ECONOMYNEXT – A delegation led by the Director of the International Monetary Fund’s Asia Pacific Department, Krishna Srinivasan is visiting Sri Lanka and discussing the new administration’s reform objectives, an official said.
“Program performance is strong, and reform efforts are bearing fruit in terms of reviving economic growth, lowering inflation, boosting reserves and improving revenue mobilization,” Julie Kozack, Director of the Communications Department said.
“However, as we have said before, important vulnerabilities and uncertainties do remain, and this means that sustaining reform momentum is critical.”
Newly elected President Anura Dissanayake has said Sri Lanka wants to cut both value added tax and income tax.
“President Dissanayake reaffirmed the government’s broad agreement in principle with the objectives of the IMF programme but emphasized the importance of achieving these objectives through alternative means that relieves the burden off the people,” a statement after the meeting said.
“The President stated that the government plans to provide relief to those who are struggling due to high VAT and income taxes.
“The IMF appreciated President Dissanayake’s willingness to commit to the programme’s goals and agreed to discuss the alternative approaches proposed by the Sri Lankan government.”
Falling prices including in foods have boosted public credibility about the IMF program, unlike in earlier cases, though there are middle class concerns, over high income tax rates as they were unable to pay mortgages, car leases and also school fees due to the tax hike.
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People who earlier could pay for private healthcare shifted to taxpayer supported hospitals as the lower income tax brackets came on top of a steep currency collapse.
Sri Lanka however needs tax revenues to pay a large salary bill, while state enterprises also need funds from the government to cover losses and also expand. State banks also need capital.
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“The delegation is discussing with the authorities the latest economic developments and their economic reform objective,” Kozack said.
“Dates for the Third Review under the EFF will be announced in due course and this delegation will communicate when their visit concludes. And we will have more information for you at that time.”
Aggressive Macroeconomic Policy
Sri Lanka’s currency crises increased in frequency after the end of 30-year civil war, amid aggressive printing of money to target the average weighted call money rate (rate cuts enforced by open market operations) blocking the benefit of a rate corridor in maintaining external stability, denying a peace dividend to the country.
Rates were cut with inflationary open market operations to either boost inflation to 5 percent or to target potential output (stimulus), triggering forex shortages and balance of payments deficits in 2012, 2015/16, 2018 and 2020/22.
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Sri Lanka borrowed heavily through bonds and syndicated loans, as inflationary OMO triggered BOP deficits, and the country lost the ability to repay maturing debt.
Sri Lanka also enacted a law to be able to borrow more in foreign markets over and above the budget deficit, instead of maintaining rates (or allow rates to move within a wide enough corridor) to run deflationary policy and BOP surpluses by squeezing the current account.
Sri Lanka defaulted selectively on its external debt in 2022 and has restructured official bilateral debt. A sign off from official creditors is awaited on a deal with bondholders. Sri Lanka’s new foreign minister said the deal is not final yet.
“..Sri Lanka and the international bondholder representatives reached an agreement in principle subject to confirmation of comparability of treatment by Sri Lanka’s Official Creditor Committee, and this does represent some significant progress in Sri Lanka’s debt restructuring process,” Kozack said.
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Sri Lanka is currently running broadly deflationary policy and triggering BOP surpluses by squeezing the current account.
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Falling prices including in foods have boosted public credibility about the IMF program, unlike in earlier cases, though there are middle class concerns over income tax rates.
Sri Lanka is now planning a ‘single policy rate’, which critics say will deny the benefit of a policy corridor to the poor and completely expose them to ‘macroeconomic policy’. (Colombo/Oct03/2024)