Colombo Telegraph

Making Sense Of IMF Credit Facility

By Sirimevan Colombage

Prof. Sirimevan Colombage

The landmark credit facility approved by the International Monetary Fund (IMF) early this month is not only a relief to ease the country’s severe external payments imbalance but also an opportunity to jump-start the long-overdue economic reforms. The facility amounting to US $ 1.5 billion comes under the Fund’s Extended Fund Facility (EFF). This three-year arrangement aims to meet balance of payments needs arising from the weakening external finance situation and pressures that may persist during the adjustment period.

Correcting economic misalignments

The arrangement is a signal to global capital markets that the government is keen on economic recovery. It thereby enhances investor confidence and provides the necessary support to execute the reforms.

Hence, it is the utmost responsibility of the government to ensure strict adherence to the reform agenda so as to rectify the prolonged macroeconomic misalignments. In the past, many such programs did not succeed due to the then governments’ failure to implement bold reforms for political reasons. The adverse effects of such negligence still haunt the economy. The success of the present program too will depend on the commitment on the part of the government.

The reform package along with the market-responsive exchange rate and interest rate systems which are now in place would facilitate rectifying the economic disarrays.

Confidence booster

Some critics argue that the IMF facility is hardly sufficient to meet the country’s external payments commitments which run to the tune of over $ 5 billion for the next 12 months. But the point is the program with the IMF has wider implications than its financial assistance per se. It is more a confidence booster giving positive signals to global investors that investment climate is going to be improved through structural adjustments under the stipulated reform agenda.

Strong focus on structural reforms

The EFF has been designed to provide assistance to countries experiencing severe payments imbalances due to structural impediments, or to countries characterized by slow growth and an inherently weak balance of payments position. The EFF provides assistance in support of comprehensive programs that include policies required to correct structural imbalances over an extended period. Given the longer time needed to correct deep-rooted structural weaknesses, the implementation of EFF and its repayment period are longer than most other Fund arrangements.

When a country borrows from the IMF, it commits to undertake policies to overcome its economic and structural problems. Under an EFF, these commitments, including specific conditionality, usually have a strong focus on structural reforms to address institutional or economic weaknesses, in addition to policies that maintain macroeconomic stability. The IMF assesses the program performance regularly allowing to readjust it depending on economic changes.

Objectives and pillars of Sri Lanka’s EFF

The key objectives of the current EFF program are to (a) implement a structural increase in revenues to reduce the fiscal deficit, (b) reverse the decline in central bank foreign exchange reserves, (c) reduce public debt relative to GDP and lower the country risk of debt distress, and (d) enhance public financial management and improve the operations of state owned enterprises. The program also aims to transition toward inflation targeting with a flexible exchange rate regime and to promote sustainable and inclusive economic growth by supporting trade and investment.

In order to achieve the objectives, the program envisages implementation of a set of reforms under six pillars – (a) fiscal consolidation, (b) revenue mobilization, (c) public financial management reform, (d) state enterprise reform, (e) transition to flexible inflation targeting under a flexible exchange rate regime, and (f) reforms in the trade and investment regime.

Fiscal consolidation

Fiscal imbalances are the root cause of many economic ills including inflation, external payments deficits and debt burden. The program envisages to restore fiscal consolidation with a budget deficit goal of 3.5 percent of GDP by 2020. This is expected to be achieved by raising tax revenue from 11.8 percent of GDP in 2016 to 14.6 percent in 2020 while maintaining expenditure more or less around the same level of about 19 percent of GDP. This means that the entire burden of fiscal adjustment falls on tax mobilization.

Revenue Mobilization

It is expected to raise revenue by broadening the base for income tax and VAT. Tax expenditures pertaining to tax holidays, tax exemptions and special tax rates offered to various entities are to be rationalized. Efficiency of tax administration will be improved by adopting key performance indicators, compliance strategies for VAT and income tax and new IT systems.

Reduction of the burden of indirect taxes which now account for about 80 percent of the total tax revenue is a major challenge for the government. Far-reaching reforms to expand the direct tax base are imperative for the purpose.

Public financial management reform

Improvement in expenditure management and fiscal risk monitoring is a key component of the reform package. A commitment control system based on commitment records and quarterly expenditure commitment ceilings is to be established by mid-2016. Summarized government fiscal operations are expected to be disseminated through quarterly financial bulletins.

State enterprise reform

Considering the heavy fiscal burden of loss-making state-owned enterprises, drastic reforms have become imperative. Financial discipline of the key enterprises are to be improved by adopting business strategies with corporate plans, financial and non-financial targets and financing plans. A formula-based automatic pricing mechanism will be introduced for petroleum products.

Enhancing monetary policy effectiveness

Prudent monetary policy management is essential to achieve price and economic stability. According to the program, monetary policy will focus on maintaining single-digit inflation, while moving towards a durable flexible exchange rate system. The program will also support the move toward flexible inflation targeting and financial deepening.

The program envisages a reduction in bank credit to both the government and private sector with a view to facilitate price stability. The projected decline for 2016 and subsequent years seems too optimistic.

Supporting trade and investment

The program aims at boosting trade and private sector activities by reducing protectionism so as to improve competitiveness. The country’s trade regime including para-tariffs and non-tariff barriers are to be reviewed. The program also envisages greater integration into regional and global supply chains, higher FDI inflows and enhancing prospects for private sector investment.

Political commitment vital

Political economy has a profound influence on implementation of adjustment programs. Sri Lanka’s past experience reveals that factors such as lack of political cohesion, bureaucratic constraints and social unrest inhibited program implementation. Generally, the governments are unable to withstand the pressures coming from lobbying groups at the implementation stages of programs. Welfare expenditure cuts, tax increases and public enterprise reforms, for instance, are bitter pills which are not popularly acceptable.

The government needs to focus on sustainable macroeconomic balances with a long-term vision rather than seeking electoral popularity.

*Prof. Sirimevan Colombage is an economist, academic and former senior central banker, can be reached at sscolom@gmail.com

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