPC and will be offset by higher disaster provisions and more front-loaded fiscal consolidation in the 2018 budget. Staff supports the request and offsetting adjustments, and noted that drought-driven cost for higher thermal electricity generation should be contained to limit the increase of SOE debt of Ceylon Electricity Board (CEB).

14. The authorities pledged to target a primary surplus of 1 percent of GDP in 2018, supported by a revenue package. The authorities’ overall deficit target of 3.5 percent of GDP by 2020 is consistent with reaching a primary surplus of 2½ percent of GDP by 2020. To anchor investor confidence amid looming financing needs, the authorities agreed to frontload the fiscal consolidation path and target a primary surplus of 1 and 2 percent of GDP in 2018 and 2019, respectively, despite the lead time for revenue measures. The 2018 budget submitted to Parliament in November was consistent with these program targets and staff recommendations, meeting the prior action for the review. The revenue package in the budget is estimated to yield 0.8 percent of GDP, which comes mostly from selected removal of VAT exemptions, changes to excise taxes, and new levies on telecom usage and cash transactions by financial institutions. While the package safeguards social and infrastructure spending, its composition could have relied more on VAT base-broadening. The budget accommodates appropriations for natural disaster mitigation programs such as crop insurance and urban flood mitigation, totaling 0.15 percent of GDP.

Sri Lanka: Summary of Central Government Operations
2015201620172017201820192020
ActualActualEFF 2nd revProj.Proj.Proj.Proj.
Rs Bln% GDPRs Bln% GDPRs Bln% GDPRs Bln% GDP% GDP% GDP% GDP
Total Revenue and Grants1,46113.31,69414.31,89414.51,85414.214.315.115.9
Total Revenue1,45513.31,68614.21,88414.41,84614.214.215.015.8
Tax Revenue1,35612.41,46412.41,71813.11,68012.912.913.714.5
Income Taxes2632.42592.23282.52722.12.32.62.6
Tax on goods & services8047.38427.11,0187.81,0297.97.88.49.2
VAT2202.02832.43722.84353.3
Excise Taxes4984.54553.85133.94763.7
Other taxes & levies860.81040.91331.01170.9
Tax on external trade2892.63633.13732.83802.92.92.82.7
Non Tax Revenue990.92221.91661.31661.31.31.31.3
Grants60.170.1100.180.10.10.10.1
Total Expenditure and net lending2,22920.42,33419.72,58119.72,59719.920.020.020.0
Current Expenditure1,70215.51,75814.81,94414.81,97315.115.315.315.3
Salaries & wages5625.15764.96154.75954.64.44.44.4
Goods & services1931.81511.31641.31781.41.41.41.4
Interest payments5274.86115.26835.27205.55.96.06.0
Subsidies & transfers4193.84193.54813.74803.73.63.63.6
Capital Expenditure and Net Lending5274.85764.96374.96244.84.74.74.7
Revenue measures0.81.00.7
Overall balance−768−7.0−640−5.4−687−5.2−742−5.7−5.0−4.0−3.5
Primary balance−241−2.2−29−0.2−30.0−23−0.21.02.02.5
Revenue (including measures)1,46113.31,69414.31,89414.51,85414.215.016.116.6
Tax revenue (including measures)1,35612.41,46412.41,71813.11,68012.913.714.715.2
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.

15. Implementing the new IRA in April 2018 and IT-based spending commitment control will support the 2018 budget. The IRA steering committee has outlined an implementation workplan, including publishing tax manuals (new SB by January 2018), updating regulations, training tax administrators, conducting taxpayer outreach, and updating IT systems. Risk of a revenue shortfall will be mitigated by realigning expenditures through the quarterly fiscal reporting to Parliament that started in 2017. The authorities also pledged to modify the existing IT system to implement quarterly commitment ceilings to reduce the risk of arrears in the case of revenue shortfalls, when line ministries start executing the 2018 budget (SB by January). However, staff urged swift implementation of a more effective commitment control by the new integrated IT system (ITMIS), which was delayed to start in 2019.

16. Strengthening public debt management and the fiscal responsibility framework will help manage large financing needs over the medium term. Staff welcomed the efforts to improve debt management, including by drafting a new Liability Management Bill which will allow the government to manage debt maturities and earmark proceeds from commercialization of public assets (e.g., the Hambantota port) for future debt service. The cabinet will approve a strategy for managing international sovereign bonds maturing over 2019–22 (a new SB by June 2018). To reinforce fiscal discipline, the authorities’ Vision 2025 aims to strengthen the Fiscal Management Responsibility Act with binding targets on fiscal deficit and government debt, which staff will support including through TAs.

B. Accelerate SOE Reforms

17. The weak financial performance of major SOEs in 2017 highlights the need for timely reforms. Three SOEs closely monitored under the program—CEB, Ceylon Petroleum Corporation (CPC), and SriLankan Airlines—recorded a combined loss of Rs 52 billion in 2017H1 (0.4 percent of GDP) as opposed to a combined profit of 0.2 percent of GDP in 2016. Rising oil prices and weather shocks raised the cost of non-commercial obligations (NCOs) to supply electricity and fuel at prices below cost-recovery levels. The efforts to restructure the airline has hit an impasse, as the search for a strategic partner restarted under the new task force overseen by the Prime Minister’s office. Future program reviews will discuss the action plan for the airline and set key milestones as an SB. Leveraging upon the publication of Statements of Corporate Intent (SCIs) by 5 major SOEs in April 2017, the authorities are developing a framework for evaluating performance against key performance indicators, and plan to expand SCIs to other SOEs.

Sri: Lanka: Performance of CEB, CPC, and SriLankan Airlines, 2017H1
Ceylon Electricity Board (CEB)Ceylon Petroleum Corp. (CPC)SriLankan Airlines
Rupees billions% of annual GDPRupees billions% of annual GDPRupees billions% of annual GDP
Revenue1621.22602.0670.5
Expenditure1961.52632.0800.6
Balance−34−0.3−40.0−13−0.1
Memorandum item:
Outstanding financial obligations, end-20162301.93853.33172.7
Sources: Sri Lankan authorities; and IMF staff estimates.
Sources: Sri Lankan authorities; and IMF staff estimates.

18. The authorities are embarking on fuel and electricity pricing reforms. To address the delay in adopting automatic pricing mechanisms, the second review recalibrated the reforms into a sequence of steps. The first step focuses on increasing transparency: a report outlining the cost of NCOs for fuel and electricity (SB) was completed with delay, and the establishment of a Bulk Supply Transactions Account is expected by March 2018 (SB) to enhance transparency of electricity NCOs. The second step sets at zero a new IT (ceiling) on uncompensated cost of fuel and electricity NCOs (i.e., cost of NCOs minus government transfers, Annex III) for 2018, which will encourage the authorities to recognize the quasi-fiscal subsidies as above-the-line government spending and incentivize cost-reflective pricing. Finally, cabinet will approve automatic pricing mechanisms for fuel by March 2018 and for electricity by September 2018 (SBs).

Sri Lanka: Sequence of Energy Pricing Reforms

Source: IMF staff.

C. Monetary Policy to Rein in Inflation Pressures

19. Monetary policy should maintain a tightening bias until clearer signs emerge that inflation and credit growth have stabilized, supported by macroprudential measures as needed. The CBSL has kept the policy rate unchanged since a 25-bps hike in March 2017, amid indications that credit growth and weather-related price pressures are moderating gradually. Near-term inflation, however, still faces upside risk from still high credit growth, a tight labor market, and the depreciating rupee. Reflecting these concerns, staff recommended the CBSL continue to assess the lagged response to monetary tightening since 2016, while maintaining a tightening bias until clear signs emerge that inflation and credit growth have stabilized. Macroprudential measures can be used to address systemic risks arising from excessive credit growth (paragraph 24).

20. The authorities reaffirmed their commitment to accumulate reserves while winding down FX swaps. Since resuming reserves accumulation in March 2017, the CBSL has accumulated net international reserves (NIR) beyond program targets through steady FX purchases against capital inflows. For 2018, the authorities target to increase NIR (program definition) by around US$700 million, bringing the end-2018 GIR to US$8.0 billion, equivalent to 67 percent of the ARA metric and 3.4 months of import. The CBSL plans to further wind down FX swaps with commercial banks (US$1.85 billion at end-September) to improve the composition of reserves.

21. In the face of substantial balance of payment pressures, Sri Lanka imposed in April 2016 a repatriation requirement for export proceeds while the country launched macroeconomic adjustments under the EFF-supported program in June 2016. This repatriation requirement could potentially discourage exporters’ outward investments (capital outflows) by increasing the cost of outward payments and transfers, constituting a capital flow management measure (CFM), according to the Fund’s Institutional View (IV) on capital flows. The repatriated export proceeds do not need to be converted into rupees and can be freely taken out from the country with no restrictions on their overseas use. Consequently, the measure has encouraged exporters to keep FX within the domestic financial system and helped reduce the imbalance in the FX market. The authorities are of the view that eliminating the measure at the current juncture could be premature as Sri Lanka remains vulnerable to shocks especially with international reserves remaining below the adequate level, while staff recommends removing this temporary measure as policy adjustments are implemented, for CFMs should not be used to substitute for warranted macroeconomic adjustment. The pace to phase out this temporary measure will be further discussed in the Article IV consultation in early 2018, together with Sri Lanka’s overall efforts to further liberalize the capital account and develop the FX market.

22. The FX market has deepened, enhancing price discovery. Since June 2017, the CBSL has withheld from intervening in the FX market, except to accumulate reserves. Combined with continued capital inflows, this has contributed to raising transaction volumes in the spot FX market and two-way exchange rate movements. Building on these positive developments, the authorities should consider adopting FX auctions and rules-based FX policies to further develop the FX market while providing a more transparent structure to accumulate reserves.

CBSL FX purchases, 2017

(In US$ millions)

Source: CBSL.

FX Market Turnover and Exchange Rate Volatility, 2017

Source: CBSL and IMF staff estimates.

23. The Monetary Board of the CBSL approved a roadmap for flexible inflation targeting and a flexible exchange rate regime (SB). Consistent with IMF TA recommendations, the roadmap identifies time-bound reform measures to be taken over the next few years, including: revising the Monetary Law Act (MLA) to establish price stability as the primary objective of monetary policy; addressing CBSL’s direct fiscal financing for a clearer separation between fiscal and monetary policies; establishing a transparent auction mechanism for reserves accumulation while enhancing FX flexibility gradually; modifying the existing policy rate structure; assessing financial sector risks associated with adopting inflation targeting and greater FX flexibility; and strengthening public communication. The cabinet approval of a policy note outlining the key elements of amendments to the MLA has been set as a new SB due by March 2018.

D. Financial Policies to Safeguard Stability

24. While financial soundness indicators remain stable, credit growth needs further stabilizing to reduce the positive credit gap and head off a buildup of systemic vulnerability. The capital adequacy ratio of the banking system has stabilized at around 15 percent in 2017H1, and the NPL and provision coverage ratios have improved to 2.7 percent and 67 percent in 2017Q2, respectively. However, broad-based credit growth far above nominal GDP growth leaves open the positive credit gap (paragraph 5), raising the risk of negative systemic spillovers from financial shocks (e.g., a sizable reversal of portfolio inflows) propagated through excessive leverage associated with the real estate sector. Macroprudential measures, the need for which the authorities are evaluating through new surveys on credit growth, can include lower LTV limits on mortgages, higher capital weights on mortgages and other construction-related debt, and overall debt-to-income limits on consumer loans. The authorities also expressed preliminary interest in a Financial System Stability Review, which staff welcomes.

25. Financial sector supervision should be further strengthened to address potential vulnerabilities. The migration to the Basel III capital standards began in July 2017 and all banks met the initial requirements. With the minimum capital ratios set to rise to international standards by January 2019, banks should develop appropriate strategies to comply with the schedule. In addition, the authorities will establish a new Resolution and Enforcement Department within the CBSL; double the minimum equity capital requirement of all licensed banks by end 2020, to enhance stability and encourage consolidation; and upgrade legislation (e.g., the Banking Act). While some progress has been made in improving the AML/CFT regime, significant deficiencies remain, and Sri Lanka was placed under the Financial Action Task Force (FATF) monitoring process in October. Staff recommends that Sri Lanka enhance the effectiveness of the supervisory framework, enact FATF-compliant AML/CFT laws and regulations, and focus on the implementation of the International Cooperation Review Group (ICRG) action plan items.

E. Structural Reforms to Support Fiscal Consolidation and Inclusive Growth

26. Following progress in macroeconomic stabilization, structural reforms are needed to bolster competitiveness and facilitate inclusive growth. The authorities and staff initiated discussions of these reforms, which will be further explored in the upcoming Article IV consultation and be incorporated into the second half of the program. Published in September 2017 with endorsement by the coalition government, the authorities’ Vision 2025 identifies policies to promote inclusive growth in the areas of trade, labor market, logistic infrastructure, social safety nets, and natural disaster management. The program will support its implementation, giving priority to structural reforms in the following areas:

  • Reforms in trade and investment regimes. The new IRA strengthens public governance and creates a transparent and predictable business environment, by adopting a simple and rules-based framework while shunning a discretionary and fragmented system of incentives. Automation of government’s tax and public finance management systems (SBs) should continue to improve transparency and efficiency of government systems. The authorities have also formulated a new trade policy that aims to facilitate trade and remove barriers to foreign investment entry and establishment. Bilateral trade negotiations are ongoing with large regional markets, while GSP plus status with EU resumed in mid-2017. With the support of development partners, government has reviewed para-tariffs and other nontariff barriers for gradual phasing out, which should be aligned with the fiscal consolidation under the program.

  • Increasing female labor participation. The low female labor participation (36 percent in 2017Q2) despite high education attainment calls for policies and labor market reforms that can increase female labor participation and enhance inclusive growth, including flexible work arrangements and more accessible child care service. The authorities are considering legislative reforms to introduce quotas on female representation in Parliament and local governments.

  • Addressing climate change. Disaster management needs to strengthen to address Sri Lanka’s vulnerability to natural disasters, which has imposed sizable costs in both economic and humanitarian terms. Recognizing the dangers from climate change, staff recommended strengthening adaptation and mitigation measures, including disaster-resilient infrastructure and stronger fiscal buffers in future budgets.

Program Monitoring

27. The attached Letter of Intent (LOI) and the MEFP describe the authorities’ progress and commitments to implement their economic program (Appendix I). The authorities request, with staff supporting, to modify the primary balance QPC and the tax revenue IT for end-December to reflect the developments since the second review (Table 1 attached to the MEFP and the TMU). Quarterly targets for 2018 are proposed, including the June QPC on primary balance and NIR, and a new IT on NCOs for fuel and electricity. As a prior action for the third review, the authorities submitted the 2018 budget to Parliament consistent with the program and staff recommendations. The proposed list of SBs includes 3 new benchmarks (Table 2 attached to the MEFP).

28. The program remains fully financed for the next 12 months, but risks remain significant. Firm financing assurances from the World Bank, the Asian Development Bank, and key bilateral donors, are in place, and prospects are favorable for adequate multilateral and bilateral financing for the remainder of the program. Capacity to repay the Fund remains adequate under the baseline scenario, while the downside risks discussed above may necessitate further adjustment or additional financing (Table 9). Key risks to the program are still present: (i) revenue slippage; (ii) weaker than expected net capital inflows and reserves shortfall; (iii) lower than expected growth and/or new pressures on the trade account; and (iv) larger than expected losses at SOEs and slow progress in SOE reforms (paragraph 7-9).

Table 3.Sri Lanka: Central Government Financing Needs, 2015–18(In billions of rupees, unless otherwise indicated, end of period)
20152016201720182016Q12016Q22016Q32016Q42017Q12017Q22017Q32017Q4
Est.Est.Proj.Proj.Est.Est.Est.Est.Est.Est.Proj.Proj.
Gross inflow2,5832,2762,4822,978445708790343640978541339
Primary surplus00014100369700
Rupee-denominated debt disbursement1,7471,5991,5782,030289580532196364514514184
US-dollar denominated debt disbursement829609904807146533535726645726155
Asset sales (net)000000000000
Other768001074−99840000
Gross outflow2,5622,2922,4822,978453720785342503737859398
Primary deficit2412923026120000038
Interest payment527611720849154135181140209140227144
Rupee-denominated debt amortization1,4901,1781,2051,566132460465121135470476124
US-dollar denominated debt amortization3044735345641411131388115912715692
Other000000
Net cash inflow22−1500−9−1251137241−318−59
Government deposits, end of period877272727866707220844913172
Memorandum items:
Overall deficit768640742707181148178134200133227183
US$ denominated debt disbursement (in US$ millions)6,0254,1435,7674,8771,0183672,4153861,7642,981169960
US$ denominated debt amortization (in US$ millions)2,2083,2183,4083,4079847799455481,054831996571
Government deposits, end of period (percent of GDP)0.80.60.50.5
Net issuance of T-bill and T-bond (in Rp billions)2894211571216775
T-bills and T-bonds outstanding (In Rp billions)4,2674,6634,3644,5384,6864,6634,757
Nonresidents’ T-bills and T-bonds holding
In Rp billions304260221253314260196
In US$ millions2,1081,7351,5381,7392,1411,7351,296
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Sources: Data provided by the Sri Lankan authorities; and IMF staff estimates.
Table 4a.Sri Lanka: Monetary Accounts, 2015–18(In billions of rupees, unless otherwise indicated, end of period)
2015201620172018
CR/17/253Proj.Proj.
Central Bank of Sri Lanka
Net foreign assets576559876938961
Net domestic assets972989129134
Net claims on central government230413188184213
Net claims on banks−3−2−2−2−2
Other items, net−130−113−95−153−77
Reserve Money6738569679671,095
Monetary survey
Net foreign assets−298−231−89−27−77
Monetary authorities576559876938961
Deposit money banks−874−790−965−965−1,038
Net domestic assets4,8645,6376,3566,4577,471
Net claims on central government1,7591,9722,1112,1082,246
Credit to corporations3,9734,7005,2855,4466,226
Public corporations523495506556613
Private corporations3,4504,2044,7794,8905,613
Other items (net)−868−1,035−1,039−1,097−1,001
Broad money4,5665,4066,2676,4307,394
Memorandum Items
Gross international reserves (in millions of U.S. dollars)7,3046,0197,2467,5058,014
Net international reserves (in millions of U.S. dollars)5,0294,5296,1616,5416,548
Net Foreign Assets (in millions of U.S. dollars)3,9993,7255,3565,7365,610
Private credit (in percent of GDP)31.535.536.537.539.3
Money multiplier6.86.36.56.66.7
Broad money velocity 1/2.42.22.12.01.9
Money and credit (percent change, end of period)
Broad money17.818.415.918.915.0
Reserve money16.527.113.013.013.3
Credit to public corporations17.2−5.32.212.210.3
Credit to private sector25.121.913.716.314.8
Sources: Central Bank of Sri Lanka; and IMF staff projections.

Calculated using end-period quarterly GDP, annualized.

Sources: Central Bank of Sri Lanka; and IMF staff projections.

Calculated using end-period quarterly GDP, annualized.

Table 4b.Sri Lanka: Monetary Accounts, 2015–18(In billions of rupees, unless otherwise indicated, end of period)
201520162017Q12017Q22017Q32017Q42018Q12018Q22018Q32018Q4
Est.Est.Est.Proj.Proj.
Central Bank of Sri Lanka
Net foreign assets5765595375987769381,1171,095994961
Net domestic assets9729835529413329−96−7077134
Net claims on central government230413467411253184194201208213
Net claims on banks−3−2−1−14−2−2−2−2−2
Other items, net−130−113−110−116−124−153−288−269−130−77
Reserve Money673856892891.69099671,0201,0251,0711,095
Monetary survey
Net foreign assets−298−231−372−24610−27−19−51−63−77
Monetary authorities5765595375987769381,1171,095994961
Deposit money banks−874−790−908−844−766−965−1,135−1,145−1,058−1,038
Net domestic assets4,8645,6376,0496,1196,1226,4576,8257,0127,2447,471
Net claims on central government1,7591,9722,2152,2352,2242,1082,1012,1592,2272,246
Credit to corporations3,9734,7004,9295,0565,1575,4465,6325,7575,9266,226
Public corporations523495553551498556527543565613
Private corporations3,4504,2044,3754,5054,6594,8905,1065,2135,3615,613
Other items (net)−868−1,035−1,094−1,172−1,259−1,097−909−904−909−1,001
Broad money4,5665,4065,6775,8736,1326,4306,8066,9617,1807,394
Memorandum Items
Gross international reserves (in millions of U.S. dollars)7,3046,0195,1176,9597,2807,5058,5598,6397,9968,014
Net international reserves (in millions of U.S. dollars)5,0294,5294,3536,0926,5556,5417,5947,4246,7816,548
Money and credit (percent change, end of period)
Broad money17.818.420.021.220.318.919.918.517.115.0
Reserve money16.527.112.717.814.513.014.415.017.813.3
Credit to private sector25.121.920.418.617.516.316.715.715.114.8
Sources: Central Bank of Sri Lanka; and IMF staff projections.
Sources: Central Bank of Sri Lanka; and IMF staff projections.
Table 5a.Sri Lanka: Balance of Payments, 2015–22(In millions of U.S. dollars, unless otherwise indicated)
20152016201720182019202020212022
CR/17/253Proj.Proj.
Current account−1,882−1,943−2,094−2,461−2,180−2,046−2,172−2,331−2,457
Balance on goods−8,388−9,090−9,278−9,796−10,072−10,463−11,109−11,644−12,198
Credit (exports)10,54710,31011,23911,24411,86112,49013,08813,75114,518
Debit (imports)−18,935−19,400−20,517−21,040−21,932−22,953−24,197−25,396−26,716
Balance on services2,3242,8792,9463,0813,5423,9704,5815,0115,498
Credit (exports)6,3967,1387,5477,6688,3589,0279,74910,33410,954
Debit (imports)−4,072−4,259−4,601−4,587−4,816−5,057−5,168−5,323−5,456
Primary income, net 1/−2,012−2,185−2,336−2,236−2,300−2,383−2,548−2,680−2,817
Secondary income, net 2/6,1946,4536,5746,4906,6506,8306,9046,9837,061
Of which: workers’ remittances (net)6,1676,4346,5556,4706,6296,8096,8836,9627,039
Capital account (+ surplus / - deficit)462555182016161212
Balance from current account and capital account−1,836−1,918−2,039−2,443−2,160−2,030−2,156−2,319−2,445
Financial account (+ net lending / - net borrowing) 3/−3,172−1,765−2,871−3,478−1,968−2,328−3,007−3,034−3,173
Direct investments−628−662−945−873−925−988−1,194−1,080−1,320
Portfolio investments−687−992−1,196−1,078−599−668−880−880−880
Equity and investment Fund shares60−24−120−309−181−140−160−180−180
Debt instruments−747−968−1,076−769−418−528−720−700−700
Of which: deposit taking corporations00514594682172000
Of which: general government−747−968−1,590−1,362−1,100−700−720−700−700
T-bills, T-bonds, and SLDBs903532−90138400−200−220−200−200
Sovereign bonds−1,650−1,500−1,500−1,500−1,500−500−500−500−500
Other investments 4/−1,857−111−730−1,527−444−672−933−1,075−973
Of which:
Currency and deposits−1,3136141946115956−107829
Central bank−1,09770140040000000
Deposit taking corporations−216−87−2062115956−107829
Loans 4/−1,266−877−1,222−2,394−256−561−579−1,079−1,361
Central bank 4/000000000
Deposit taking corporations−787507−445−1,028−380−504−275−352−520
General government−470−1,288−452−1,13334034896−327−441
Disbursements−1,268−2,305−1,817−2,583−1,477−1,400−1,400−1,525−1,600
Amortizations7981,0171,3651,4501,8171,7481,4961,1981,159
Other sectors−9−96−325−233−216−405−400−400−400
Errors and omissions−475−200017700000
Overall balance (- = need of inflow) 3/861−3538321,213−192298850716728
Total financing (- = inflow)862−5368321,213−192298850716728
Financing (- = inflow)862−171,4601,725509774850716728
Change in reserve assets355−4721,2271,486509774836659580
Use of Fund credit, net507455233239001456147
Purchases/Disbursements000000000
Repurchases/repayments507455233239001456147
Financing gap (- = inflow)0−518−628−512−701−476000
IMF0−333−403−412−501−251000
Other IFIs0−185−225−100−200−225000
Memorandum items:
Current account (in percent of GDP)−2.4−2.4−2.5−3.0−2.5−2.2−2.2−2.2−2.1
Gross official reserves7,3046,0197,2467,5058,0148,7889,62410,28310,864
In months of prospective imports of goods and services3.72.83.33.43.43.63.83.83.9
In percent of ARA composite metric68.956.264.866.966.570.173.674.875.3
Net international reserves5,0294,5296,1616,5416,5487,0717,9228,6379,365
In percent of ARA composite metric47.542.355.158.354.456.460.662.864.9
GDP79,56580,51783,56783,11786,28292,66899,704107,348115,533
Sources: Data provided by the Central Bank of Sri Lanka; and IMF staff estimates and projections.

Under BPM5 known as Income.

Under BPM5 known as Transfers.

Excluding changes in reserves assets and credit and loans with the IMF.

Excluding credits and loans with the IMF, other than reserves (net purchases and repurchases).

Sources: Data provided by the Central Bank of Sri Lanka; and IMF staff estimates and projections.

Under BPM5 known as Income.

Under BPM5 known as Transfers.

Excluding changes in reserves assets and credit and loans with the IMF.

Excluding credits and loans with the IMF, other than reserves (net purchases and repurchases).

Table 5b.Sri Lanka: Balance of Payments, 2016–18(In millions of U.S. dollars, unless otherwise indicated)
201620172018
Q1Q2Q3Q4AnnualQ1Q2Q3Q4AnnualQ1Q2Q3Q4Annual
Est.Est.Est.Proj.Proj.Proj.Proj.
Current account35−681−126−1,171−1,943−685−796−411−569−2,461−758−498−393−531−2,180
Balance on goods−1,855−2,336−1,969−2,930−9,090−2,505−2,249−2,301−2,741−9,796−2,614−2,462−2,427−2,569−10,072
Credit (exports)2,7392,3912,6562,52410,3102,7742,6232,8333,01411,2443,0172,7752,9883,08111,861
Debit (imports)−4,594−4,727−4,625−5,454−19,400−5,279−4,872−5,134−5,755−21,040−5,631−5,237−5,415−5,650−21,932
Non-oil imports−4,108−4,035−4,126−4,650−16,919−4,396−4,130−4,342−5,029−17,897−4,881−4,429−4,794−4,975−19,080
Oil imports−486−692−499−804−2,481−883−742−792−727−3,143−749−808−621−675−2,853
Balance on services8424717947722,8798885208378363,0819417329579123,542
Credit (exports)1,9281,5651,8161,8297,1382,0241,6221,9482,0747,6682,1291,9332,1242,1728,358
Debit (imports)−1,086−1,094−1,022−1,057−4,259−1,136−1,102−1,111−1,237−4,587−1,188−1,201−1,167−1,260−4,816
Primary income, net 1/−523−449−525−688−2,185−574−464−572−626−2,236−612−424−589−676−2,300
Secondary income, net 2/1,5711,6331,5741,6756,4531,5061,3971,6251,9626,4901,5261,6561,6661,8026,650
Capital account (+ surplus / - deficit)0022325265518555520
Balance from current account and capital account35−681−124−1,148−1,918−683−790−406−564−2,443−753−493−388−526−2,160
Financial account (+ net lending / - net borrowing) 3/353318−1,634−802−1,765−71−2,683−608−116−3,478−1,807−323355−193−1,968
Direct investments−23−33−29−577−662−96−377−147−253−873−148−327−192−258−925
Portfolio investments56755−1,942328−992302−1,3388−50−1,078−1,435344342149−599
Debt instruments56413−1,918373−968417−1,252660−769−1,500450432200−418
Of which: general government56413−1,918373−968417−1,752−270−1,362−1,5002000200−1,100
T-bills, T-bonds, and SLDBs56413−418373532417−252−27013802000200400
Sovereign bonds00−1,5000−1,5000−1,50000−1,500−1,500000−1,500
Other investments 4/−191296337−553−111−277−968−469186−1,527−224−339205−85−444
Of which: Currency and deposits2505989−243614551−32786611−257950−4559
Central bank0701−1170140000040000000
Loans 4/−84610−161120−877−475−1,026−797−96−2,394−210100−99−47−256
Central bank 4/000000000000000
Deposit taking corporations−590166588343507−469−433−80−46−1,028−1509−84−156−380
General government42−141−804−385−1,288−54−462−64225−1,133−414438162340
Disbursements−286−305−1,169−545−2,305−419−784−1,053−326−2,583−369−369−369−370−1,477
Amortizations3281643651601,0173653224113511,4503655134075321,817
Other sectors−298−1555162−9648−131−75−75−233−56−53−53−53−216
Errors and omissions−6758491300−20011760017700000
Overall balance (- = need of inflow) 3/−993−9151,601−46−353−6112,069202−4471,2131,053−170−743−332−192
Total financing (- = inflow)−990−9121,601−234−536−6112,069202−4471,2131,053−170−743−332−192
Financing (- = inflow)−990−7451,601118−17−6112,069368−1011,7251,05380−64318509
Change in reserve assets−1,134−8651,50522−472−7061,974320−1011,4861,05380−64318509
Use of Fund credit, net1441209696455959548023900000
Purchases/Disbursements000000000000000
Repurchases/repayments1441209696455959548023900000
Financing gap (- = inflow)0−1670−352−51800−166−346−5120−250−100−350−701
IMF0−1670−167−33300−166−246−4120−2500−250−501
Other IFIs000−185−185000−100−10000−100−100−200
Memorandum items:
Gross official reserves6,2215,2936,4566,0196,0195,1176,9597,2807,5057,5058,5598,6397,9968,0148,014
In months of prospective imports of goods and services2.92.53.02.82.82.33.13.33.43.43.73.73.43.43.4
In percent of ARA composite metric58.149.560.356.256.245.662.064.966.966.971.171.766.466.566.5
Net international reserves4,3093,8435,2724,5294,5294,3536,0926,5556,5416,5417,5947,4246,7816,5486,548
In percent of ARA composite metric40.335.949.342.342.338.854.358.458.358.363.061.656.354.454.4
Sources: Data provided by the Central Bank of Sri Lanka; and IMF staff estimates and projections.

Under BPM5 known as Income.

Under BPM5 known as Transfers.

Excluding changes in reserves assets and credit and loans with the IMF.

Excluding credits and loans with the IMF, other than reserves (net purchases and repurchases).

Sources: Data provided by the Central Bank of Sri Lanka; and IMF staff estimates and projections.

Under BPM5 known as Income.

Under BPM5 known as Transfers.

Excluding changes in reserves assets and credit and loans with the IMF.

Excluding credits and loans with the IMF, other than reserves (net purchases and repurchases).

Table 6.Sri Lanka: Gross External Financing, 2015–22(In millions of U.S. dollars, unless otherwise indicated)
20152016201720182019202020212022
Proj.
Current account−1,882−1,943−2,461−2,180−2,046−2,172−2,331−2,457
Balance on goods−8,388−9,090−9,796−10,072−10,463−11,109−11,644−12,198
Credit (exports)10,54710,31011,24411,86112,49013,08813,75114,518
Debit (imports)−18,935−19,400−21,040−21,932−22,953−24,197−25,396−26,716
Balance on services2,3242,8793,0813,5423,9704,5815,0115,498
Primary and secondary income, net4,1824,2684,2544,3504,4474,3564,3034,244
Amortization−509−2,280−2,092−2,477−3,784−3,203−2,792−3,196
General government−1298−1017−1450−1817−3248−2496−2198−2659
Sovereign bonds−500000−1500−1000−1000−1500
Syndicated loans00−280−613−560−28000
Bilateral and multilateral−798−1017−1170−1204−1188−1216−1198−1159
Central bank591−1156−63900−14−56−147
IMF repurchases/repayments−506−455−23900−14−56−147
Other central bank liabilities, net1097−701−40000000
Private sector loans198−107−3−660−536−693−538−390
Gross external financing needs−2,391−4,223−4,553−4,657−5,830−5,376−5,123−5,654
Sources of financing2,3914,2234,5534,6575,8305,3765,1235,654
Borrowing2,7463,2335,5274,4656,1286,2125,7826,234
General government2,5643,3083,9452,5773,6003,1203,2253,800
T-bills, T-bonds, and SLDBs, net−903−532−138−400200220200200
Sovereign bonds2,1501,5001,5001,5002,0001,5001,5002,000
Syndicated loans070098500000
Bilateral and multilateral 1/1,2681,6051,5981,4771,4001,4001,5251,600
Official capital transfers4935000000
Other capital inflows, net182−761,5821,8882,5283,0922,5572,434
Deposit-taking corporations, excl. central bank, net787−798530−43449637594804
FDI inflows, net6286628739259881,1941,0801,320
Private sector loans21102006009451,0001,0001,100
Other capital inflows, net−1,44460−21406146261−117−790
Change in reserve assets−355472−1,486−509−774−836−659−580
External financing gap0518512701476000
Financing0518512701476000
IMF0333412501251000
Other IFIs0185100200225000
Sources: Central Bank of Sri Lanka; and IMF staff estimates and projections.

Based on existing and expected commitments (incl. ADB, China, and Japan).

Sources: Central Bank of Sri Lanka; and IMF staff estimates and projections.

Based on existing and expected commitments (incl. ADB, China, and Japan).

Table 7.Sri Lanka: Financial Soundness Indicators—All Banks, 2015–17
2015201520152015201620162016201620172017
Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2
Capital adequacy
Regulatory capital to risk weighted assets16.316.015.215.415.014.714.115.614.915.0
Tier 1 capital/risk weighted assets13.813.512.813.012.412.211.712.512.012.2
Equity capital and reserves to assets ratio8.28.28.17.97.87.97.87.87.78.0
Asset quality
Gross nonperforming loans to total gross loans (without interest in suspense)4.34.34.03.23.13.02.92.62.72.7
Net nonperforming loans to total gross loans2.72.72.41.71.71.61.61.21.41.4
Provision coverage ratio (total)48.148.451.662.361.264.364.571.866.866.8
Earnings and profitability
Return on equity (after tax)16.416.016.216.213.716.417.617.316.518.1
Return on assets (after tax)1.41.31.31.31.11.31.41.41.31.4
Net Interest income to gross income74.674.573.073.275.075.475.374.774.472.7
Staff expenses to noninterest expenses45.646.645.645.539.944.845.444.945.146.7
Total cost to total income73.773.973.873.178.476.075.875.677.776.2
Net interest margin3.83.73.63.63.63.63.53.63.63.5
Liquidity
Liquid assets to total assets31.031.329.430.028.528.328.327.327.628.3
Assets/funding structure
Deposits to total assets66.667.466.566.966.767.568.769.669.470.4
Borrowings to total assets21.420.621.721.821.921.019.818.819.017.8
Credit to deposits (loans net of interest in suspense to deposits)85.585.087.787.388.488.587.188.088.788.1
Source: Central Bank of Sri Lanka.
Source: Central Bank of Sri Lanka.
Table 8.Sri Lanka: Reviews and Purchases Under the Three-year Extended Arrangement
Availability dateAmount (SDR millions)Percent of Quota (%)Conditions
June 3, 2016119.89420.714Board Approval of the Extended Arrangement
November 18, 2016119.89420.714Completion of the first review based on end-June 2016 and continuous performance criteria
April 20, 2017119.89420.714Completion of the second review based on end-December 2016 and continuous performance criteria
November 20, 2017177.77430.714Completion of the third review based on end-June 2017 and continuous performance criteria
April 20, 2018177.77430.714Completion of the fourth review based on end-December 2017 and continuous performance criteria
November 20, 2018177.77430.714Completion of the fifth review based on end-June 2018 and continuous performance criteria
April 20, 2019177.77630.715Completion of the sixth review based on end-December 2018 and continuous performance criteria
Total1070.780185.000
Source: IMF staff.
Source: IMF staff.
Table 9.Sri Lanka: Projected Payments to the Fund, 2017–28 1/(In millions of SDR, unless otherwise indicated)
201720182019202020212022202320242025202620272028
Fund repurchases and charges
In millions of SDR2.914.219.229.859.4123.0180.3192.4189.4176.6144.077.6
In millions of U.S. dollars4.019.927.042.083.8173.4254.3271.3267.2249.0203.1109.4
In percent of exports of goods and NFS0.00.10.10.20.30.71.01.00.90.80.60.3
In percent of quota0.52.43.35.110.321.231.233.232.730.524.913.4
In percent of gross official reserves0.10.20.30.40.81.62.32.32.21.91.50.8
Fund credit outstanding 2/
In millions of SDR537.5893.01,070.81,060.81,020.8916.4752.8574.3395.9227.488.914.8
In millions of U.S. dollars7571,2591,5121,4971,4391,2921,06180955832112521
In percent of quota92.9154.3185.0183.3176.4158.3130.199.268.439.315.42.6
In percent of GDP0.91.51.61.51.31.10.80.60.40.20.10.0
In percent of gross official reserves10.115.717.215.614.011.99.46.94.52.50.90.2
Memorandum items:
Exports of goods and services (in millions of U.S. dollars)18,91220,21921,51722,83724,08525,47126,55327,88129,27530,73932,27633,890
Quota 2/578.8578.8578.8578.8578.8578.8578.8578.8578.8578.8578.8578.8
Quota (in millions of U.S. dollars) 2/815816817817816816816816816816816816
Gross official reserves (in millions of U.S. dollars) 2/7,5058,0148,7889,62410,28310,86411,30011,80012,30012,80013,30013,800
GDP (in millions of U.S. dollars)83,11786,28292,66899,704107,348115,533125,242135,261146,082157,769170,390184,022
U.S. dollars per SDR (eop)1.411.411.411.411.411.411.411.411.411.411.411.41
U.S. dollars per SDR (avg.)1.381.411.411.411.411.411.411.411.411.411.411.41
Source: IMF staff estimates.

As of October 30, 2017. Data for current year shows remaining payment in the year.

As of the end of the year.

Source: IMF staff estimates.

As of October 30, 2017. Data for current year shows remaining payment in the year.

As of the end of the year.

29. Other issues. The planned revision of the MLA is expected to address the issues identified by IMF safeguards assessment (August 2016), including on the CBSL’s autonomy and governance arrangement (e.g., the government’s voting representation in the Monetary Board, absence of recapitalization provisions, and inadequate limits on credit to government). Following the establishment of a payment platform, external arrears with the Export Development Bank of Iran are being paid based on a schedule shared with the Iranian authorities and will be cleared by February 2018. Staff will review the regulations associated with the new FX Act—albeit enacted to further liberalize FX transactions—for their adherence to the Article VIII obligation.

Staff Appraisal

30. The EFF-supported program remains broadly on track. The authorities continue to make progress with revenue-based fiscal consolidation and reserves accumulation, while amending and legislating the VAT and the new IRA albeit with some delay. The 2018 budget consistent with the program was submitted to parliament, and a roadmap for inflation targeting has been approved by the Monetary Board. As the impact of the weather calamities subsides, growth and inflation are projected to normalize in 2018.

31. Nonetheless, downside risks and implementation delays call for a stronger ownership to uphold reform momentum. High public debt and low external buffers continue to expose Sri Lanka to severe downside risks. SOE operating results and debts present further fiscal and debt sustainability risks. Delays with the IRA implementation and SOE reforms could weaken confidence and reverse the progress made under the program, raising the need for stronger and more consistent ownership to accelerate reforms.

32. Revenue-based fiscal consolidation should continue. Front-loaded consolidation that targets 1 percent-of-GDP primary surplus in 2018 will help anchor investor confidence. Effective implementation of the new IRA and the tax package of the 2018 budget will also protect social and infrastructure spending. Stronger disaster provisions in the 2018 budget should mitigate weather-related adversities. Enhancing debt and fiscal management frameworks will support durable fiscal consolidation.

33. SOE reforms should progress without further delay. Following steps to raise the transparency of NCOs for fuel and electricity, the authorities should make timely progress in adopting the automatic pricing formula. The authorities should also resolve the impasse in restructuring Sri Lankan Airlines and move forward.

34. Reserves accumulation should continue with greater exchange rate flexibility. Greater reserve coverage and exchange rate flexibility will help contain external vulnerability and provide buffer against market volatility. The authorities should build on the growing depth of FX market by adopting FX auctions to enhance market development and transparency.

35. The central bank should focus on stabilizing inflation and manage financial sector risks. Monetary policy should maintain a tightening bias, supplemented by macroprudential measures as needed, until clearer signs emerge that inflation and credit growth have stabilized. Financial sector supervision should be strengthened to safeguard stability and protect against rapid credit growth.

36. Staff supports the completion of the third review under the EFF arrangement, in light of the progress so far and the authorities’ commitment to ongoing reforms. Staff also supports the authorities’ request for modification of program conditionality as described in paragraph 27.

Box 1.Sri Lanka: Coping with Natural Disasters

Sri Lanka has experienced exceptionally severe weather events since late 2016. Nationwide shortage of rainfall since late 2016, far below the average, has led to a historical drought across the country. The monsoon in May 2017 then triggered devastating floods and landslides in southwest regions, claiming more than 200 lives and damaging more than 9,000 houses. Nevertheless, the overall level of rainfall was insufficient to resolve the drought condition. The government estimates that more than 2 million people have been affected by these two severe weather events. Climate change would be a possible culprit for the erratic weather pattern—global warming is projected to make monsoon rainfall more variable in South Asia, with greater frequency of devastating floods and droughts (World Bank, 2013, “Turn Down the Heat: Climate Extremes, Regional Impacts, and the Case for Resilience”).

The weather calamities suppressed economic growth, raised inflation, and worsened trade deficit. With two rice cultivation cycles disrupted since fall 2016, the government estimates domestic rice production in 2017 to be the lowest in the last 10 years and meet only 7 months of national consumption. Affected also by the 2017 floods, agriculture GDP contacted by 3.1 percent in 2017H1, with adverse consequences on overall growth and tax revenues. The food shortage contributed to food inflation accelerating to 10.4 percent y/y in September and an increase in food imports by US$170 million over January–August 2017 (0.2 percent of annual GDP) compared with the same period last year. Moreover, the drought caused a shift in power generation from hydro to thermal sources, raising oil imports by US$560 million (0.7 percent of GDP) over January–August and the cost of power generation with it.

The impact has been felt disproportionately by the poor. The drought has deprived livelihood from families engaged in agricultural labor and subsistence. According to the UN World Food Program, the number of food insecure households rose to 277,000 by August, with 30 percent of them possibly consuming less than the daily minimum calorie intake. The property damage from the floods would also be more difficult for poor households to overcome.

Post-disaster relief efforts resulted in significant fiscal cost. Aside from indirect costs, immediate recovery and humanitarian assistance include: targeted income support that provides more than 800,000 severely affected households with a food voucher of Rs 5,000 (US$ 33); rehabilitation for damaged property, e.g., construction of new houses for landslide victims; and rehabilitation of road and irrigation systems. The government estimates the cost of these spending items to be 0.4 percent of GDP in 2017. In addition, the cost for higher thermal power generation caused CEB to record a financial loss of Rs 34 billion (0.3 percent of GDP) in 2017H1, for which the government transferred Rs 6 billion to CEB so far.

In recognition of the rising risk of damages from climate change, the authorities pledged to prioritize environmental protection and disaster management (Vision 2025). The government established a disaster insurance scheme for houses against natural disasters, and intends to establish a natural disaster reserve fund to finance post-disaster reconstruction. The government is considering resettling communities in landslide prone areas, as well as undertaking vulnerability and risk assessment.

Figure 1.Sri Lanka: Real Sector

Sources: Central Bank of Sri Lanka; and IMF staff calculations.

Figure 2.Sri Lanka: Fiscal Sector

Sources: Central Bank of Sri Lanka; Ministry of Finance; and IMF staff calculations.

Figure 3.Sri Lanka: Financial Market

Sources: Central Bank of Sri Lanka; CEIC Daily Database; Bloomberg Data LP; and IMF staff calculations.

Figure 4.Sri Lanka: Foreign Exchange Reserves

Sources: Central Bank of Sri Lanka; APDCORE Database; Bloomberg Data LP; and IMF staff calculations.

Figure 5.Sri Lanka: Monetary and Financial Sector

Sources: Central Bank of Sri Lanka; and IMF staff calculations.

Annex I. Debt Sustainability Analysis

Sri Lanka’s public debt and gross funding needs stand high compared with peers, with the ratio of gross financing needs to GDP being the third largest among emerging economies. Fiscal consolidation envisaged under the EFF-supported program would steadily reduce them. However, there are significant downside risks including those related to contingent liabilities, with stress tests indicating a high risk to public debt sustainability. External debt remains sustainable, though with high currency risks. Risks to external debt sustainability are mitigated by long maturities and Sri Lanka’s access to international financial markets.

A. Background and Key Assumptions

1. Public debt reached 85.2 percent of GDP at end-2016. Public debt in this DSA covers debt owed by the central government (80.1 percent of GDP), outstanding amount of loans guaranteed by the central government (4.4 percent of GDP), and outstanding Fund credit (0.7 percent of GDP). Compared with the figures reported in the staff report for the EFF second review (CR/17/253), the debt level has been revised up for the treasury bonds issued in the past to support SOEs and a guaranteed international bond that had not been part of the reported figure. Foreign-currency denominated debt accounted for 47 percent of total, while debt owed to official and multilateral creditors accounted for about a quarter of the total. Gross financing needs are estimated at 17.6 percent of GDP in 2016, comprising amortization payments (including short-term debt repayment) of 12.2 percent of GDP and an overall deficit of 5.4 percent of GDP. Sri Lanka’s debt to GDP ratio remains higher than the median for emerging economies (57 percent; excluding major oil exporters), and gross funding needs are the third largest among them.

2. The financial obligations of nonfinancial state-owned enterprises (SOEs) are estimated to be 11.9 percent of GDP at end-2016.1 Sri Lanka has more than 200 state-owned enterprises, and Ministry of Finance publishes financial performance of 41 nonfinancial SOEs. They recorded a profit of 0.3 percent of GDP as a whole in 2016, as the profit of the Ceylon Petroleum Corporation (0.6 percent of GDP) offset the losses of the Ceylon Electricity Board and Sri Lankan Airlines (0.1 percent and 0.3 percent of GDP, respectively). Nonfinancial SOEs’ financial obligations are estimated to have decreased by 1.8 percentage points of GDP in 2016, reflecting the fact that CPC used its profit for debt repayment and SriLankan Airlines cancelled part of future airplane lease commitments. Nonfinancial SOEs’ financial obligations are not included in the public debt outstanding under this DSA, but the impact from possible realization of the contingent liabilities is assessed under a shock scenario.

Sri Lanka: Nonfinancial SOE Balance

(In percent of GDP) 1/

Citation: 2018, 3; 10.5089/9781484337035.002.A001

Source: MOF and IMF staff calculations.

1/ Comprises 41 nonfinancial SOEs reported by Ministry of Finance.

Sri Lanka: Public Debt, 2015–16
20152016
CR/17/253Updated 1/CR/17/253Updated 1/
Rs. Bn% GDPRs. Bn% GDPRs. Bn% GDPRs. Bn% GDP
Public debt8,99682.19,11383.29,96884.210,08685.2
Central government debt8,50377.68,59578.59,38779.39,47980.1
Domestic4,95945.35,05146.15,34245.15,43345.9
Treasury Bills6586.06586.07806.67806.6
Treasury Bonds3,30530.23,39731.03,71531.43,80632.2
Other9969.19969.18477.28477.2
External3,54432.43,54432.44,04634.24,04634.2
Multilateral and bilateral2,23720.42,23720.42,43720.62,43720.6
International sovereign bonds9588.79588.71,22110.31,22110.3
Nonresident holdings of T-Bills and T-Bonds3042.83042.82602.22602.2
Other450.4450.41281.11281.1
Publicly guaranteed debt3823.54083.74974.25244.4
Ceylon Electricity Board30.030.0200.2200.2
Ceylon Petroleum Corporation1961.81961.82121.82121.8
National Water Supply and Drainage Board90.190.1350.3350.3
Road Development Authority1361.21361.21351.11351.1
SriLankan Airlines260.2270.2
Other380.3380.3950.8950.8
Fund credit outstanding1101.01101.0830.7830.7
Financial obligations of SOEs 2/1,28011.71,50113.71,41411.9
Ceylon Electricity Board2372.22142.02301.9
Ceylon Petroleum Corporation4243.94253.93853.3
Road Development Authority1361.21351.1
Sri Lanka Ports Authority2402.22332.12372.0
SriLankan Airlines3092.84053.73172.7
Other690.6880.81080.9
Memorandum item:
Central government debt, Fund credit outstanding, and financial obligations of SOEs 2/10,20593.210,97692.7
Nominal GDP10,95210,95211,83911,839
Sources: Sri Lankan authorities and IMF staff estimates.

The main revisions from CR/17/253 are:

(1) Central government debt now includes treasury bonds amounting to Rs 78,447 million issued to settle dues to CPC in January 2012 and Rs 13,125 million issued to capitalize SriLankan Airlines in March 2013.

(2) Publicly guaranteed debt now includes the Eurobond amounting to US$175 million issued by SriLankan Airlines.

(3) Debt owed by Road Development Agency is now added to financial obligations of SOEs.

(4) Financial obligations of SriLankan Airlines now include lease commitment on aircrafts on order.

IMF staff estimates. Including short-term debt, project loans, and SriLankan Airlines’ liabilities related to aircraft lease. Data for SriLankan Airlines are as of end-March.

Sources: Sri Lankan authorities and IMF staff estimates.

The main revisions from CR/17/253 are:

(1) Central government debt now includes treasury bonds amounting to Rs 78,447 million issued to settle dues to CPC in January 2012 and Rs 13,125 million issued to capitalize SriLankan Airlines in March 2013.

(2) Publicly guaranteed debt now includes the Eurobond amounting to US$175 million issued by SriLankan Airlines.

(3) Debt owed by Road Development Agency is now added to financial obligations of SOEs.

(4) Financial obligations of SriLankan Airlines now include lease commitment on aircrafts on order.

IMF staff estimates. Including short-term debt, project loans, and SriLankan Airlines’ liabilities related to aircraft lease. Data for SriLankan Airlines are as of end-March.

3. External debt is estimated at 57 percent of GDP at end-2016. It is predominantly owed by the public sector (34 percent of GDP is held by the general government and 2 percent by the central bank). Private external debt has been steady over the last few years, remaining at around 22 percent of GDP since 2014. The ratio of debt to exports is also high, at 264 percent in 2016. However, rollover risks remain contained as 85 percent of total debt (i.e., public and private) is medium or long term. However, preparation is needed as the next sovereign bond repayment of US$1.5 billion falls due in 2019. About half of the central government’s external debt stock is denominated in dollars.

Sri Lanka: Profile of Central Government External Loans (2015)

Source: Sri Lankan authorities.

4. The baseline scenario of the DSA reflects the macroeconomic framework and the proposed policies under the EFF-supported program. Real GDP growth is projected to recover from 4.4 percent in 2016 to 5 percent by 2022. Inflation is projected to stay around 5 percent over the medium term. Fiscal deficit is programmed to decrease from 5.4 percent of GDP in 2016 to the authorities’ target of 3.5 percent of GDP in 2020. This implies that primary balance improves from deficit of 2.2 percent of GDP in 2015 to a surplus of 1 percent of GDP in 2018, followed by a surplus of 2.5 percent of GDP in 2020. Interest payments are projected on the basis of the projected interest payments for existing debt, and the interest rates in the primary and secondary government security markets prevailing thus far in 2017 for the newly issued debt in 2017. Interest rates for newly issued debts are assumed to decrease gradually from these levels over the medium term. Publicly guaranteed debt is projected to remain constant as a percent of GDP at the 2016 level. External debt projections are based on a projected path of the current account deficit from 3 percent of GDP in 2017 to around 2 percent of GDP over the medium term, and incorporate planned purchases under the Fund’s Extended Arrangement and disbursements of program loans by multilateral and bilateral creditors.

B. Public Debt Sustainability

5. Fiscal consolidation envisaged under the EFF-supported program would steadily reduce public debt. The consolidation path envisaged under the program scenario is projected to bring down the ratio of public debt to GDP from 85.2 percent in 2016 to 75.1 percent in 2022. It will reduce the debt to GDP ratio by about 2–3 percent annually from 2018 onwards, supported by favorable debt dynamics with a negative interest-rate-and-growth differential and primary surpluses. Gross financing needs are projected to rise to 20 percent of GDP in 2018 and then decrease to around 13–14 percent of GDP in 2022.

6. Nevertheless, there are significant downside risks to the program scenario. If fiscal consolidation stalls and primary balance remains at a historical level (−1.5 percent of GDP), the debt-to-GDP ratio would remain at about the same level as in 2016. Debt reductions would become less significant under individual shock scenarios on primary balance (lower primary surplus by 0.5 percentage points of GDP for 2018–19), GDP growth (2 percentage points lower than in the program scenario for 2018–19), the exchange rate (15 percent real depreciation in 2018 vis-à-vis the program scenario), and the interest rate (an increase by 300 basis points for new borrowings during 2017–20 vis-à-vis the program scenario). When these shocks are combined, the debt to GDP ratio would reach 94 percent in 2022. Similarly, in a contingent liability shock scenario (the central government becomes liable for additional debt of 10 percent of GDP in 2017), the debt to GDP ratio would initially jump to 98 percent of GDP and gradually decline to 89 percent of GDP in 2022. The likelihood of such a scenario has increased due to delays in introducing fuel and electricity pricing mechanisms, which are crucial to ensure profitability of oil and electricity SOEs. In the combined shock scenario and the contingent liability shock scenario, gross funding needs would remain elevated at 16–19 percent of GDP in 2022. Also, the debt level is high relative to revenues, constraining repayment capacity. The envisaged improvement in the cyclically adjusted primary balance by 3.3 percentage points of GDP over 2016–18 is higher than in 80 percent of international experiences, highlighting the challenge of the fiscal consolidation plan.

7. Heat map analysis indicates a high risk to debt sustainability. The debt burden benchmark of 70 percent of GDP and gross financing need benchmark of 15 percent of GDP are exceeded in the program and the shock scenarios during the projection period, reflecting the initial conditions (under the program scenario, the debt to GDP ratio and gross financing needs as a percent of GDP were 87 percent and 19 percent in 2017, respectively). Debt profile analysis indicates moderate degree of vulnerabilities related to market perception, external financing requirement, debt held by non-residents, and debt denominated in foreign currency.

C. External Debt Sustainability

8. The ratio of external debt to GDP is projected to gradually decline over the medium term. Under the program scenario, external debt is projected to decrease from 57 percent of GDP in 2016 to around 52 percent in 2022. The decline is driven by robust GDP growth, a steady pace of fiscal consolidation, and gradual current account adjustments.

9. Nevertheless, vulnerabilities linked to inadequate reserve coverage, exchange rate depreciation, and deleveraging could pose a risk for debt servicing. Currency risk, notably related to the dollar, is high. Large rupee depreciation could pose a significant risk, if sustained; as stress tests show that a 30 percent real depreciation could raise the external debt to GDP ratio to about 75 percent by 2022. In the short run, tighter global liquidity and shifts in investor confidence could raise rollover vulnerabilities and costs. Although rollover risks are currently low due to the high share of medium- to long-term debt, there are lumpy repayments starting in 2019, and external financing at non-concessional terms gradually substitutes concessional financing, pointing to a need to speedily build up buffers. Lower than expected GDP or export growth would also deteriorate debt dynamics.

Sri Lanka: Public DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are:

200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ EMBIG, an average over the last 3 months, 12-Aug-17 through 10-Nov-17.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Sri Lanka: Public DSA—Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes program countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/Sri Lanka has had a positive output gap for 3 consecutive years, 2014-2016. For Sri Lanka, t corresponds to 2017; for the distribution, t corresponds to the first year of the crisis.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Sri Lanka: Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(in percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as central government and includes public guarantees, defined as outstanding amount of loans guaranteed by the central government and Fund credit outstanding.

2/ Based on available data.

3/ EMBIG.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Sri Lanka: Public DSA—Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Sri Lanka: Public DSA—Stress Tests

Source: IMF staff.

Sri Lanka: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2017.

Sri Lanka: External Debt Sustainability Framework, 2012–2022(In percent of GDP, unless otherwise indicated)
ActualProjections
20122013201420152016201720182019202020212022
Debt-stabilizing

non-interest

current account 6/
Baseline: External debt54.253.654.256.457.158.257.957.055.253.552.3−2.2
Change in external debt4.0−0.60.72.10.81.0−0.3−0.9−1.8−1.7−1.2
Identified external debt-creating flows (4+8+9)1.4−2.5−2.11.30.7−0.4−1.3−1.4−1.7−1.5−1.7
Current account deficit, excluding interest payments4.52.01.00.90.91.30.50.0−0.2−0.6−0.8
Deficit in balance of goods and services11.98.68.17.67.78.17.67.06.56.25.8
Exports19.820.321.121.321.722.823.423.222.922.422.0
Imports31.828.929.228.929.430.831.030.229.428.627.8
Net non-debt creating capital inflows (negative)−1.7−1.5−1.3−0.7−0.9−1.1−1.3−1.1−1.4−1.2−1.3
Net foreign direct investment, equity1.31.21.00.80.81.11.11.01.21.01.1
Net portfolio investment, equity0.40.30.2−0.10.00.00.20.20.20.20.2
Automatic debt dynamics 1/−1.5−3.0−1.91.10.7−0.6−0.6−0.4−0.20.30.4
Contribution from nominal interest rate1.31.41.51.51.51.72.02.22.42.82.9
Contribution from real GDP growth−4.4−1.7−2.5−2.6−2.4−2.3−2.6−2.5−2.5−2.5−2.5
Contribution from price and exchange rate changes 2/1.6−2.7−0.92.31.6
Residual, incl. change in gross foreign assets (2-3) 3/2.71.92.80.80.01.41.00.6−0.1−0.20.5
External debt-to-exports ratio (in percent)273.3264.6257.2264.6263.5255.6246.9245.5241.1238.6237.4
Gross external financing need (in billions of US dollars) 4/13.011.911.112.212.811.010.612.712.612.813.4
in percent of GDP19.016.014.015.315.810-Year10-Year13.212.313.712.612.011.6
Scenario with key variables at their historical averages 5/58.256.456.055.154.053.5−4.7
Key Macroeconomic Assumptions Underlying BaselineHistorical

Average
Standard

Deviation
Real GDP growth (in percent)9.13.45.04.84.45.92.04.24.64.74.84.95.0
GDP deflator in US dollars (change in percent)−4.05.31.5−4.3−3.03.77.7−0.9−0.72.62.72.62.5
Nominal external interest rate (in percent)2.72.92.92.82.72.80.33.03.54.04.55.55.9
Growth of exports (US dollar terms, in percent)−0.511.111.01.23.07.910.68.46.96.46.15.55.8
Growth of imports (US dollar terms, in percent)−2.4−1.07.6−0.62.89.019.98.34.44.74.84.64.7
Current account balance, excluding interest payments−4.5−2.0−1.0−0.9−0.9−2.62.5−1.3−0.50.00.20.60.8
Net non-debt creating capital inflows1.71.51.30.70.91.20.41.11.31.11.41.21.3

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex II. State of Fiscal Structural Reforms
AreaProgressFuture actions
Tax policyAmendments to VAT were introduced in 2016 which increased the VAT rate from 11 to 15 percent, removed exemptions on telecoms and health care (excluding diagnostic tests, dialysis and services provided by the Outpatient Department), and lowered the VAT threshold for wholesale and retail sectors. VAT diagnostics were used to identify the removal of exemptions that formed a key component of the 2018 Budget’s revenue package.



In order to simplify the income tax system and broaden its base, a new Inland Revenue Act (IRA) was drafted and submitted to Parliament in July 2017, and legislated in October 2017. This is a flagship reform of the program and key to revenue mobilization efforts.
With legislation of the new IRA complete, focus now turns to its implementation.



Efforts will continue to identify further tax policy options, including base-broadening through the removal of VAT exemptions and the streamlining of other indirect taxes.
Tax administrationA VAT compliance strategy that includes a time-bound plan to implement risk-based audits, and key performance indicators on the number of the audits that have been conducted, has been implemented for large businesses on a pilot basis.



Technical capacity to improve revenue administration was enhanced with the rollout of the RAMIS IT system in December 2016.
On income tax, the Implementation Steering Committee for the new IRA has drafted a detailed implementation plan that will be rolled over the next year. It includes publication of tax manuals (January 2018 structural benchmark), updating regulations, training tax administrators, taxpayer education, and modifications to the existing IT system. Extensive technical assistance has been, and will continue to be, provided to aid in these efforts.



VAT compliance strategies will be implemented for all large taxpayers and extended to medium- and small-taxpayers.
Public financial managementThe Ministry of Finance has modified its existing IT system and is now capable of tracking spending commitments for each line ministry on a monthly basis and has begun reporting fiscal performance to parliament on a quarterly basis.



The complete operationalization of ITMIS, including the ability to centrally control commitments, has been delayed. ITMIS has been rolled out in the Ministries of Health and Finance but is currently being operated in parallel to the existing system and commitment ceilings are being modified manually.
ITMIS will be expanded to 100 spending units in 2018 and is expected to become fully operational in 2019.



Starting in 2018, quarterly commitment ceilings will be established for line ministries through modification of the existing IT system (CIGAS) (January 2018 structural benchmark); but this will be administered manually. This will require training accounting officers in line departments and upgrading IT systems.
SOE reformAfter some delays, Statements of Corporate Intent (SCIs) for five SOEs (electricity, petroleum, airport and aviation, water, and ports authority) were signed by MOF, line ministries, and SOE management, and published in April 2017. The SCIs should create a transparent framework for strategic performance oversight, hold SOEs’ boards and management accountable for performance, and identify costs of non-commercial obligations.



Restructuring of SriLankan Airlines is ongoing: a resolution strategy was approved by cabinet and the airline has undertaken route and fleet optimization. Securing a strategic partner and resolving the need for capital injection and debt consolidation has been significantly delayed.
The authorities are developing a framework for evaluating the five SOEs against key performance indicators contained in the SCIs and plan to expand them to other SOEs.



The authorities aim to put SriLankan Airlines on a commercial footing and resolve fiscal contributions, if any, to the airline’s liabilities. A government task force, overseen by the Prime Minister’s office, has been set up to map out the reform timeline.
Fuel and electricity pricingAlthough the authorities have the capacity to design and implement automatic fuel and electricity prices, political sensitivity has hampered progress in this reform area. The reform sequencing has been recalibrated to allow time for public consultation and education.



As the first step, a report on the cost of non-commercial obligations for fuel and electricity was completed and published as an annex to the 2018 budget.
A Bulk Supply Transactions Account will be established by March 2018 (structural benchmark) to refine estimates on the cost of non-commercial obligations for electricity.



The authorities will then recognize the quasi-fiscal cost of fuel and electricity NCOs as central government expenditure by explicitly accounting for them in the EFF program targets. Specifically, starting in 2018, an indicative target is set on the cost of NCOs for fuel and electricity (net of government transfers).



As the final step, cabinet approval of the automatic pricing mechanism will be obtained for fuel by March 2018 and for electricity by September 2018 (structural benchmarks).
Annex III. Compensating Fuel and Electricity NCOs

1. Fuel prices and electricity tariffs are publicly administered in Sri Lanka and have been predominantly fixed since 2015. Because of this, CEB and CPC, dominant state-owned suppliers of electricity and fuel in Sri Lanka, have been occasionally tasked with supplying electricity and fuel at prices below cost-recovery levels. This is referred to as non-commercial obligations (NCOs).

2. Because the cost of NCOs is equivalent to quasi-fiscal energy subsidies, it should in principle be compensated by on-budget government transfers to CEB and CPC. This has not been the case in Sri Lanka: in the past, the losses of CEB and CEB were financed by bank loans, resulting in large debt (CPC) or equity injections by the government (CEB).

3. Adoption of automatic pricing mechanisms for fuel and electricity—envisaged by March and September 2018, respectively—would effectively eliminate the NCOs. In the absence of pricing mechanisms, however, recording the cost of NCOs explicitly as on-budget spending enhances transparency and motivates public debate on adjustments in fuel and electricity prices.

4. Against this backdrop, a zero ceiling on the cost of NCOs (net of government transfers) will be introduced as an indicative target under the EFF-supported program. For CPC, the cost of NCOs is measured by the difference between the cost to provide fuel products minus revenue. For CEB, it will be defined as the decline in the balance of the Bulk Supply Transaction Account, which mirrors financial shortfall of the electricity sector in a given period.

Appendix I. Letter of Intent

Colombo, November 17, 2017

Ms. Christine Lagarde

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Ms. Lagarde:

This letter serves as a supplement to our Letters of Intent dated May 12, 2016, November 3, 2016, and June 23, 2017, and the associated Memorandums of Economic and Financial Policies (MEFP) dated May 12, 2016, and June 23, 2017. The attached MEFP updates the MEFP dated June 23, 2017, by describing reform progress so far and setting out the plans and policies of the authorities of Sri Lanka for 2017–2019. Table 1 and Technical Memorandum of Understanding (TMU) attached to the MEFP set out quantitative targets that are to be observed under the Extended Arrangement. Table 2 attached to the MEFP sets out a prior action for the third review (which we have met) as well as new structural benchmarks. We have also met all end-June PCs and continuous PCs and implemented most SBs. Tables 1 and 2 document progress with quantitative targets and structural benchmarks.

Table 1.Sri Lanka: Quantitative Performance Criteria (PC) and Indicative Targets (IT)(Cumulative from the beginning of the year, unless otherwise noted)
20172018
end-Jun.end-Sep. (IT)end-Dec.end-Mar.

(IT)
end-Jun.end-Sep.

(IT)
end-Dec.

(IT)
Prog.Adj. ProgAct.Met / not metProg.Adj. ProgAct.Met / not metProg.Prog.Prog.Prog.Prog.
Quantitative performance criteria
Central government primary balance (floor, in billion rupees)−8−816Met−4−416Met−23154590141
Program net official international reserves (Program NIR, floor, in million US$) 1/2/2,0271,8742,049Met1,9762,0572,568Met2,2361,0531,133922690
Continuous performance criteria (cumulative from beginning of the program)
New external payment arrears by the nonfinancial public sector and the CBSL (ceiling, in million US$)000Met000Met00000
Monetary policy consultation clause
Year-on-year inflation in Colombo Consumers Price Index (in percent) 3/
Outer band (upper limit)7.97.98.88.88.57.77.77.98.0
Inner band (upper limit)6.46.4Within7.37.3Within7.06.26.26.46.5
Actual / Center point4.94.96.3inner5.85.86.0inner5.54.74.74.95.0
Inner band (lower limit)3.43.4band4.34.3band4.03.23.23.43.5
Outer band (lower limit)1.91.92.82.82.51.71.71.92.0
Indicative targets
Central government tax revenue (floor, in billion rupees)803803819Met1,2321,2321,240Met1,6804479241,4381,954
Reserve money of the CBSL (ceiling, end of period stock, in billion rupees) 4/905905892Met935935909Met9671,0201,0251,0711,095
Cost of non-commercial obligations (NCOs) for fuel and electricity (net of government transfers) (ceiling, in billion rupees) 5/0000
Memorandum items:
Net official international reserves (CBSL’s conventional definition, end of period stock, in million US$, market exchange rate) 1/6,1686,0926,0236,5566,5417,5947,4246,7816,548
CBSL’s outstanding liabilities in FX swaps with domestic commercial banks (in million US$)1,9241,851
Foreign program financing by the central government (in million US$) 2/1250125022500100200
Net borrowings from SLDBs and FCBUs by the central government (in million US$) 2/6276276275716270−150−150−150
External commercial loans by the central government (in million US$) 2/1,9501,9411,9502,4822,2001,5001,5001,5001,500
Proceeds from commercialization of public assets to non-residents (in million US$) 2/0020002000400400400
Amortization of official external debt by the central government (in million US$) 2/5295478899591,0653655729791,204
Cost of NCOs for fuel (net of government transfers) 5/0000
Cost of NCOs for fuel
Government transfers for NCOs for fuel
Cost of NCOs for electricity (net of government transfers) 5/0000
Cost of NCOs for electricity
Government transfers for NCOs for electricity

The CBSL’s conventional definition of net official international reserves (NIR) includes outstanding liabilities in foreign exchange swaps with domestic commercial banks. The Program NIR excludes the outstanding liabilities in foreign exchange swaps with domestic commercial banks from the CBSL’s conventional NIR definition. See TMU for details.

Program NIR will be adjusted upward/downward by the cumulative amounts of (i) foreign program financing by the central government, (ii) net borrowings from SLDBs and FCBUs by the central government, (iii) external commercial loans (including Eurobonds and syndicated loans) by the central government, and (iv) proceeds from commercialization of public assets to non-residents, that are higher/lower than assumed under the program; and by the cumulative amount of amortization of official external debt by the central government that is lower/higher than assumed under the program.

See the TMU for how to measure year-on-year inflation. Note June 2017 onwards the MPCC and inflation is based on the new index (2013=100).

See TMU for details on the calculation of reserve money for the test date.

NCOs refer to the obligation of CPC and CEB to supply fuel and electricity at administered prices. See TMU for how to measure the cost of NCOs.

The CBSL’s conventional definition of net official international reserves (NIR) includes outstanding liabilities in foreign exchange swaps with domestic commercial banks. The Program NIR excludes the outstanding liabilities in foreign exchange swaps with domestic commercial banks from the CBSL’s conventional NIR definition. See TMU for details.

Program NIR will be adjusted upward/downward by the cumulative amounts of (i) foreign program financing by the central government, (ii) net borrowings from SLDBs and FCBUs by the central government, (iii) external commercial loans (including Eurobonds and syndicated loans) by the central government, and (iv) proceeds from commercialization of public assets to non-residents, that are higher/lower than assumed under the program; and by the cumulative amount of amortization of official external debt by the central government that is lower/higher than assumed under the program.

See the TMU for how to measure year-on-year inflation. Note June 2017 onwards the MPCC and inflation is based on the new index (2013=100).

See TMU for details on the calculation of reserve money for the test date.

NCOs refer to the obligation of CPC and CEB to supply fuel and electricity at administered prices. See TMU for how to measure the cost of NCOs.

Table 2.Sri Lanka: Prior Action and Structural Benchmarks under the EFF-Supported Program
Prior Action
Submit to Parliament the 2018 budget consistent with program targets and staff recommendations.Met
Structural BenchmarksTarget Completion DateStatusComment
A. Proposed Structural Benchmarks
Approval by cabinet of a policy note outlining the key elements of amendments (or replacement) to the Monetary Law Act (MLA), in consultation with the IMF.March 2018
Cabinet to approve a debt management strategy for international sovereign bonds maturing over 2019-22.June 2018
MOF to publish a detailed IRA tax manual with practical tax and administrative examples.January 2018
B. Existing Structural Benchmarks
Monetary and Exchange Rate Policies
Develop a roadmap for flexible inflation targeting and flexible exchange rate regime that identifies timebound reform measures to be taken during the program period.October 2017MetAn IMF TA mission for designing the roadmap took place in May 2017. The Monetary Board approved this roadmap.
Fiscal Policy Management
Submit to Parliament the 2018 budget that is in line with the program targets and includes: (i) a tax expenditure statement, (ii) a plan to rationalize tax expenditures in 2018 as agreed with IMF staff, and (iii) the estimated fiscal cost of non-commercial obligations (including subsidies) for SOEs.November 2017MetAt the second review, the structural benchmark for the 2018 budget was updated to incorporate the unmet structural benchmarks for a tax expenditure rationalization plan and publication of the noncommercial obligations for SOEs.
Submit to Parliament the 2019 budget that is in line with the program targets and includes: (i) a tax expenditure statement, (ii) a plan to rationalize tax expenditures in 2019 as agreed with IMF staff, and (iii) the estimated fiscal cost of non-commercial obligations (including subsidies) for SOEs.November 2018At the second review, the structural benchmark for the 2019 budget was updated to incorporate the unmet structural benchmarks for a tax expenditure rationalization plan and publication of the noncommercial obligations for SOEs.
Tax Policy Reform
Complete by Ministry of Finance (MOF) a diagnostic review of the VAT system.June 2017Not met (implemented with delay)MOF completed the review in November 2017 with inputs from FAD TA on VAT gap analysis.
Tax Administration Reform
Adopt by MOF Inland Revenue Department compliance strategies for corporate and personal income taxes.June 2017Not metThe authorities will not design compliance strategies for corporate and personal income taxes until the new IRA is fully implemented. However, the new Act contains increased powers for the Inland Revenue Department (e.g., interest and penalties on late filings) which should improve compliance in general.
Public Financial Management
MOF to implement an IT-based commitment control system with commitment ceilings for line ministries for the 2018 budget.January 2018Given delays in implementing the ITMIS modules for commitment control, the existing CIGAS system will be modified so that quarterly commitment ceilings will be operational for the 2018 budget. This enables MOF to transition from cash-based expenditure management to commitment-based control.
State Enterprise Reform
MOF to complete a report outlining the cost of non-commercial obligations for fuel and electricity.September 2017Not met (implemented with delay)A step in a sequence of reforms to put the automatic fuel and electricity pricing reform back on track. The report was published as an annex to the 2018 budget speech in November.
Cabinet to approve automatic fuel pricing mechanism (agreed with IMF staff) that ensures retail prices above cost-recovery levels and a financial position of Ceylon Petroleum Corporation capable of covering debt service.March 2018The target date has been reset at the second review to allow time for public consultation and education, followed by a sequence of reforms.
CEB and the Public Utilities Commission (PUC) to establish a Bulk Supply Transactions Account and start using it to settle transactions between generators, the transmission operator, and distributors as specified in the November 2015 tariff methodology.March 2018A step in a sequence of reforms to put the automatic electricity pricing reform back on track.
Cabinet to approve automatic electricity pricing mechanism (agreed with IMF staff) that ensures retail prices above cost-recovery levels and a financial position of Ceylon Electricity Board capable of covering debt service.September 2018The target date has been reset at the second review to allow time for public consultation and education, followed by a sequence of reforms.
C. Past Structural Benchmarks
Fiscal Policy Management
Submit to Parliament the 2017 budget in line with the program targets.November 2016MetThe 2017 budget was submitted to Parliament on November 10, 2016.
Tax Policy Reform
Publish a tax expenditure statement as part of the official government budget.December 2016MetPublished as part of the 2017 budget.
Approve by cabinet a time-bound strategy (agreed with IMF staff) to reduce or eliminate tax expenditures.December 2016Not metIn the context of the 2017 budget, Cabinet approved a plan to rationalize profit-based corporate tax incentives and tax exemptions for financial income in 2017. However, a comprehensive multi-year plan for reducing or eliminating tax expenditures has not been adopted. This remaining step has been built into the benchmarks for the 2018 and 2019 budgets.
Submit to Parliament a new Inland Revenue Act with a view to simplifying and broadening the income tax.March 2017Not met (implemented as a prior action)The new IRA was submitted to Parliament on July 5th satisfying the prior action for the second review.
Tax Administration Reform
Adopt by MOF Inland Revenue Department Key Performance Indicators on the number of risk-based VAT audit.December 2016MetThe Key Performance Indicators for risk-based VAT audit were included in the VAT compliance strategy for large taxpayers.
Adopt by MOF Inland Revenue Department a VAT compliance strategy that includes a time-bound plan to implement risk-based audit.December 2016MetDraft VAT compliance strategies for large, medium and small taxpayers were developed with support from IMF TA in October 2016. Considering the IRD’s capacity, a decision has been made to first implement the VAT compliance strategy to large businesses and then extend to small- and medium-sized businesses.
Fully roll out by MOF Inland Revenue Department new IT systems (RAMIS) for major domestic taxes (including income tax and VAT), including web-based tax filings for income tax and VAT.December 2016Met
Public Financial Management
Establish by MOF a commitment record system (with quarterly reports produced no later than one month after the end of each quarter) and quarterly expenditure commitment ceilings for the 2016 budget and the 2017 budget.December 2016Not met(implementedpartially)Through modification of the existing IT system (CIGAS) and manual reporting from line ministries, the MOF is now capable of tracking spending commitment for each line ministry on a monthly basis. The authorities started to report to parliament on the status of commitments in each quarter beginning in 2017Q2 and plan put in place a system of commitment ceilings for line ministries for the rest of the year.
MOF to roll out ITMIS with an automated commitment control module for Ministry of Finance.January 2017MetThe system has been fully rolled out to all ministries including Ministries of Finance and Health. It is being operated in parallel to the existing IT system to ensure it is functioning properly.
MOF to roll out ITMIS with an automated commitment control module for Ministry of Health.January 2017MetThe system has been fully rolled out to all ministries including Ministries of Finance and Health. It is being operated in parallel to the existing IT system to ensure it is functioning properly.
State Enterprise Reform
Cabinet to approve a resolution strategy for Sri Lankan Airlines.December 2016MetSubstantial reforms have been undertaken under a strategy approved by the Cabinet in June 2015. The airline has taken restructuring measures (e.g., route and fleet optimization) and reduced operational losses under the oversight of the Ministry of Public Enterprise Development and a Cabinet Committee. The authorities will report the airline’s financial performance to IMF staff on a quarterly basis.
Record the fiscal cost of non-commercial obligations (including subsidies) for SOEs in the central government budget, starting in 2017.November 2016Not met (implemented in effect for major SOEs)The 2017 budget did not report the cost of the noncommercial obligations. Nonetheless, the Statement of Corporate Intent includes information on non-commercial obligations of the respective SOE. Therefore, the benchmark has been effectively fulfilled since the SCIs for the 5 large SOEs were published in April 2017. Publication of the non-commercial obligations is built into the benchmarks for the 2018 and 2019 budgets.
MOF, line ministries, and SOEs to sign and publish Statements of Corporate Intent for the six largest SOEs (Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Airlines, National Water Supply and Drainage Board, Airport and Aviation Services Limited, and Sri Lanka Ports Authorities).December 2016Met with delayDraft Statement of Corporate Intents (SCIs) were finalized in December 2016 for each of the 6 SOEs except for Sri Lankan Airlines. Following Cabinet approval, the SCIs were signed in March 2017 and published in April 2017.

We believe that the policies set forth in the attached MEFP, together with the previously issued MEFP and Letters of Intent, are adequate to achieve the objectives of our economic program, but the Government stands ready to take additional measures as appropriate to ensure achievement of its objectives. We will continue to consult in advance with Fund staff on adoptions of measures or revisions of the policies contained in the MEFP and in this letter, in accordance with the Fund’s policies on such consultations. We will provide the Fund with the information it requests for monitoring program implementation.

Against the background of our performance to date and our strong commitment going forward, we request completion of the Third Review of the Extended Arrangement under the EFF, after which we intend to draw one tranche amounting to SDR 177.774 million. We are also seeking the modification of the performance criterion on central government primary balance and the indicative target on tax revenue for December 2017 as specified in Table 1 and TMU attached to the MEFP.

In keeping with its policy of transparency, the Government has authorized the publication of this letter and its attachments as well as the associated staff report.

Sincerely yours,

/s/

________

Mangala Samaraweera

Minister of Finance and Mass Media

/s/

________

Indrajit Coomaraswamy

Governor

Central Bank of Sri Lanka

Attachment I. Memorandum of Economic and Financial Policies

I. Macroeconomic Outlook

1. Growth has been subdued for most of 2017 due to lingering effects of the drought since late 2016 and floods in 2017. Growth was 3.9 percent in 2017 H1 and is projected to be below 4.5 percent for the entire year, as growth in manufacturing, construction, and services will marginally offset the weather-inflicted agriculture. Credit growth will likely continue the downward trend, in a lagged response to monetary tightening in 2016 and 2017. The current account deficit is expected to widen due to higher imports of food and fuel as the after effects of the drought in 2016 and floods in 2017. As weather-related supply disruptions dissipate, headline inflation will stabilize to mid-single digit and will stay within the inner band for the remainder of the year. We expect growth to rebound in 2018 as agriculture production normalizes and various infrastructure projects take off.

II. Program Performance

2. Program performance for the third review has been on track and the passage of the Internal Revenue Act (IRA) reaffirms our commitment towards reforms. The end-June quantitative targets were met for the primary balance and tax revenues, the NIR target was met by a margin of $174 million, and the reserve money target was below the IT target by about Rs 15 billion. Despite supply disruptions, inflation stayed within the inner consultation band. We have made progress on structural measures, especially on legislating the IRA which is essential for our strategy to raise revenue in a transparent and efficient manner. We have also made progress in implementing other structural measures, albeit with further delays in some areas than originally intended. We will take necessary corrective actions to ensure future structural benchmarks are met in a timely manner.

III. Fiscal Policy

Fiscal stance

3. The main priority for fiscal policy remains a durable reduction of the fiscal deficit and public debt through domestic revenue mobilization. The government reduced the overall fiscal deficit to 5.4 percent of GDP in 2016, from a deficit of 7 percent in 2015. This deficit reduction was achieved through bolstering tax revenues—rather than one off measures—while containing recurrent, discretionary, and capital spending. Looking ahead, we are committed to a steady path of lowering fiscal deficits to ensure a medium-term reduction in the public debt to GDP ratio. As first indicated in the Prime Minister’s November 2015 speech to parliament, we aim to bring the overall central government deficit down to at least 3.5 percent of GDP by 2020 and beyond. This decline in the deficit should lower the central government debt to about 75 percent of GDP in 2020 and further to 70 percent of GDP by 2022. To achieve this, the program targets a small primary deficit in 2017, followed by a primary surplus of 1 and 2 percent of GDP in 2018 and 2019, respectively. This entails an annual increase in the tax to GDP ratio by about 1 percentage point of GDP for three consecutive years (2017–19). Annual budget proposals for 2018–19 will be in line with the program targets as described in Table 2 (structural benchmark). We will ensure fiscal consolidation beyond 2019 by revising the Fiscal Management (Responsibility) Act to include binding targets for the government deficit and level of overall public debt.

4. Fiscal consolidation will rely mainly on broadening the tax base and improving the efficiency of spending. Sri Lanka’s fiscal deficits stem not from exceptionally high expenditures, but from a steady erosion of the tax base over the last two decades. Sri Lanka’s tax-to-GDP ratio fell to one of the lowest in the world, and the nation’s tax efficiency ratio is also below that of comparator countries. Our strategy thus focuses on: (i) broadening the tax base; (ii) rationalizing the tax system and removing the many exemptions, holidays, and special rates that have undermined fair and effective tax administration; (iii) strengthening capacity for risk-based revenue administration to improve tax compliance; and (iv) bolstering public financial management, in particular in commitment control, and financial planning and discipline. We have improved transparency and accountability of the budget execution process by submitting quarterly reports to Parliament since 2017Q1.

5. For 2017, revenue underperformance and weather-related spending may hinder meeting the primary balance target. The ratio of tax revenue to GDP is projected to increase by ½ percentage point to about 13 percent in 2017, but fall short of the program’s indicative target by 0.3 percentage point. This reflects a growth slowdown owing to the drought and the floods, the delay in implementing the new IRA, and weak excise collections due to a sharp drop in the volume of liquor and tobacco sales, which buoyant VAT collections could not offset. On the expenditure side, spending needs to address the drought and floods so far are expected to reach about Rs 50 billion (0.4 percent of GDP), including in-kind assistance to 840,000 needy families and reconstruction of damaged infrastructure. Spending reallocation has been initiated in mid-year to generate the necessary budget space without unduly cutting productive expenditure. Further, a drought-driven surge in thermal power generation pushed the electricity supply cost above current tariff levels. This resulted in quasi-fiscal losses of Rs 48 billion (0.3 percent of GDP) in 2017H1 for Ceylon Electricity Board (CEB), i.e., non-commercial obligations (NCOs) to provide electricity at below cost-recovery tariffs (see below for more discussions), for which the government transferred Rs 6 billion to CEB. As a result, the central government is expected to record a small primary deficit. Given the unusual and temporary nature of the deficit overrun, we request that the end-2017 quantitative performance criterion on primary balance (floor) be revised down from Rs −3 billion (0 percent of GDP) to Rs −23 billion (0.2 percent of GDP).

6. The 2018 budget targets a primary surplus of about Rs 140 billion (1 percent of GDP). This will be achieved by an increase in the revenue-to-GDP ratio by about 1 percentage point, anchored by a package of measures yielding Rs 110 billion (0.8 percent of GDP). The revenue package consists of VAT base-broadening, excise tax reforms for vehicle and beverage, new levies on telecom and cash transactions by financial institutions, and rate revision of fees and charges. Expenditure space for productive human and physical capital will be preserved. To prepare for possible weather-related disasters, mitigation programs such as river bank protection, crop insurance, urban flood mitigation and resettlement of people who are living in identified risk areas of landslides amounting to Rs 21 billion (0.15 percent of GDP), are appropriated within the total budget envelope. We will continue to present fiscal performance to Parliament on a quarterly basis, and any revenue shortfalls will prompt us to realign expenditure under Parliamentary oversight. If retail fuel prices or electricity tariffs dip below cost-recovery levels, the government will compensate Ceylon Petroleum Corporation (CPC) or CEB for the cost of the NCOs. The published budget speech contains a tax expenditure statement, a plan to rationalize tax expenditures, the estimated fiscal cost of NCOs for SOEs, and a report outlining the cost of fuel and electricity NCOs (structural benchmarks). A diagnostic review of the VAT system (structural benchmark completed in November) helped us to identify the VAT measures envisaged in the 2018 budget.

7. We have been developing the medium-term debt management framework and strengthening technical capacity with multilateral and bilateral TA support. Legislative reforms toward active liability management are underway, with a view to smoothing out the government-debt amortization over time. The Cabinet approved pre-funding of T-bonds maturity payments in early 2018 and is considering liability management operations for international sovereign bonds. Proceeds from commercializing public assets, if any, will be earmarked for debt services over the medium term, including for maturing international sovereign bonds starting in 2019. We will obtain cabinet approval of a debt management strategy on managing the international sovereign bonds maturing over 2019-22 by June 2018 (a new structural benchmark).

Revenue mobilization

8. A number of measures have been implemented to improve revenue performance. As an initial step towards rationalizing tax incentives, the Cabinet suspended the Board of Investment Act in May 2016, annulling its capacity to grant tax exemptions and other forms of preferential treatment and instead concentrating these powers in the Ministry of Finance, which has ultimate oversight of tax policy. The VAT amendment enacted in November 2016 raised the VAT rate from 11 percent to 15 percent and broadened the VAT base by eliminating exemptions for telecommunication and private healthcare, excluding diagnostic tests, dialysis and services provided by the Outpatient Department (OPD), while the VAT continues to apply to wholesale and retail trade. A diagnostic review of the VAT system (structural benchmark), completed with delay in November, concludes that VAT expenditure is 1.3 percent of GDP. Informed by the review, the VAT base will be further broadened in 2018 through rationalization of exemptions.

9. An important milestone in revenue mobilization was reached with the legislation of the Inland Revenue Act (IRA). The Act creates a predictable, stable, and transparent income tax system. Notable features include:

  • Removal of tax exemptions to broaden the tax base;

  • A modernized legal framework that utilizes a principle-based drafting style helping to streamline the law’s structure, and simplify its language;

  • Introduction of a capital gains tax on immovable property, increased taxes on dividends and interest incomes, and specified fees.

  • A transparent set of investment-based tax incentives;

  • Strengthened administrative powers for the Inland Revenue Department (IRD) which should improve compliance.

10. Our attention has now turned to implementation of the Act. With passage of the Act later than originally planned, its effective date has been set to April 1, 2018, to ensure taxpayers and IRD have sufficient time to prepare for activation of the new law. Adoption of compliance strategies for corporate and income taxes (structural benchmark originally planned for June 2017) will be postponed until the new IRA has been successfully implemented. The IRA implementation steering committee has outlined a detailed workplan to facilitate the transition:

  • Regulations. Drafts of revised regulations are expected to be completed soon. They will be published in draft form, by January 2018, to allow taxpayers time to familiarize.

  • Staff training. MOF and IRD staff will be trained during the fall of 2017 and then will, in turn, be tasked with training other head office and regional IRD staff in February 2018.

  • Communication and taxpayer awareness. A detailed IRA tax manual has been developed outlining practical tax and administrative examples. We plan to publish it by January 2018 (a new structural benchmark). A comprehensive media campaign will be rolled out once the IRA is issued in the gazette, followed by taxpayer awareness programs in Colombo and key regional centers.

  • Changes to IT systems. A detailed upgrade plan of the RAMIS system, including an appropriate funding, will be finalized by the end of 2017 and approved by the Steering Committee.

  • Redesign of business processes. New taxes such as capital gains tax and modified withholding taxes such as Pay-As-You-Earn income taxes will require modifications to internal business processes for approval by the Steering Committee by December 2017.

11. Steadfast efforts to improve tax administration have been underway, including the use of information technologies. IRD successfully rolled out the RAMIS IT system and adopted a VAT compliance strategy with risk-based audits. IRD will first implement the VAT compliance strategy to large businesses and then extend to small- and medium-enterprises. More broadly, organizational and business procedure reform has begun at the IRD including restructuring along functional lines, creating a design and monitoring unit, making management structure more efficient to speed up interaction with taxpayers, strengthening the Large Taxpayer Unit, introducing mandatory e-filing, and enhancing the use of taxpayer identification numbers. The IT system for customs administration (ASYCUDA) has been improved, with case selection for risk-based cargo audit now automated.

12. A disciplined approach to government spending and prioritization of public spending complements revenue-based fiscal consolidation. We intend to keep the overall spending envelope under control, while reallocating spending within this envelope to areas that will bolster our medium-term prospects for robust and inclusive economic growth, such as health, education, and infrastructure. To ensure a more effective, targeted and expanded social welfare scheme, we established the Welfare Benefits Board that will rationalize the various social assistance schemes through a consolidated national database for social assistance beneficiaries. Ongoing social safety net reform aims to improve its targeting system through establishing a centralized registry of beneficiaries for various social assistance programs including the Samurdhi cash transfer program. The frequency of weather-related natural disasters has increased due to climate change, inflicting severe damage to both private and public sectors. We plan to cope with this challenge through mitigation and adaptation measures, which include contingent budgeting for natural disasters and enhanced insurance schemes for the agricultural sector.

IV. Public Financial Management

13. Reforms to improve public financial management (PFM) are underway, despite delays in rolling out the new Integrated Treasury Management Information System (ITMIS).

  • MOF has modified the existing PFM IT system (CIGAS) and is now capable of tracking spending commitment on a real-time basis for a subset of line ministries. This helped the government to adjust and reallocate spending through cash management. Nonetheless, a system to control commitment, i.e., quarterly commitment ceilings over which the PFM IT system prevents spending units from contracting with vendors, has yet to be put in place, due to delays in rolling out the ITMIS. In the interim, we will further modify the CIGAS and equip it with capability to impose quarterly commitment ceilings for individual spending units from the beginning of 2018 (structural benchmark).

  • The ITMIS should significantly expand PFM capabilities, including commitment control, budget preparation, treasury and accounting. This process has been delayed due to difficulties in upgrading IT equipment for spending units, especially in the regions, and delays in customizing the ITMIS software as per the requirements of Ministry of Finance. Phase I of the ITMIS system – the budget planning module – was used by Ministry of Finance and Ministry of Health in December 2016. Further, National Budget Department trialed ITMIS to prepare Budget Book by processing budget estimates sent by all ministries and departments in 2016. All ministries and departments used ITMIS in October/November 2017 to send 2018 budget estimates. Regarding functionalities of revenue management, purchasing management, treasury management, expenditure management and general ledger, Ministry of Finance and Ministry of Higher Education and Highways will soon pilot the system. We plan to expand ITMIS functionalities to 100 additional spending units in 2018. Currently, the ITMIS is expected to become fully operational only in 2019.

  • To boost transparency, the MOF will begin publishing quarterly financial bulletins summarizing government fiscal operations, ensure that annual budgets explicitly cost out tax expenditures, and adhere to Government Finance Statistics Manual (GFSM) standards. Budgets will also include an analysis of fiscal risks, including those related to SOEs and public-private partnerships (PPPs).

V. State Enterprises

14. The financial condition of some of our state enterprises and ultimate responsibility for their existing obligations are a challenge we seek to address and resolve as part of the program. Sri Lanka currently has about 200 public enterprises representing a substantial share of the nation’s economic activity. With technical assistance from the IMF, we identified outstanding financial obligations of SOEs totaling Rs 1.4 trillion in end-2016, including Rs 1.2 trillion for CPC, CEB, SriLankan Airlines, and the Sri Lanka Ports Authority. Collectively they represent a risk to public finances (either directly or through the state banks which fund the largest SOEs). In the near-term, however, our strategy encompasses the following elements:

  • To enhance oversight and financial discipline, Statements of Corporate Intent (SCIs) were signed and published in April 2017 for the five largest SOEs (CPC, CEB, National Water Supply and Drainage Board, Airport and Aviation Services Limited, and Sri Lanka Ports Authority). The SCIs encompass the SOE’s mission, high level objectives, and multiyear corporate plan; capital expenditure and financing plans; and explicit financial and non-financial key performance indicators (KPIs). Our engagement with these SOEs will be based on the SCIs, with periodical monitoring of financial performance and compliance with the KPIs. They also include description and cost of non-commercial obligations (NCOs) such as utility subsidies to strengthen the transparency and fiscal accountability. We will also look at strengthening the legal framework for the governance and oversight of SOEs, including through establishment of coherent financial regulations for SOEs on governance, accountability, and funds management.

  • We have been implementing a resolution strategy for SriLankan Airlines, originally approved by Cabinet in 2015. The airline has already undertaken route and fleet optimization, reducing operational losses. The next step—securing a strategic partner and resolving the need for capital injection and debt consolidation, thereby effectively removing this company from the government’s accounts—has been significantly delayed. The airline still operates with losses and is subject to a lease contract of 4 large airplanes which can further worsen profitability. We aim to put the airline on a commercial footing and resolve fiscal contributions, if any, to the airline’s liabilities. To speed up the process, a government task force, overseen by the Prime Minister’s office, has been set up to map out the reform timeline. If necessary, key milestones in the timeline will be set as a structural benchmark for future program reviews. We will continue to report the company’s financial performance on a quarterly basis (see the Technical Memorandum of Understanding).

  • The original structural benchmark for establishing automatic fuel and electricity pricing mechanisms by end-2016 has not been met. We are pursuing a sequence of steps to put the reform process back on track. First, we completed with delays a report outlining the cost of non-commercial obligations (NCOs) for fuel and electricity in November 2017 (structural benchmark), supported by IMF TA. To correctly estimate the cost of noncommercial obligations for electricity, the CEB and the Public Utilities Commission will establish a Bulk Supply Transactions Account and start using it to settle transactions between generators, the transmission operator, and distributors as specified in the November 2015 tariff methodology by March 2018 (structural benchmark). Second, we will recognize the quasi-fiscal cost of fuel and electricity NCOs as central government expenditure by explicitly accounting for them in the EFF program targets. Specifically, starting in 2018, an indicative target will be set on the cost of NCOs for fuel and electricity (net of government transfers) (see the Technical Memorandum of Understanding for detail). Finally, to reduce the possibility of future financial losses by CPC and CEB and avoid large ad hoc adjustments in retail prices, while allowing time for public consultation and education, we will obtain cabinet approval of the automatic pricing mechanism for fuel by March 2018 and for electricity by September 2018 as described in Table 2 (structural benchmarks). To monitor progress, we will continue to report the financial performance of CPC and CEB on a quarterly basis (see the Technical Memorandum of Understanding). We intend to introduce cost-reflective water tariff settings when the PUC starts regulating the water sector.

VI. Monetary and Exchange Rate Policy

15. The focus of monetary policy will remain on keeping inflation in the mid-single digits. Inflation peaked in October 2017 due to continued increase in food price and the base effect of lower price levels that prevailed in October 2016. To rein in inflationary pressure and curtail the buildup of adverse inflation expectations as well as to control credit growth, the CBSL raised policy rates by 25 bps in March 2017. The CBSL considers the lagged response to monetary policy—which has been tightened since early 2016—will be adequate to stabilize inflation and credit growth that have begun to moderate. However, it will maintain a tightening bias until clear signs emerge that inflation and credit stabilize. This tightening bias will also help preempt potential capital outflows as interest rates in the US gradually rise. Monetary policy will continue to be monitored through a monetary policy consultation clause (see the Technical Memorandum of Understanding), supported by monitoring of reserve money developments.

16. We completed a roadmap for flexible inflation targeting and flexible exchange rate regime in October 2017 (a structural benchmark). The roadmap, which aims to establish inflation as the nominal anchor allowing for greater exchange rate flexibility, identifies time-bound reform measures, consistent with IMF staff recommendations (TA in May 2017), and has been approved by the Monetary Board. These time-bound measures will be incorporated into future program reviews, and one of them has already been set as a structural benchmark (see below). We will amend the Monetary Law Act (MLA) that will establish price stability as the primary objective of monetary policy. Towards this goal, in consultation with the IMF, we will obtain cabinet consent for the amendments to the MLA, including those to strengthen the envisaged flexible inflation targeting framework by March 2018 (a new structural benchmark). By implementing the roadmap, we will also: (i) ensure there is a clear separation between fiscal and monetary policies; (ii) retain a role for the CBSL in smoothing excessive exchange rate volatility, (while guarding against a real or perceived conflict of objectives) and adopt FX intervention policies consistent with a flexible exchange rate regime; (iii) improve foreign exchange market functionality, including by further liberalizing financial account transactions, deepening the FX market, and introducing FX auction; (iv) ensure the stability of the financial sector by adequately assessing the risks associated with adopting greater FX flexibility; (v) develop technical infrastructure, including through improved forecasting and modeling capabilities with continued support from IMF TA; (vi) establish a policy decision making process governed by the guidelines on the choice of targets and how unanticipated shocks would be addressed; and (vii) strengthen public-awareness outreach program as the cornerstone of CBSL’s communication strategy during the IT transition.

17. We stand ready to further strengthen CBSL’s autonomy and governance arrangement. The IMF safeguards assessment, completed in August 2016, identified issues in the areas of the CBSL’s autonomy and governance arrangement (e.g., the government’s voting representation in the Monetary Board, absence of recapitalization provisions, and inadequate limits on credit to government). These issues will be addressed as we amend the legal framework for the CBSL (MLA) in consultation with the IMF.

18. In tandem with moving toward flexible inflation targeting, the CBSL will strengthen a market-oriented approach to exchange rate policy. It is the CBSL’s intention to durably transition to a more flexible exchange rate regime. In this context, the CBSL will aim to develop (i) a deeper and more liquid foreign exchange market; (ii) adequate systems to review and manage exchange rate risks; and (iii) adopt an intervention strategy, aimed at building external reserves to adequate level while maintaining exchange rate flexibility. Accordingly, since late May, the CBSL has intervened in the FX market only to build up reserves or to stem excessive movements in the exchange rate and will continue to do so. Introducing FX auctions can also provide a more transparent structure to accumulate reserves while promoting FX market development.

19. A strengthening of reserve coverage (guided by the IMF’s ARA reserve metric) has been programmed, supported by regular FX purchases. Supported by FX purchase and financial inflows since March, the level of program NIR (per the TMU definition) recovered from a low level below the program target at end-2016 to $2.3 billion by end-April, and to $4.2 billion at end-June with the $1.5 billion Eurobond issuance in May and continuing FX purchase. Between January and May 2017, the exchange rate has depreciated by around 1.8 percent against the US$. We will continue to make the necessary FX purchases to enable the steady buildup of reserves with a view to fully offsetting the end-2016 NIR shortfall within 2017, while allowing for greater exchange rate flexibility. Further, we are committed to having monthly consultation with the IMF in making necessary corrective actions in foreign exchange intervention if there are significant deviations from an agreed upon benchmark. However, in the event that the gap between supply and demand of foreign exchange results in a highly disruptive movement of the exchange rate, we will consult with the Fund staff on the appropriate policy response. We have also gradually wound down FX swaps with domestic commercial banks, from $2.5 billion at end-2016 to $1.9 billion at end-August 2017. We plan to further reduce swap liabilities gradually during 2018.

20. During the program, we will not impose or intensify restrictions on the making of payments and transfers for current international transactions; introduce or modify multiple currency practices; conclude bilateral payments agreements that are inconsistent with Article VIII; or impose or intensify import restrictions for balance of payments reasons. Recently, the Government of Sri Lanka enacted the Foreign Exchange act which repealed the previous exchange control law to further liberalize the FX transactions. We will ensure that the new regulations are consistent with Article VIII. The CBSL and the government will also abstain from providing subsidized exchange guarantees for foreign currency borrowing.

VII. Financial Sector Policies

21. We have recently implemented several measures to strengthen the financial system. We (i) implemented the first phase of the Basel III capital standards in July and will continue to ensure that banks comply with the schedule; and (ii) have taken steps to establish by January 2018 a new Resolution and Enforcement Department within CBSL which will oversee any resolution of financial institutions supervised by CBSL.

22. To ensure greater stability of the financial sector, we intend to: (i) start new surveys to analyze emerging issues and developments on credit growth with the intention of implementing macro-prudential tools, as needed; (ii) improve risk management of greater exchange rate flexibility within the financial sector, including through a Financial System Stability Review provided by IMF assistance; (iii) update several laws including the Banking Act, Finance Business Act, Finance Leasing Act, and the Microfinance Act to modernize the financial sector; and (iv) increase the minimum core capital requirement to strengthen the financial sector. While financial soundness indicators remain adequate for the banking system as a whole, the capital adequacy ratio (CAR) had been declining until recently as the broad-based and still high credit growth had increased risk-weighted assets.

VIII. Structural Reforms to Boost Trade, Investment, and Inclusive Growth

23. Achieving medium-term macroeconomic objectives will require a renewed effort toward greater integration into regional and global supply chains, higher levels of FDI, and enhancing prospects for private sector investment. In addition to better infrastructure, this will entail improvements in the trade regime and investment climate. An immediate step toward this end has been to start negotiations on several new Free Trade Agreements. The lifting of the EU ban on fishery imports was a welcome change, and the GSP plus trade status with EU—reinstated in May 2017—has already started to have a positive impact on our exports. In July 2017, we signed a $1.1 billion deal with China for the operation and development of the southern deep sea port of Hambantota.

24. To boost trade and private sector development, we will seek to reduce costs and bolster competitiveness. A key element in this work would be a review of Sri Lanka’s trade regime including an evaluation of para-tariffs and other nontariff barriers that have led to a high level of effective protection and hampered exports. We are working with the World Bank to strengthen our structural competitiveness. We have formulated a new Trade Policy along with a National Export Strategy which aims to increase the efficiency of trade facilitation, remove barriers to foreign investment entry and establishment (including access to land), enhance access to finance, and strengthen financial market infrastructure. We will also create a central portal for information on trade regulations in Sri Lanka. These steps should help create a predictable, consistent, and transparent trade regime which will improve competitiveness, attract FDI, and unlock new sources of growth.

25. To boost growth, we have recently developed a 3-year economic delivery program that will ensure Sri Lanka’s transition to a higher income country by 2025. Structural reforms include the following, among others:

  • Gender gap and inequality. We will facilitate female labor participation. This will be done through improving access to good quality and affordable child care facilities, facilitating part-time and flexible work arrangements, and improving access to tertiary education and vocational training.

  • Climate change. Weak disaster management has raised Sri Lanka’s vulnerability to natural disasters. We have already established a crop insurance scheme and a disaster insurance scheme under the National Insurance Trust Fund (NITF). A National Disaster Reserve Fund for financing post-disaster reconstruction will be established.

  • Access to finance. To boost domestic private investment, we will integrate the SME sector into the formal sector through the financial system. We will implement policies to increase project-based lending rather than collateral-based lending.

IX. Risks and Contingencies

26. The high degree of uncertainty continues to pose economic and financial risks to the program. The main risks include; (i) weaker than projected revenues; (ii) weaker than expected capital inflows, which would widen the projected financing gap given already substantial gross fiscal financing needs of about 19 percent of GDP in 2017; (iii) lower than expected growth or new pressures on the trade or financial account; (iv) weaker than expected performance of state owned enterprises; and (v) continued credit growth and higher inflation which could erode external competitiveness. These risks could further challenge public debt and external sustainability. Should such risks materialize, the government stands ready to adjust promptly its policies, in close consultation with the IMF staff, to ensure the achievement of a sustainable external position at the end of the program.

X. Program Monitoring

27. Our program will be subject to semiannual reviews with performance criteria and indicative targets set out in Table 1 attached to this MEFP and Technical Memorandum of Understanding (TMU). Completion of the fourth and fifth reviews will require observance of the quantitative performance criteria for end-December 2017 and end-June 2018, respectively, as well as continuous performance criteria, as specified in Table 1 attached to this MEFP. The reviews will also assess progress toward observance of the structural benchmarks specified in Table 2 attached to this MEFP. The fourth and fifth reviews of the program will take place on or after April 20, 2018 and November 20, 2018, respectively.

Attachment II. Technical Memorandum of Understanding

1. This Technical Memorandum of Understanding (TMU) sets out a framework for monitoring the performance of Sri Lanka under the program supported by the Extended Arrangement under the Extended Fund Facility (EFF). It specifies the performance criteria and indicative targets (including adjustors) under which Sri Lanka’s performance will be assessed through semiannual reviews. Monitoring procedures and reporting requirements are also specified.

2. The quantitative performance criteria and indicative targets specified in Table 1 attached to the Memorandum of Economic and Financial Policies (MEFP) are listed as follows.

Table 1.Sri Lanka: Exchange Rates(Rates as of June 30, 2017)
CurrencySri Lankan Rupee per

currency unit
U.S. dollar153.5100
British pound199.9314
Japanese yen1.3728
Canadian dollar118.2757
Euro175.6154
Chinese yuan22.6789
SDR213.5920
Source: CBSL and IMF.
Source: CBSL and IMF.
  • a) a quantitative performance criterion on central government primary balance (floor);

  • b) a quantitative performance criterion on net official international reserves (floor);

  • c) a continuous quantitative performance criterion on new external payment arrears by the nonfinancial public sector and the CBSL (ceiling);

  • d) a monetary policy consultation clause;

  • e) an indicative target on central government tax revenue (floor);

  • f) an indicative target on reserve money of the CBSL (ceiling); and

  • g) an indicative target on cost of non-commercial obligations for fuel and electricity (net of government transfers) (ceiling).

3. Throughout this TMU, the central government is defined to include line ministries, departments, and other public institutions. The Central Bank of Sri Lanka (CBSL), state-owned enterprises, parastatals and other agencies that do not receive subventions from the central government are excluded from the definition of central government. Debt is defined in accordance with paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements attached to Executive Board Decision No. 15688-(14/107), adopted December 5, 2014.

I. Performance Criteria

A. Performance Criterion on Central Government Primary Balance

4. The primary balance of the central government on cash basis is defined as central government revenues and grants minus expenditures and net lending, plus interest payments. The proceeds from privatization or commercialization of public assets to residents or non-residents (as defined in paragraph 10) will not be recorded as part of central government revenues. Spending will be recorded in the period during which cash disbursements are made.

5. For the purpose of program monitoring, the primary balance of the central government on cash basis will be measured as the overall balance of the central government plus the interest payment of the central government. The overall balance of the central government is measured from the financing side, as the negative of the sum of the items listed below. Here, net borrowings refer to gross disbursements minus principal repayments. For 2015, the primary balance of the central government on cash basis measured in this manner was Rs –241 billion (the overall balance was Rs –768 billion and the interest payment was Rs 527 billion).

  • a) Net borrowings from issuances of Treasury Bills, Treasury Bonds, and Rupee Loans.1 In 2015, the total amount of such net borrowings was Rs 257.6 billion.

  • b) Net borrowings from Sri Lankan Development Bonds (SLDBs) and commercial borrowings including international sovereign bonds and syndicated loans. In 2015, the total amount was Rs 455.7 billion.

  • c) Net borrowings from project and program loans. In 2015, the total amount was Rs 69.7 billion, after adjustment for program loans that were contracted and disbursed during 2014 but were recorded in the 2015 fiscal account (Rs 61.6 billion).

  • d) Net increases in non-market borrowings, CBSL advances, government import bills, government overdraft from the banking system, cash items in process of collection, and borrowings from offshore banking units of domestic commercial banks. In 2015, the total amount was Rs –10.1 billion.

  • e) Net decreases in the deposit of the central government in the banking system. In 2015, the total amount was Rs –4.4 billion (an increase in deposit).

  • f) Net borrowings from all other bonds, loans, and advances contracted by the central government. In 2015, the total amount was Rs –0.5 billion (net repayment).

  • g) Proceeds from privatization or commercialization of public asset to residents and non-residents. In 2015, the total amount was Rs 0 billion.

The following adjustment will apply:

6. If the actual amount of gross cash disbursement of project loans in 2017 is higher than Rs 230 billion, the floor on the primary balance of the central government for end-December 2017 will be adjusted downward by the difference between the actual amount and Rs 230 billion. The downward adjustment of the primary balance target will be capped at Rs 20 billion. If the actual amount of gross cash disbursement of project loans in 2017 is lower than Rs 230 billion, the floor on the primary balance of the central government for end-December 2017 will not be adjusted.

B. Performance Criterion on Net Official International Reserves

7. For the purpose of program monitoring, net official international reserves (NIR) will be measured as the difference between (a) and (b) below, and will be called the “Program NIR.” At end-2015, the Program NIR, evaluated at market exchange rates, stood at US$ 2,893.1 million. At end-2016, the Program NIR, evaluated at market exchange rates, stood at US$ 2,032.1 million. Targets for the Program NIR are set for cumulative flows from the end of the previous year. To calculate the cumulative flows, the Program NIR at the test dates and the end of the previous year are evaluated at the program exchange rates and gold price specified in paragraph 9.

a) The CBSL’s conventional definition of the NIR, that is, (i) the difference between the gross foreign assets and liabilities of the CBSL and (ii) the balance of State Treasury’s (DSTs) Special Dollar, Japanese Yen, and Chinese Yuan Revolving accounts, both expressed in terms of market values. Gross foreign assets of the CBSL consists of monetary gold; foreign exchange balances held outside Sri Lanka; foreign securities (valued in market prices); foreign bills purchased and discounted; the reserve position at the IMF and SDR holdings; and the Crown Agent’s credit balance. Foreign exchange balances, securities, and bills denominated in Chinese Yuan are part of the gross foreign assets of the CBSL. Excluded from gross foreign assets will be participation in international financial institutions; holdings of nonconvertible currencies; holdings of precious metals other than monetary gold; claims on residents (e.g., statutory reserves on foreign currency deposits of commercial banks and central bank foreign currency deposits with resident commercial banks); pledged, non-liquid, collateralized or otherwise encumbered foreign assets (such as the government’s war risk insurance deposit with Lloyds during 2001/02); and claims in foreign exchange arising from derivative transactions (such as futures, forwards, swaps and options). Gross foreign liabilities are all foreign currency denominated liabilities of the CBSL to non-residents (including currency swap arrangements with foreign central banks); the use of Fund credit; and Asian Clearing Union debit balance. Commitments to sell foreign exchange to residents arising from derivatives such as futures, forwards, swaps, and options, such as commitments arising from currency swaps with domestic commercial banks, are not included in the gross foreign liabilities. DST accounts are foreign currency accounts held by the Treasury and managed by the CBSL as an agent of the government. At end-December 2015, the NIR as per the CBSL’s conventional definition, evaluated at market exchange rates, stood at US$ 5,028.8 million. At end-December 2016, this amount was US$4,529.0 million (evaluated at market exchange rates).

b) The CBSL’s outstanding liabilities (i.e., net short positions) in foreign exchange swaps with domestic commercial banks, which stood at US$ 2,135.7 million at end-December 2015 and $2,498.6 million at end-December 2016.

8. The framework to wind down outstanding liabilities in foreign exchange swaps with domestic commercial banks will include discontinuing the provision of FX swaps on concessional terms and gradually reducing outstanding net short positions of FX swaps with commercial banks as described in the MEFP.

9. For the purpose of the program, all foreign-currency related assets and liabilities will be converted into U.S. dollar terms at the exchange rates prevailed on June 30, 2017, as specified in Table 1. Monetary gold will be valued at US$1,246.59 per troy ounce, which was the price prevailed on June 30, 2017.

The following adjustment will apply:

10. If (i) the amount of foreign program financing by the central government, (ii) the amount of net borrowings from SLDBs and FCBUs by the central government, (iii) the amount of external commercial loans (including international sovereign bonds and syndicated loans) by the central government, and (iv) proceeds from commercialization of public assets to non-residents—as set out in Table 2—are higher/lower in U.S. dollar terms than assumed under the program, the floor on the program NIR will be adjusted upward/downward by the cumulative differences on the test date. The proceeds from commercialization of public assets are defined as cash receipts from the sale or lease of publicly held assets. Such assets will include, but not be limited to, publicly held land, public holdings of infrastructure or commercial real estate, and public or quasi-public enterprises. These adjustors will apply to the NIR floor for end-December 2017 and thereafter.

Table 2.Sri Lanka: Program Assumptions(Cumulative from the beginning of the year, in million US$)
Dec. 2017Mar. 2018Jun. 2018Sep. 2018Dec. 2018
Foreign program financing by the central government22500100200
Net borrowings from SLDBs and FCBUs by the central government6270−150−150−150
External commercial loans (including Eurobonds and syndicated loans) by the central government2,2001,5001,5001,5001,500
Proceeds from commercialization of public assets to nonresidents2000400400400
Amortization of official external debt by the central government1,0653655729791,204

11. If the amount of amortization of official external debt by the central government in U.S. dollar terms—as set out in Table 2—is higher/lower than assumed under the program, the floor on the program NIR will be adjusted downward/upward by the cumulative differences on the test date. Official external debt refers to external debt owed to multilateral and official bilateral creditors, as defined in the 2013 External Debt Statistics: Guide for Compilers and Users. These adjustors will apply to the NIR floor for end-December 2017 and thereafter.

II. Continuous Performance Criteria

A. Performance Criterion on New External Payment Arrears by the Nonfinancial Public Sector and the CBSL

12. A continuous performance criterion applies to the non accumulation of new external payments arrears on external debt contracted or guaranteed by the nonfinancial public sector and the CBSL. The nonfinancial public sector is defined following the 2001 Government Finance Statistics Manual and the 1993 System of National Accounts. It includes (but is not limited to) the central government as defined in paragraph 3 and nonfinancial public enterprises, i.e., boards, enterprises, and agencies in which the government holds a controlling stake. External payments arrears consist of debt-service obligations (principal and interest) to nonresidents that have not been paid at the time they are due, as specified in the contractual agreements, subject to any applicable grace period. However, overdue debt and debt service obligations that are in dispute will not be considered as external payments arrears for the purposes of program monitoring.

III. Monetary Policy Consultation Clause

13. The inflation target bands around the projected 12-month rate of inflation in consumer prices, as measured by the headline Colombo Consumers Price Index (CCPI) published by the Department of Census and Statistics of Sri Lanka, are specified in Table 1 attached to the MEFP. The new CCPI index (2013=100) will be used to measure actual inflation. For this purpose, the year-on-year inflation for each test date is measured as follows:

{CCPI*(t) – CCPI*(t-12)} / CCPI*(t-12)

where

t = the month within which the test date is included

CCPI(t) = CCPI index (all items) for month t

CCPI(t-k) = CCPI index (all items) as of k months before t

CCPI*(t) = {CCPI(t-2) + CCPI(t-1) + CCPI(t) / 3

CCPI*(t-12) = {CCPI(t-14) + CCPI(t-13) + CCPI(t-12)} / 3

If the observed year-on-year inflation for the test date of end-December 2017 or end-June 2018 falls outside the outer bands specified in Table 1 attached to the MEFP, the authorities will complete a consultation with the IMF Executive Board which would focus on: (i) the stance of monetary policy and whether the Fund-supported program remains on track; (ii) the reasons for the deviation; and (iii) on proposed policy response. When the consultation with the IMF Executive Board is triggered, access to Fund resources would be interrupted until the consultation takes place and the relevant program review is completed. In addition, if the observed year-on-year inflation falls outside the inner bands specified in Table 1 attached to the MEFP for the test date of end-December 2017, end-March 2018, end-June 2018, end-September 2018, and end-December 2018, the authorities will complete a consultation with IMF staff on the reasons for the deviation and the proposed policy response.

IV. Indicative Targets

A. Indicative Target on Central Government Tax Revenue

14. Central government tax revenue refers to revenues from taxes collected by the central government. It excludes all revenues from asset sales, grants, and non tax revenues. The revenue target is calculated as the cumulative flow from the beginning of the year. For 2015, central government tax revenue defined in this manner was Rs. 1,356 billion.

B. Indicative Target on Reserve Money of the CBSL

15. Reserve money of the CBSL consists of currency in circulation (with banks and with the rest of the public), financial institutions’ domestic currency deposits at the CBSL, and the deposits of following government agencies: the National Defense Fund (General Ledger Acc. No. 4278), the Buddha Sasana Fund A/C (General Ledger Acc. No. 4279); and the Road Maintenance Trust Fund (General Ledger Acc. No. 4281). At end-December 2015, reserve money defined in this manner stood at Rs. 673.4 billion. From December 2017 onwards, reserve money for each test date is measured as the average reserve money from 16th to end of the month.

The following adjustment will apply:

16. If any bank fails to meet its legal reserve requirement, the ceiling on reserve money will be adjusted downward to the extent of any shortfall in compliance with the requirement.

17. Changes in required reserve regulations will modify the reserve money ceiling according to the formula:

ΔMrB0+r0ΔBrΔB

where ΔM denotes the change in reserve money, r0 denotes the reserve requirement ratio prior to any change; B0 denotes the reservable base in the period prior to any change; Δr is the change in the reserve requirement ratio; and ΔB denotes the immediate change in the reservable base as a result of changes to its definition.

C. Indicative Target on Cost of Non-Commercial Obligations for Fuel and Electricity (Net of Government Transfers)

18. The non-commercial obligations (NCOs) for fuel and electricity refer to the obligations of Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) to supply fuel and electricity at prices below cost-recovery levels. The indicative target is set on the cost of fuel and electricity NCOs net of government transfers, which corresponds to the cost of the NCOs that are not compensated by the central government budget.

19. The cost of NCOs for fuel during each quarter is measured as the cost of sales (including fuel cost, terminal charges, transport charges, personnel cost, other operational expenses, exchange rate variation, and finance cost; excluding sales taxes) minus revenues (net of sales taxes) with regard to fuel supplies by CPC for transport, power generation, aviation, industries, kerosene and LPG, and agrochemicals. If the revenues (net of taxes) exceed the cost of sales, the cost of NCOs for fuel is zero. The government transfers to cover the cost of fuel NCOs are measured as central government current transfers disbursed to CPC.

20. The cost of NCOs for electricity during each quarter is measured as total expenditures (including energy purchases and allowed revenue for transmission) minus total sales revenues from 5 distribution licensees under CEB, as shown in the statement of the Bulk Supply Transaction Account managed by CEB. If the total sales revenues exceed the total expenditures, the cost of NCOs for electricity is zero. The government transfers to cover the cost of electricity NCOs are measured as central government current transfers disbursed to CEB.

21. For the purpose of program monitoring, the cost of fuel and electricity NCOs net of government transfers is calculated as follows. This takes account of a time lag in estimating the cost of fuel and electricity NCOs.

For the test date of end-March 2018: NCO(2017Q4) – G(2018Q1)

For the test date of end-June 2018: {NCO(2017Q4) + NCO(2018Q1)} – {G(2018Q1) + G(2018Q2)}

For the test date of end-September 2018: {NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2)} – {G(2018Q1) + G(2018Q2) + G(2018Q3)}

For the test date of end-December 2018: {NCO(2017Q4) + NCO(2018Q1) + NCO(2018Q2) + NCO(2018Q3)} – {G(2018Q1) + G(2018Q2) + G(2018Q3) + G(2018Q4)}

where

NCO(q) = cost of NCOs for fuel and electricity during quarter “q”

NCO_fuel(q) = cost of NCOs for fuel during quarter “q”

NCO_electricity(q) = cost of NCOs for electricity during quarter “q”

NCO(q) = NCO_fuel(q) + NCO_electricity(q)

G(q) = central government current transfers to CPC and CEB disbursed during quarter “q”

G_fuel(q) = central government current transfers to CPC disbursed during quarter “q”

G_electricity(q) = central government current transfers to CEB disbursed during quarter “q”

G(q) = G_fuel(q) + G_electricity(q).

V. Data Reporting Requirements

22. Sri Lanka shall provide the Fund, through reports at intervals or dates requested by the Fund, with such information as the Fund requests in connection with the progress of Sri Lanka in achieving the objectives and policies set forth in the Memorandum of Economic and Financial Policies and Letters of Intent. All the program monitoring data will be provided by the Ministry of Finance and the CBSL. For the purpose of monitoring the fiscal performance under the program, data will be provided in the format as shown in Tables 3 and 4. For the purpose of monitoring the monetary targets under the program, data will be provided in the format shown in Table 5. For the purpose of monitoring the external sector performance under the program, data will be provided in the format shown in Tables 6 and 7. For the purpose of monitoring the financial performance of three state-owned enterprises—CEB, CPC, and SriLankan Airlines—data will be provided in the format shown in Tables 8, 9, and 10, respectively, on a quarterly basis. For the purpose of monitoring the performance against the indicative target on the cost of fuel and electricity NCOs (net of government transfers), data will be provided in the format shown in Tables 11 and 12 on a quarterly basis.

Table 3.Sri Lanka: Central Government Operations 1/(In millions of rupees)
Total Revenue & Grants
Total Revenue
Tax revenue
Income Tax
Personal & Corporate
Corporate & non-corporate
PAYE
Economic Service Charge
Tax on interest income
Taxes on goods & services
VAT
Excise Taxation
Liquor
Cigarettes
Motor vehicles
Petroleum
Other
Other Taxes & Levies
NBT
Stamp duties
Telecommunication Levy
Motor vehicles Taxes & Other
Sales tax
Debit tax
Telephone Subscriber Levy
National Security Levy
Tax on treasury bills
Taxes on External Trade
Imports
Cess
Special Commodity Levy
PAL
Non-Tax Revenue
Property income
Fines,Fees & Charges
Other
Grants
Total Expenditure
Recurrent Expenditure
Salaries & wages
Goods & Services
Interest Payments
Subsidies & Transfers
Public Corporations
Public Institutions
Households
Capital Expenditure
Net lending
Primary Balance
Overall balance
Total Financing
Total Foreign Financing (Net)
Total Domestic Financing (Net)
Privatization

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 4.Sri Lanka: Central Government Financing(In millions of rupees)
1. Domestic instrument borrowings
T-Bills (net)
T-Bonds
Rupee Loans
Other
2. Domestic non-instrumental borrowings
Sri Lankan Development Bonds (SLDB)
Non market borrowings
CBSL advances
Government deposit at CBSL
Government import bills
Cash items in process of collection (CIPC)
Overdraft to government
Short term loans
Deposit with commercial banks
Oversee Banking Units
Other
3. Net foreign financing
Net T-Bill purchase by nonresidents
Net T-Bond purchase by nonresidents
International sovereign bonds
Project loans
Other
Total financing (1+2+3)
Memorandum items:
T-Bonds
Gross borrowings
Repayments
Net borrowings
SLDBs
Grossborrowings
Repayments
Net borrowings
ISBs
Grossborrowings
Repayments
Net borrowings
Project loans
Grossborrowings
Repayments
Net borrowings

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 5.Sri Lanka: Balance Sheet of the Central Bank of Sri Lanka 1/(In millions of rupees)
Net foreign assets
Foreign assets
Cash and balances abroad
Foreign securities
Claims on ACU
IMF Related Assets
SDRs
RR on FCDs of banks
Receivables (Accrued Interest)
Derivative Financial Instruments
Foreign liabilities
IMF & nonresident a/c
SDRs
Liabilities to ACU
Payables
Derivative Financial Instruments
Net domestic assets
Claims on Government
Advances
Treasury bills & Treasury Bonds
Treasury Bonds
Cash items in collection
Government deposits
Claims on commercial banks
Medium and long-term
Short-term
Other assets (net)
Reserve money
Currency in circulation
Commercial bank deposits
Government agencies deposits

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 6.Sri Lanka: Foreign Exchange Cashflows of the Central Bank and the Government 1/(In millions of U.S. dollars)
1. Total inflows
Loans
Program
IMF
Project (cash component only)
Commercial borrowing (incl. new and rolled over SLDBs)
Interest earnings, forex trading profits, cap gains
Purchases of foreign exchange
Change in balances in DST’s A/Cs
Of which: Proceeds from commercialization of public assets
Other inflows
Borrowing from SLDBs
Loans from FCBUs
Syndicated Loans
International Swaps/Commercial Loans/Sovereign Bonds
OMO FX swap transactions
2. Total outflows
Public Debt Service Payments
Amortization
Principal (foreign loans)
Settlement SLDBs
Settlement FCBU
Settlement of syndicated loans
Interest
Foreign loans
Domestic foreign currency loans
SWAP/Loan interest
ISB interest
Payments to the IMF/ change in valuation of liabilities
Foreign exchange sales to commercial banks
OMO FX swap transactions
3. SWAP
Inflow
Outflow Including Interest
3. Net flow at current rates (1-2)
Net International Reserves (at market exchange rates)
Net International Reserves (at program exchange rates)
Gross International Reserves (at market exchange rates)

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 7.Sri Lanka: Gross Official Reserve Position 1/(In millions of U.S. dollars)
DateCentral BankGovernmentGross Official ReservesLiabilitiesNet International ReservesOverall balanceMemorandum Items -





Swaps with Commercial Banks
Reserves managed by IODReserve Position at I.M.F. & SDR hol.





2
Total





(1)+(2)



3
Crown Agent’s Credit Balance





4
D S T’s Special Dollar Revolving Cr.balance





5
DST’s Yen Accounts





6
Total





(4)+(5)+(6)



7
(without ACU & DA & with





(8) - (10)



(with ACU & SWAP & without DA)





(3)+(7)



8
Other DepositsAsian Clearing UnionDrawings from the IMFInternational Currency SwapTotal
Foreign Assets (FA) (with ACU & Without DA)



1
Domestic Assets (DA) (BOC & PB)1st Leg (New)2nd Leg (Maturity)Outstanding stock (Short position)

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 8.Sri Lanka: Financial Outturn of Ceylon Electricity Board 1/(In millions of rupees)
Total revenue
Sale of electricity
Other income
Total expenditure
Direct generation cost
Generation, transmission, and distribution O&M cost
Corporate expenses
Interest on borrowings and delayed payments
Depreciation
Other cost
Operating profit/loss
Liquidity position
Borrowings from banks
Payments to banks
Outstanding debt to banks
Purchases from CPC and IPP
Payments to CPC and IPP
Outstanding to CPC and IPP

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 9.Sri Lanka: Financial Outturn of Ceylon Petroleum Corporation 1/(In millions of rupees)
Total revenue
Octane 90
Diesel
Other products
Other income
Total expenditure
Cost of sales
Sales and distribution
Administration
Finance cost
Depreciation
Other cost
Operating profit/loss
Outstanding dues to state banks

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 10.Sri Lanka: Financial Outturn of Sri Lankan Airlines 1/(In millions of rupees)
Total revenue
Passenger
Cargo
Other income
Total expenditure
Aircraft fuel cost
Employee cost
Other operating expenses
Financial cost
Operating profit/loss
Capital contribution

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 11.Sri Lanka: Cost of Non-Commercial Obligations for Fuel 1/(In millions of rupees, unless otherwise noted)
Producta=e-b



Cost of NCOs

Rs millions
b=c-d



Net sales revenue (net of

Rs millions
c



Sales revenue

Rs millions
d



Sales taxes

Rs millions
e=f+g+h+i+j+k+l

Total cost (net of sales

Rs millions
f



Cost of sales

Rs millions
g



Terminal charge

Rs millions
h



Transport charge

Rs millions
i



Personnel cost

Rs millions
j



Other expenses

Rs millions
k

Exchange rate variation

Rs millions
l



Finance cost

Rs millions
m



Sales quantity

Million liters
A. TRANSPORT
Super petrol (92 octane)
Unladed petrol (95 octane)
Auto diesel
Super diesel
B. POWER GENERATION
Auto diesel
Fuel oil 800’
Fuel oil 1500’
Fuel oil 1500’ low sulphur
Fuel oil 200’
Naphtha
C. AVIATION
Jet A-1 (Foreign)
Jet A-1 (Sri Lankan Airline)
Jet A-1 (Local)
Avgas
D. INDUSTRIES
Ind Kero
Fuel oil 800’
S.B.P.
Bitumen
Lubricant
E. DOMESTIC
Kerosene
LPG
F. AGRO
Agro chemicals
Total (A-F)
Memorandum item:
Central government current transfers to CP[x]

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

Table 12.Sri Lanka: Statement of Bulk Supply Transaction Account 1/(In millions of rupees)
aTotal revenue
Sales by DL1, 2, 3, 4, 5
UNT adj ustme nt
bExpenditures
Energy purchases
Mahawell complex
Laxapana complex
Other hydro complex
Thermal complex
Coal complex
Old Chunnakam+ Islands
Uturu janani
IPP plants
NCRE
Other
UNT adjustment
Transmission allowed revenue
BSOB allowed revenue
Other
Subsidy Requirement from General Treasury/(surplus)
c=b-aCost of electricity NCOs
Memorandum item:
Central government current transfers to CEB

As agreed for the purpose of monitoring the program.

As agreed for the purpose of monitoring the program.

23. Data relating to the fiscal targets (Table 3 and Table 4) will be furnished within no more than five weeks after the end of each month, except for the data on salaries and wages, goods and services, subsidies and transfers (and its subcomponents) that will be furnished within no more than seven weeks after the end of each month (the data on total recurrent expenditure and interest payments will be furnished within no more than five weeks after the end of each month). Data relating to the external and monetary targets (Tables 5, Table 6, and Table 7) will be furnished within no more than three weeks after the end of each month. Data relating to the three state-owned enterprises (Tables 810) will be furnished within no more than 2 months after the end of each quarter. Data relating to the indicative target on the cost of fuel and electricity NCOs (net of government transfers) (Table 11 and Table 12) will be furnished within no more than 5 weeks after the end of each quarter.

The debt estimates have been revised upward since the second review, as detailed in Annex I.

This prior action was set on the most macro-critical part the SB on the 2018 budget (due by November 2017).

For progress in fiscal structural reforms, including revenue mobilization, see Annex II.

The financial obligations now include debt owed by Road Development Authority and SriLankan Airlines’ lease commitment on aircrafts on order.

Rupee Loans are a medium to long-term debt instrument issued with maturities more than two years on tap basis or as private placements by the CBSL on behalf of the government under the Registered Stock and Securities Ordinance.

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