Columns - The Sunday Times Economic Analysis

IMF staying in business: Certifies good economic performance

By the Economist

The IMF announced that it was continuing its standby facility of US$ 2.6 billion and restoring the delayed tranches. Its announcement on the eve of the 2010 mini Budget last Tuesday also praised the government’s economic policies and predicated a strong economic growth. The IMF statement, as well as its continuation of the credit facility, would enhance confidence in the economy, boost international confidence, improve the government’s capacity to borrow from abroad and ensure financial stability. It was good for the IMF too as it could remain in business in an international environment where their business opportunities are diminishing.

Particularly significant was the good report on the Sri Lankan economy by the IMF. The IMF statement said that “Overall economic conditions in Sri Lanka are improving and the economy is likely to show strong growth this year. Inflation remains subdued and average inflation for the year as a whole is expected to remain in the single digits. External balances are strong, remittance inflows continue at a high rate, tourism prospects are strengthening rapidly, and gross reserves are at comfortable levels.” This concise good report compliments and supports the longer account of the good economic performance of the country in the Budget Speech. In fact the acting Minister of Finance Dr. Sarath Amunugama interrupted his budget speech to announce that the IMF stand-by facility would boost reserves to a plentiful US$ 6.4 billion.

The IMF statement went on to say that “Monetary conditions are stable. Interest rates have declined and credit growth has shown signs of recovering. The Central Bank’s policy stance remains appropriate, although there may be a need to tighten it if credit and inflationary pressures pick up sharply. The Central Bank has intervened in the foreign exchange market to rebuild reserves, and has allowed the exchange rate to trade within a recently widened, although still narrow band.” Further, the IMF’s announcement said that “Financial sector reform is in line with the programme and has substantially addressed the regulatory weaknesses. The authorities’ reform agenda has been broadened to include the introduction of a deposit insurance scheme, regulation of pension funds, and steps to deepen capital markets.”

What about the fiscal deficit that has been the sore point in the budgets of the past and in the negotiations with the IMF? The budget expectation is that the fiscal deficit would be brought down to 8 per cent of GDP this year and then reduced further to 5 per cent in the next five to six years. This is a familiar story repeated so often in budget speeches that it is only sweet music to the ears. It lacks any sort of credibility. The government promised to bring down the deficit to 7 per cent of GDP in 2009 but overshot it by nearly 3 per cent of GDP to reach a huge 9.75 of GDP last year.

The arrangement under the stand-by agreement was to reduce the deficit this year to 6 per cent of GDP. The goals have now been shifted by the government renegotiating with the IMF. This revised target was predictable, as earlier promised fiscal deficit levels could not be achieved. The new goal is easier to keep at 8 per cent of GDP. Yet there are doubts that government revenue will rise to the expected levels. This is especially so as there are no specific proposals to cut expenditure or increase revenue.

The IMF’s response to the fiscal deficit is very reconciliatory. It says, “Despite the weaker-than-programmed 2009 fiscal performance, the government’s 2010 budget proposal, if carried out, would significantly address past fiscal slippages, mainly through comprehensive tax reforms and sizeable cuts in recurrent spending. At the same time, the budget would allow for much needed reconstruction-related infrastructure investment, while protecting the societies most vulnerable and addressing the humanitarian needs of those adversely affected by the conflict.” Experience suggests that the IMF’s expectations are unlikely as in the past. The IMF has an escape clause in “if carried out”. It is not difficult to guess whether the measures agreed with the IMF would be carried out.

The Report of the taxation commission is not out. The Deputy Minister said it would be out in August and that its recommendations would be considered in Budget 2011 to be presented in November this year. The IMF it appears is privy to some of the recommendations. Besides, recent changes in duties appear to be partly an indication of the thrust in policies.

This is implied in the IMF statement: “The authorities’ efforts to reform trade and excise taxes and the Board of Investment’s tax concession regime are a signal that they recognize the importance of a broader tax base and higher revenue in achieving the programme’s original goals of fundamental and sustainable reduction of the deficit and the public debt. These efforts should be followed by important steps to permanently reform tax concessions and broaden the VAT and income tax bases to be introduced as part of the 2011 budget.”

Whatever happened to the original conditions laid down by the IMF for the granting of the facility? The third tranche of the facility was withheld as the government failed to comply with the requirement that the fiscal deficit should be contained within 7 per cent of GDP in 2009. The government transgressed this requirement by a large margin to incur a deficit of 9.75 per cent of GDP. An explanation is that since the IMF is keen on remaining in Sri Lanka, it accepted various reasons as to why the government was unable to achieve the fiscal target in 2009. Now, the government is asked to achieve a less stringent deficit of 8 per cent of GDP in 2010.

When the government decided not to present a Budget, this posed a problem for the IMF. It appears that the mini Budget presented last Tuesday, June 29 was in order to meet the IMF requirement. It is also known that the government negotiated fresh terms to change the fiscal targets, such as to make the 2010 deficit much higher. What the actual agreement is with respect to the fiscal deficit is not known. The IMF statement however implies that they are satisfied with steps to be introduced in the budget.

The IMF involvement has confused the issue of the fiscal deficit. Containing the fiscal deficit is vital for economic stabilization and long term economic growth. This has been accepted by successive governments and advocated strongly by economists and economic advisors. The 2010 mini Budget re-emphasized this and promised once again to reduce the fiscal deficit from the targeted 8 per cent this year to lower levels in the next few years. However there were no specific budget measures to either control expenditure or to increase revenue.

This makes one sceptical as to whether the fiscal deficit would in fact be tapered down from this year onwards. There is a good reason to think it is unlikely. The IMF conditions of containing the deficit no longer has any teeth as they appear to bend backwards to accommodate the government, to remain in business.

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