IMF funding tied to political developments-Citi Research

A key implication of the end of the conflict is the International Monetary Fund’s (IMF) stand-by arrangement of US$1.9 billion, under negotiation since March 2009 but that funding is closely tied to political developments and there are concerns that it may face delays or be entirely stalled, Citi Research has said in a report.

In a report titled ‘Sri Lanka Macro View’, Citi Research states that this could renew pressure on forex reserves/the currency, although private capital inflows and bilateral loans could provide some cushion. Adhering to conditionalities is also a worry, the report said.

Fiscal consolidation will likely be a prerequisite, although Sri Lanka’s previous record with stand-by arrangements, coupled with significant fiscal slippages, suggests that implementation would require strong political will according to the reoprt. While this could be difficult during an election year when public spending would peak and post-war rehabilitation efforts are underway, President Mahinda Rajapaksa’s strengthening political base is encouraging.

The report stated that given Sri Lanka’s chronically high fiscal deficits (averaging 8%+ of GDP over the last 10 years) and high public debt (81% of GDP), the imposition of fiscal discipline would likely be foremost amongst conditionalities imposed. While Sri Lanka already has fiscal responsibility legislation in place, implementation in the past has not been stringent and slippages have been significant.

The report said one way to curb external imbalances is for the IMF to prescribe tighter monetary policy on top of fiscal tightening. However, with Sri Lanka’s inflation having come down dramatically to 2.9% as of April 2009 (from a peak of 28.4% in June 2008), private sector credit growth slowing down significantly to only 3.1% YoY in March 2009 from 15.7% just a year ago, and reserve money now contracting, Citi Research believes the IMF will not go significantly against the monetary easing that the Central Bank (CB) has been pursuing since early 2009. The fact that the CB has been cutting interest rates alongside negotiating with the IMF likely implies that monetary tightening is not a major component of the IMF policy agenda.