Columns - The Sunday Times Economic Analysis

A concessionary loan of US $2.5 billion

At last the IMF loan facility
By the Economist

Almost a month ago in our column of June 28 we said of the pending and delayed IMF loan facility: “Our conjecture is that despite all the controversy and confusion the loan would be given. Then we could say ‘all’s well that ends well’”. This has happened and the IMF loan was approved two days ago by the Executive Board of the IMF. All’s well that ends well.

There can be no reservation whatsoever that this loan facility will ease our foreign exchange reserve position, enhance investor confidence, improve the country’s credit rating and enable a better management of public expenditure for development. We should set aside narrow political thinking and quibbling over what was said in the controversy about the loan and rejoice in the fact that this facility is of economic advantage to the country. That is the important fact in as far as the economy is concerned and any opposition to the loan or the conditions that are attached to it are nothing less than that narrow self-centredness for political gain.
The Central Bank expects the IMF to grant a facility of US$2.5 billion. This is 400 per cent of Sri Lanka 's quota at the IMF.. The quota is determined on the basis of the level of income, openness to trade and access to other sources of capital. It has been revised a few times following the initial quota allocation when Sri Lanka joined the IMF in 1950. Curiously, Sri Lanka joined the IMF one day after the Central Bank was established on August 28.

The IMF loan or stand-by facility is at a very nominalrate of interest of one half of one percent per annum repayable in four to five years. The stand by arrangement is for 20 months. During this period policy changes have to be undertaken. One could characterise this as almost a free facility that would hardly add to interest costs, in contrast to the commercial loans we have been obtaining recently. This is a facility for relief in the balance of payments. It is not a development loan. The granting of long term project loans is not a function of the IMF. The main objective of the IMF is to come to the assistance of countries in balance of payments difficulties and to oversee the international monetary system and exchange rate regimes. The granting of project loans is the function and responsibility of the twin institution the World Bank whose long title, the International Bank for Reconstruction and Development indicates this. The smooth disbursement of the IMF facility will however be an additional reason for the World Bank to assist the country in the reconstruction and development of the country.

This Stand-by facility is expected to be disbursed in several tranches. The first instalment of US$ 313 million will be given immediately. Certain conditions would have to be met for the grant of the other tranches. One of the important conditions would be the bringing down of the fiscal deficit. This is of vital importance. The sooner we are able to rein in expenditure and increase revenue collection, the sooner the economic fundamentals would become conducive to the country’s economic development. It has been repeatedly said that it is vital that there is fiscal consolidation and one would hope that the conditions imposed for the release of the other instalments of the loan will spur the government to take measures to bring down the fiscal deficit. It is likely that there would be an agreed programme to bring down the fiscal deficit. This would be insisted upon by the IMF. This is expected to be similar to the one in the Fiscal Responsibility Act. Unfortunately successive budget outturns have strayed from the stated goals. Fiscal consolidation is essential for the country's long term growth. Therefore following a path of fiscal discipline would be of utmost benefit to the economy.

Another condition that is likely to be attached to the disbursement of the loan would be an exchange rate policy that would keep the Rupee at a realistic exchange rate. This too is vital for the economy that is very much dependent on exports. If we do not have a competitive exchange rate our exports would suffer. In the determination of the real effective exchange rate the relative rates of inflation of competing countries are relevant. If the Sri Lankan rate of inflation is higher than those of its competitors then there is a need to adjust the exchange rate to keep exports competitive. This fact must be underscored as there is much misunderstanding and misinformation on the role of the exchange rate. The inextricable connection between the exchange rate and the fiscal deficit lies in the fiscal deficit being a most important factor in determining the rate of inflation in the economy.

Other detailed conditions that the government would have to satisfy to receive the additional instalments have not been disclosed and in fact these may never be disclosed. The present thinking of the IMF is that it will not lay down political conditions and details on how the fiscal deficit should be brought down. It may advise the government on these, but they may not lay down specific conditions. Instead they would require the end result to be achieved. Cutting wasteful expenditure and reducing unproductive expenditure everyone knows is an essential strategy for fiscal consolidation. The specifics the IMF may well leave to the government.

The economy would benefit in several ways by obtaining the IMF loan on conditions that are very favourable to the country. Its low interest rate facility is of much benefit. The funds would boost the reserve position. This in turn would enhance the country's financial credit ratings. However it would tend to appreciate the currency. This would mean some intervention by CBSL so as to not affect exports adversely as discussed earlier. The share market has already risen even on the expectation of the loan.

On Wednesday it reached a record level. The stabilisation of the economy brought about by this loan would boost investment as the granting of the IMF loan would be looked upon as a pointer that the economy is on a sound basis and that the country is good for investment. The IMF loan provides another opportunity to get the country’s economic fundamentals straightened out. This is no easy task. However if the path to improving the economic fundaments is not taken now, the hoped for economic recovery will not materialise and the possibility of correcting the fundamentals of the economy will become even more problematical.

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