Statement by the Staff Representative on Sri Lanka Executive Board Meeting, June 3, 2016

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.

The information below has become available following the issuance of the staff report on May 20. It does not alter the thrust of the staff appraisal.

Natural disaster: Heavy rains since mid-May triggered flooding and landslides in a number of regions, including the Colombo district. As of May 29, 294,000 people were estimated to have been affected (about 1.4 percent of population), with Colombo accounting for two thirds of this total. 105 deaths have been confirmed, 116 people remain missing, and about 4,500 houses have been damaged. With weather improving and water levels falling, the government has intensified rescue and rehabilitation efforts, supported by the international community. The economic damage of the flooding has yet to be fully estimated.

Data update. Headline inflation rose to 4.8 percent in May from 3.1 percent in April, largely due to increases in health and communication prices, in addition to the impact of the increase in the VAT rate from 11 to 15 percent. Core inflation rose to 6.6 percent and there is some upside risk given recent flooding. Preliminary fiscal data suggest that the central government recorded an overall deficit of Rs 233 billion (1.9 percent of annual GDP) and a primary deficit of Rs 37 billion (0.3 percent of annual GDP) during January–April.

Monetary policy and foreign exchange management. At its meeting held on 20 May 2016, the Monetary Board of the CBSL decided to maintain the current monetary policy stance by keeping policy rates unchanged. With respect to foreign exchange developments, the CBSL achieved net foreign exchange purchases of US$78 million in the first 30 days of May—breaking the 20-month pattern of net foreign exchange sales. Despite this shift, the rupee remained broadly stable, with the spot and the 3-month forward rates depreciating only 1.3 percent and 1.9 percent, respectively, since end-April.