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IMF Country Report No. 23/116

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IMF Country Report No. 23/116

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IMF Country Report No. 23/116

SRI LANKA

REQUEST FOR AN EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY—PRESS RELEASE; STAFF REPORT; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR SRI LANKA

March 2023

In the context of the Request for an Extended Arrangement Under the extended Fund Facility, the following documents have been released and are included in this package:

  • A Press Release including a statement by the Chair of the Executive Board.

  • The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on March 20, 2023, following discussions that ended on September 1, 2022, with the officials of Sri Lanka on economic developments and policies underpinning the IMF arrangement under the Extended Fund Facility. Based on information available at the time of these discussions, the staff report was completed on March 6, 2023.

  • A Staff Supplement updating information on recent developments.

  • A Statement by the Executive Director for Sri Lanka.

The IMF’s transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities’ policy intentions in published staff reports and other documents.

Copies of this report are available to the public from

International Monetary Fund • Publication Services

PO Box 92780 • Washington, D.C. 20090

Telephone: (202) 623-7430 • Fax: (202) 623-7201

E-mail: publications@imf.org Web: http://www.imf.org

Price: $18.00 per printed copy

International Monetary Fund

Washington, D.C.

© 2023 International Monetary Fund

Press Release

PR 23/79

IMF Executive Board Approves US$3 Billion Under the Extended Fund Facility (EFF) Arrangement for Sri Lanka

FOR IMMEDIATE RELEASE

  • The IMF Board approved a 48-month extended arrangement under the Extended Fund Facility (EFF) of SDR 2.286 billion (about US$3 billion) to support Sri Lanka’s economic policies and reforms.

  • The objectives of the EFF-supported program are to restore macroeconomic stability and debt sustainability, safeguarding financial stability, and stepping up structural reforms to unlock Sri Lanka’s growth potential. All program measures are mindful of the need to protect the most vulnerable and improving governance.

  • Close collaboration between Sri Lanka and all its creditors will be critical to expedite a debt treatment that will restore debt sustainability consistent with program parameters.

Washington, DCMarch 20, 2023: The Executive Board of the International Monetary Fund (IMF) approved today a 48-month extended arrangement under the Extended Fund Facility (EFF) with an amount of SDR 2.286 billion (395 percent of quota or about US$3 billion).

Sri Lanka has been hit hard by a catastrophic economic and humanitarian crisis. The economy is facing significant challenges stemming from pre-existing vulnerabilities and policy missteps in the lead up to the crisis, further aggravated by a series of external shocks.

The EFF-supported program aims to restore Sri Lanka’s macroeconomic stability and debt sustainability, mitigate the economic impact on the poor and vulnerable, safeguard financial sector stability, and strengthen governance and growth potential. The Executive Board’s decision will enable an immediate disbursement equivalent to SDR 254 million (about US$333 million) and catalyze financial support from other development partners.

Following the Executive Board discussion on Sri Lanka, Ms. Kristalina Georgieva, Managing Director, issued the following statement:

“Sri Lanka has been facing tremendous economic and social challenges with a severe recession amid high inflation, depleted reserves, an unsustainable public debt, and heightened financial sector vulnerabilities. Institutions and governance frameworks require deep reforms. For Sri Lanka to overcome the crisis, swift and timely implementation of the EFF-supported program with strong ownership for the reforms is critical.

“Ambitious revenue-based fiscal consolidation is necessary for restoring fiscal and debt sustainability while protecting the poor and vulnerable. In this regard, the momentum of ongoing progressive tax reforms should be maintained, and social safety nets should be strengthened and better targeted to the poor. For the fiscal adjustments to be successful, sustained fiscal institutional reforms on tax administration, public financial and expenditure management, and energy pricing are critical.

“Having obtained specific and credible financing assurances from major official bilateral creditors, it is now important for the authorities and creditors to make swift progress towards restoring debt sustainability consistent with the IMF-supported program. The authorities’ commitments to transparently achieve a debt resolution, consistent with the program parameters and equitable burden sharing among creditors in a timely fashion, are welcome.

“Sri Lanka should stay committed to the multi-pronged disinflation strategy to safeguard the credibility of its inflation targeting regime. As the market regains confidence, the authorities’ recent introduction of greater exchange rate flexibility will help to rebuild the reserve buffer.

“Maintaining a sound and adequately capitalized banking system is important. Implementing a bank recapitalization plan and strengthening financial supervision and crisis management framework are crucial to ensure financial sector stability.

“The ongoing efforts to tackle corruption should continue, including revamping anti-corruption legislation. A more comprehensive anti-corruption reform agenda should be guided by the ongoing IMF governance diagnostic mission that conducts an assessment of Sri Lanka’s anti- corruption and governance framework. The authorities should step up growth-enhancing structural reforms with technical assistance support from development partners.”

Sri Lanka: Selected Economic Indicators 2019-2026 1/

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

This table is based on data as of March 6.

Colombo CPI.

Comprising central government debt, publicly guaranteed debt, and CBSL external liabilities (i.e., Fund credit outstanding and international currency swap arrangements).

Excluding PBOC swap ($1.4bn in 2022) which becomes usable once GIR rise above 3 months of previous year’s import cover.

Title page

SRI LANKA

REQUEST FOR AN EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY

March 6, 2023

EXECUTIVE SUMMARY

Context. Sri Lanka fell into an unprecedented crisis as a result of a series of shocks and policy missteps. Debt rose to unsustainable levels resulting from large fiscal imbalances, and access to international capital markets was lost soon after large tax cuts and the onset of the COVID-19. Reserves were depleted, leading to a sharp exchange rate depreciation, and debt service was suspended in the spring of 2022. Sizable monetary financing to meet fiscal obligations contributed to a surge in inflation. Sri Lanka’s economy is in deep recession and financial stability is at risk given the tight financial-sovereign nexus. People are suffering from food and energy shortages, exacerbating deep-rooted public dissatisfaction and creating a vulnerable political and social environment.

Recent Policies. To address the crisis, extraordinary measures have been put in place to manage the economic challenges and jumpstart reforms. Import restrictions and other balance of payment measures were tightened to alleviate foreign exchange (FX) shortages and depreciation pressure. A digital fuel rationing system helped manage access to fuel. Social transfers were scaled up alongside external humanitarian support to protect the vulnerable. The authorities have taken decisive policy actions since mid-2022, including a downsizing of monetary financing and raising policy rates to rein in inflation, introducing tax measures to improve fiscal balance, raising electricity prices and introducing automatic energy pricing mechanisms, and embarking on institutional and other structural reforms.

Program Strategy. Staff proposes a 48-month normal-access Extended Arrangement under the Extended Fund Facility (EFF), with an access to Fund resources of SDR 2.286 billion (395 percent of quota or about US$3 billion). The program prioritizes: (i) an ambitious revenue-based fiscal consolidation, accompanied by stronger social safety nets, fiscal institutional reforms, and cost-recovery based energy pricing; (ii) restoration of public debt sustainability, including through a debt restructuring; (iii) a multi-pronged strategy to restore price stability and rebuild reserves under greater exchange rate flexibility; (iv) policies to safeguard financial sector stability; and (v) structural reforms to address corruption vulnerabilities and enhance growth. Policy actions that are key to tackling the root causes of the crisis and building confidence during the initial stabilization phase, such as revenue measures and central bank autonomy, will be implemented upfront. Long-lasting institution building reforms to ensure macroeconomic stability and debt sustainability will be implemented under visible reform ownership and carefully sequenced under the program.

Program Risks. Risks to program implementation are exceptionally high, given the complex debt restructuring process, unfavorable external environment, elevated risks of persistently high inflation, and challenging political and social situation. Given Sri Lanka’s weak track record of reform implementation, the program runs significant risks of slippages regarding fiscal consolidation, revenue mobilization, and reserves buildup. A deeper crisis induced by a further economic fallout, the weakened banking sector, exchange rate pressure, and loss of market confidence could also complicate program implementation. In this regard, contingency plans are crucial and policies should remain agile to adjust to the evolving circumstances.

Approved By

Anne-Marie Gulde-Wolf and Bikas Joshi

Discussions were held virtually during May 16–23, 2022, and in Colombo during June 20–30 and August 24–September 1, 2022. The mission met with President Rajapaksa; President, Prime Minister and Finance Minister Wickremesinghe; Prime Minister Gunawardena; Central Bank of Sri Lanka Governor Weerasinghe; Secretary to the Treasury Siriwardana; other senior officials; C. Amarasekara (OED); and representatives of the Parliamentary Opposition, the business community, civil society, and international partners. The staff team comprised P. Breuer, M. Nozaki (Co-Heads), M. Li, K. Hellwig, H. Selim, Y. Zhang (all APD), M. Kryshko (SPR), F. Vitek, D. Rozhkov (FAD), M. Adam, H. Miao (both MCM), and T. Feridhanusetyawan (ICD), S. Jahan (resident representative), and M. Abeyawickrama (local economist). A. Gulde-Wolf (APD) and T. Yan (COM) also joined for part of the missions. P. Polec and M. Odoño (both APD) assisted in the preparation of this report.

Contents

  • CONTEXT AND RECENT DEVELOPMENT

  • OUTLOOK AND RISKS

  • PROGRAM OBJECTIVES

  • A. Advancing Revenue-Based Fiscal Consolidation, Reforms to Social Safety Nets, Fiscal Institutions, and State-Owned Enterprises

  • B. Restoring Public Debt Sustainability

  • C. Restoring Price Stability and Rebuilding External Buffers

  • D. Ensuring Financial Stability

  • E. Reducing Corruption Vulnerabilities

  • F. Raising Potential Growth

  • PROGRAM MODALITIES

  • PROGRAM RISKS AND CONTINGENCY PLANNING

  • STAFF APPRAISAL

  • References

  • FIGURES

  • 1. Real Sector

  • 2. Fiscal Sector

  • 3. Financial Market

  • 4. Foreign Exchange and Reserves

  • 5. Monetary and Financial Sector

  • 6. Balance of Payments

  • TABLES

  • 1. Selected Economic Indicators 2019–2028 (Restructuring Scenario)

  • 2a. Summary of Central Government Operations, 2019–28 In Billions of Rupees

  • 2b. Summary of Central Government Operations, 2019–28 In Percent of GDP

  • 3. Monetary Accounts, 2019–28 1/ (Restructuring Scenario) In Billions of Rupees

  • 4. Balance of Payments, 2019–28 (Restructuring Scenario) In Percent of GDP

  • 5. Composition of Public Debt (including arrears)

  • 6. Gross External Financing, 2019–2028 (Restructuring Scenario)

  • 7. Projected Payments to the Fund, 2023–2036

  • 8. Reviews and Disbursements under the Proposed Four-Year Extended Arrangement

  • ANNEXES

  • I. External Sector Assessment

  • II. Public Debt Sustainability Analysis

  • III. Capacity Development

  • IV. Reforming the Social Safety Nets

  • V. Financial-Sovereign Nexus

  • VI. Central Bank Act

  • VII. Governance Diagnostic and Anti-Corruption Legislation

  • APPENDIX

  • I. Letter of Intent

    • Attachment I. Memorandum of Economic and Financial Policies

    • Attachment II. Technical Memorandum of Understanding

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