Sri Lanka: Staff Report for the 2016 Article IV Consultation and Request for a Three Year Extended Arrangement Under the Extended Fund Facility—Informational Annex
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
14 Jun 2016
eISBN:
9781475532388
Language:
English
Keywords:
ISCR; CR; data update; core inflation; monetary policy stance; headline inflation; Monetary Board of the CBSL; Colombo consumer price index; net loan amount; loan portfolio; Sri Lanka rupee; Consumer price indexes; Loans; Exchange rate arrangements; Government finance statistics
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Context. The Sri Lankan economy has good underlying momentum but is starting to show signs of strain from a combination of unbalanced macroeconomic policies and an increasingly difficult external environment. A significant political transition has brought a new unity government to the fore. There is now an important window of opportunity to re-set macroeconomic policies to support stability and resilience, as well as undertake structural reforms to help Sri Lanka achieve high and sustained economic growth. Fiscal Policy. There is a clear need to put tax revenues on an upward path as part of a growth-friendly phase of fiscal consolidation and debt reduction. The significant reduction in the 2016 deficit to 5.4 percent of GDP will need to be followed by further revenue-based fiscal consolidation over the medium-term, guided by the 2020 deficit target of 3.5 percent of GDP (a primary surplus of 1 percent of GDP). Support on tax policy and revenue administration will be essential to successful implementation and creation of a simple, efficient, and equitable tax system.

Abstract

Context. The Sri Lankan economy has good underlying momentum but is starting to show signs of strain from a combination of unbalanced macroeconomic policies and an increasingly difficult external environment. A significant political transition has brought a new unity government to the fore. There is now an important window of opportunity to re-set macroeconomic policies to support stability and resilience, as well as undertake structural reforms to help Sri Lanka achieve high and sustained economic growth. Fiscal Policy. There is a clear need to put tax revenues on an upward path as part of a growth-friendly phase of fiscal consolidation and debt reduction. The significant reduction in the 2016 deficit to 5.4 percent of GDP will need to be followed by further revenue-based fiscal consolidation over the medium-term, guided by the 2020 deficit target of 3.5 percent of GDP (a primary surplus of 1 percent of GDP). Support on tax policy and revenue administration will be essential to successful implementation and creation of a simple, efficient, and equitable tax system.

Fund Relations

(As of May 4, 2016)

Membership Status

Joined 8/29/50; accepted Article VIII, Sections 2, 3, and 4, March 1994.

General Resources Account

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SDR Department

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Outstanding Purchases and Loans

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Latest Financial Arrangements

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Formerly PRGF.

Projected Payments to Fund2

(SDR million; based on existing use of resources and present holdings of SDRs)

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When a member has overdue financial obligations outstanding for more than three months, the amount of such arrears will be shown in this section.

Exchange Rate Arrangement

The de jure exchange rate arrangement is free floating since its introduction by the Central Bank of Sri Lanka (CBSL) on January 23, 2001. The CBSL intervenes in the foreign exchange market to limit volatility in the exchange rate. The de facto exchange rate arrangement was classified as a stabilized arrangement as of December 31, 2014, because the Sri Lanka rupee stabilized within a 2 percent band against the U.S. dollar during October 2013–October 2014. While the exchange rate has exhibited a depreciating trend against the U.S. dollar beginning in mid-October 2014, further observation is necessary to determine the new trend. Until then, the de facto exchange rate arrangement remains classified as stabilized. The CBSL publishes intervention data on its website and in its annual report. Sri Lanka maintains an exchange system that is free of restrictions on payments and transfers for current international transactions, except for restrictions maintained solely for the preservation of national or international security that have been notified to the Fund pursuant to Executive Board Decision 144 (52/51).

Safeguards Assessment

Under the Fund’s safeguards assessment policy, the Central Bank of Sri Lanka (CBSL) was subject to an update safeguards assessment with respect to a Stand-by Arrangement approved in July 2009. The assessment found that the CBSL continued to have a relatively strong safeguards framework, especially in the external audit, financial reporting and control areas. An update safeguard assessment would be conducted and completed no later than the first program review of the proposed 3-year arrangement under the Extended Fund Facility.

Article IV Consultation

It is proposed that the next Article IV consultation be held on the 24-month cycle.

FSAP and ROSC Participation

  • MCM: Both the FSSA and the FSAP reports were completed in 2002. An FSAP update took place in July 2012.

  • STA: A data ROSC was completed and the report published in 2002.

  • FAD: A fiscal transparency ROSC was completed and the report published in 2002. A ROSC update was completed and the report published in July 2005.

Resident Representative

Mrs. Eteri Kvintradze has been the resident representative since March 2014.

Technical Assistance

  • FAD. A number of TA missions in tax policy and administration took place during the 2000s. A series of TA missions in revenue administration were conducted in 2003. Tax policy missions took place in 2001 and 2009, to provide advice on the reform of the tax system. In 2012, a mission visited Sri Lanka to evaluate the state of the Inland Revenue Department, with a particular focus on the effectiveness of the administration of the Value Added Tax (VAT) and secondarily the Nation Building Tax to identify measures to staunch and reverse the decline in VAT collections and improve the overall performance of the VAT system and taxpayers compliance. In 2015, a mission reviewed income tax expenditures and recent VAT performance. In addition, a number of missions took place during 2012–2016 to strengthen Public Financial Management, improving oversight of the State-Owned Enterprises, strengthening budget preparation, and improving the commitment control system.

  • ICD. Since August 2015, TA missions provided the CBSL with assistance on macroeconomic forecasting, including developing a Forecasting and Policy Analysis System (FPAS) and a semi-structural Quarterly Projection Model (QPM).

  • LEG. In March 2016, TA missions provided assistance on drafting a new income tax legislation.

  • MCM. In August 2001, a TA mission to develop a strategy for strengthening the framework and implementation of monetary and foreign exchange cooperation took place. In May 2002, an IMF/World Bank mission advised the government of Sri Lanka on options for reform of People’s Bank. In 2003, TA mission on financial sector issues and financial sector reforms took place, followed by 2005 mission to provide advice on the introduction of new deposit insurance scheme. Recently, TA missions advised on strengthening the financial stability framework (January 2016) and improving financial regulations, supervision, and the domestic government securities market (May 2016),

  • STA. In November 2012, a mission visited Sri Lanka to report on data dissemination practices with respect to the requirements of the Special Data Dissemination Standards (SDDS). During 2013–2014, Sri Lanka has received TA provided by the IMF/STA as part of the Asia module of the JSA Project on the Improvement of statistics in the Asia and Pacific Region. This TA focused on improving data collection and compilation of ESS including balance of payments, IIP, EDS, and Reserves Data Template (RDT), and supporting the authorities in their transition to the BPM6 format. In 2013, TA missions also took place to review work on methodological improvements to the consumer price index and the development of the new producer price index, and to provide guidance on rebasing of GDP estimates and quarterly national accounts. In 2014, a mission took place to review the Government Financial Statistics (GFS) compilation system and make recommendations on the implementation of the GFSM 2001 and its 2014 update (GFSM 2014). More recently, STA has been closely engaged with the authorities through TA in various areas, including national accounts, external statistics, GFS, and monetary accounts (see the Statistical Issues Appendix).

Relations with the World Bank Group

(As of April 28, 2016)

1. In the Country Partnership Strategy (CPS) for FY13–16, the World Bank Group supported Sri Lanka to address long-term strategic and structural development challenges as it transitioned to middle-income country (MIC) status. The CPS FY13-16) focused on: (i) facilitating sustained private and public investment; (ii) supporting structural shifts in the economy; and (iii) improving living standards and social inclusion.

2. A CPS Progress Report prepared in FY 14 provided an opportunity to review the country program and refocused the activities in line with the government’s evolving development needs and agenda. The Progress Report proposed the inclusion of a fourth strategic area of engagement, namely increasing resilience to disasters and climate change, deemed central to Sri Lanka’s development agenda and poverty reduction efforts. As the country shifted from reconstruction to addressing the challenges of development on a middle income trajectory greater emphasis was placed on facilitating and creating the enabling environment for increased foreign and domestic investment. Continued pockets of poverty also highlighted the need for renewed efforts to better target the poor.

3. The Systematic Country Diagnostic prepared in 2015 identified critical constraints and opportunities that Sri Lanka faced in accelerating progress toward the goals of ending extreme poverty and promoting shared prosperity in a sustainable manner. The SCD concluded that the challenges of i) fiscal sustainability; (ii) enhancing competitiveness and promoting more and better jobs for the bottom 40 percent, iii) providing for social inclusion for disadvantaged segments of the population; and (iv) longer term sustainability (especially of the environment, political stability, and an aging population) were priority areas. Governance was identified as a cross-cutting challenge.

4. The Country Partnership Framework (2017- 2020) for the World Bank Group is anchored in the analysis of the SCD and consists of three major pillars. Interventions under pillar one will seek to improve macroeconomic stability and competitiveness, pillar two will tackle the promotion of inclusion and opportunities, while pillar three will seek to enhance resilience and management of natural assets. The IFC will give priority to sustainable infrastructure (through PPPs), financial inclusion, and access to input/output markets, products, services and jobs. MIGA will where possible support foreign investment projects, across sectors.

5. The World Bank is supporting the GoSL in a number of macro-critical areas:

  • The Bank is preparing a Development Policy Financing (DPF) operation to support the long-term competitiveness of the Sri Lankan economy through a first package of reforms to eliminate obstacles to private sector competitiveness, enhance transparency and public sector management and improve fiscal sustainability. The actions supported by the proposed DPF represent an important initial set of reforms that are expected to be part of a longer-term policy reform package. In the context of this and possible future operations, the Bank anticipates to give extensive implementation support to help achieve the intended results. The Bank anticipates that some of this support will be carried out jointly with the Fund.

    • a. The Bank is providing support to increase competitiveness and FDI attraction, to develop a Public Finance Bill and a strategy for its implementation, and to strengthen the public debt management framework and analytical capacity.

    • b. The Bank is also providing ongoing support for statistical capacity building to better measure poverty and to update the national poverty line, and is updating an analysis of the distributional impact of tax and expenditure.

6. The World Bank has been supporting Sri Lanka’s development for close to six decades, having accompanied the country as it has grown to join the ranks of middle-income countries. The current active World Bank portfolio comprises 12 projects (10 IDA and two IBRD operations) with a total net commitment value of $1.48 billion. Human development accounts for 33 percent of the overall portfolio followed by urban development (24 percent), water (21 percent) and resilience to climate and disaster risk (14 percent). Trust funds have continued to play an important role with the portfolio currently comprises six recipient-executed trust funds with a total net commitment value of $54.4 million.

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Source: World Bank

Relations with the Asian Development Bank

(As of May 2, 2016)

Country Partnership Strategy: ADB’s Interim Country Partnership Strategy (ICPS, 2016-2017) for Sri Lanka, approved in 2015 included the agriculture, natural resources, and rural development sectors in ADB’s priority sectors for operation in Sri Lanka. The ICPS continued other strategic thrusts and priority sectors as in the CPS 2012–2016 that identified the three pillars: (i) inclusive and sustainable economic growth, (ii) catalyzing private investment and enhancing the effectiveness of public investment, and (iii) human resource and knowledge development. The priority sectors are transport, energy, water supply and wastewater management, irrigation, and education sectors.

Indicative Resources: The allocation for 2016-2018 consists of $741.78 million from ordinary capital resources (OCR) and $468.99 million from the Asian Development Fund (ADF). Co-financing and private sector operation opportunities will be actively explored.

Indicative Pipeline for 2016-18: Country Operations Business Plan (COBP) for the period 2016–18 indicates that the indicative project pipeline addresses the priority agendas of middle-income countries. It emphasizes on human resource development, completes final stage of basic infrastructure development such as rural road connectivity and rural electrification and shifts towards advanced infrastructure such as expressway and railways, and supports inclusive growth through small and medium-sized enterprises (SME) and agriculture assistance. To the extent possible, thematic priorities such as gender, governance, climate change, and regional cooperation will be included in each project.

Lending for education will further strengthen support for human capital development. In addition to continued support for secondary education and support for skills development, opportunity in higher education will be explored. The Science and Technology Human Resource Development Program will focus on science and technology faculties, industry linkages and entrepreneurship. The proposed Skills Sector Enhancement Program (additional financing) will continue support for the government’s Skills Sector Development Program for 2017–2020.

The Expressway Connectivity Investment Program (MFF) for 2017 will optimize the connectivity of highways and expressways. This includes providing the access to the expressway network from Colombo City to limit congestion. The priority highways to be constructed under the project will be (i) elevated highway from Kelani Bridge to Colombo Port (port access road) and (ii) highway from Meerigama to Kurunegala (central highway).

The proposed Electricity Supply Reliability Improvement Project will support achieving 100% electrification (currently 98%) in Sri Lanka. It will provide electricity to more than 17,500 rural households, including in the Northern and Eastern provinces. A TA loan for Preparing the Power Development and Interconnection Project will support connectivity and power trade between Sri Lanka and India. The Wind Power Generation Project is proposed to develop renewable energy potential and ensure energy security. The use of a public–private partnership approach will be explored.

In the urban and water supply sector, most of the interventions are continuations from the earlier COBPs and consist of additional financing. The Local Government Enhancement Sector Project (additional financing) will include additional works for areas affected by chronic kidney diseases and expand coverage of the original scope. The Greater Colombo Wastewater Management Project (additional financing) will construct a secondary wastewater treatment plant in the north catchment area of Colombo city. The proposed Jaffna Kilinochchi Water Supply Project (additional financing) will include a desalination plant (as a source of water) and improvement of the water supply system in Jaffna Peninsula. For cities in Eastern Province (Trincomalee, Ampara, and Batticaloa), the Cities Development Initiative of Asia will support development of an integrated strategic master plan.

The SME Credit Line provides funding to SMEs through participating financial institutions. An auction mechanism was introduced to price the additional operating and credit costs of lending to targeted sectors, such as uncollateralized working capital loans, new borrowers, women-led enterprises, and SMEs outside of Colombo. An attached TA will support the enabling environment of a promising export-oriented cluster.

Capital Market Development Program Loan is currently proposed as an additional loan for 2016. It will combine policy reforms with information and communication technology investments and technical assistance to enhance capacity and size of the capital market in Sri Lanka grounded on a strong legal and regulatory framework.

In the absence of a public-private partnership (PPP) framework, ADB adopts a project-based approach to promote PPP in Sri Lanka. Performance-based contracts are structured as part of regular sovereign projects, such as in water and wastewater management and road maintenance. ADB signed a Transaction Advisory Service mandate in February 2016 for the East Container Terminal of Colombo Port. The project will add three deep water berths, increasing its competitiveness. Projected capacity is 2.4 million TEUs (twenty-foot equivalent unit) once the project is complete.

ADB’s Private Sector Operations supports finance sector development by providing loans, equity investments, or guarantees for banks or nonbank institutions to enable them to expand activities in targeted areas including housing, small and medium-sized enterprise finance, leasing, renewable energy, and infrastructure lending.

Ongoing Projects:

  • Projects approved in 2015: During 2015, ADB approved 3 new sovereign projects for a total of $478 million and 1 new non-sovereign loan facility of $100 million as follows:

    • - Greater Colombo Water and Wastewater Management Improvement Investment Program (tranche 3) ($123 million from OCR and $5 million from ADF)

    • - Mahaweli Water Security Investment Program (tranche 1) ($76 million from OCR and $74 million from ADF)

    • - Integrated Road Investment Program (tranche 3) ($175 million from OCR and $25 million from ADF)

    • - Lanka Orix Leasing Finance Company PLC and Lanka Orix Leasing Company Micro Credit Limited (ADB loan up to $55 million and B loan up to $45 million)

  • Portfolio: As of 31 December 2015, ADB has approved a total of 179 loans, with cumulative lending of $6.97 billion to Sri Lanka. In addition, ADB has provided $358 million grant assistance (including ADB-administered co-financed grants) for projects and $130 million through 280 technical assistance grants.

    The current portfolio includes 53 ongoing loans and grants for 28 projects with a net loan amount of $2.9 billion. Cumulative contract awards reaches $1.7 billion, and disbursements $1.3_billion. About 76% of the ongoing portfolio are in transport, urban and water, and energy sectors. The sector composition of the ongoing loan portfolio is in Figure 1.

Figure 1:
Figure 1:

Sectoral Distribution

Citation: IMF Staff Country Reports 2016, 150; 10.5089/9781475532388.002.A002

Source: Asian Development Bank

Sri Lanka—Statistical Issues Appendix

As of May 1, 2016

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Sri Lanka: Table of Common Indicators Required for Surveillance

As of March 23, 2016

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Any reserve assets that are pledged or otherwise encumbered should be specified separately. Also, data should comprise short-term liabilities linked to a foreign currency but settled by other means as well as the notional values of financial derivatives to pay and to receive foreign currency, including those linked to a foreign currency but settled by other means

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Includes external gross financial asset and liability positions vis-à-vis nonresidents.

Daily (D); Weekly (W); Monthly (M); Quarterly (Q); Annually (A); Irregular (I); Not Available (NA).

Reflects the assessment provided in the data ROSC published in May 2002 and based on the findings of the mission that took place during June 2001 for the dataset corresponding to the variable in each row. The assessment indicates whether international standards concerning (respectively) concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O), largely observed (LO), largely not observed (LNO), not observed (NO), or not applicable (NA).

Same as footnote 8, except referring to international standards concerning (respectively) source data, statistical techniques, assessment and validation of source data, assessment and validation of intermediate data and statistical outputs, and revision studies.

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Cover IMF Staff Country Reports
Sri Lanka: Staff Report for the 2016 Article IV Consultation and Request for a Three-Year Extended Arrangement under the Extended Fund Facility-Press Release; Staff Report; Staff Statement, and Statement by the Executive Director for Sri Lanka
Author: International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2016: Issue 150
Publisher:
International Monetary Fund
ISBN:
9781475532388
ISSN:
1934-7685
Pages:
120
DOI:
https://doi.org/10.5089/9781475532388.002

Sectoral Distribution