Financial Times

IMF commends Sri Lanka, stresses need to tackle inflation, other risks

The International Monetary Fund (IMF) this week commended Sri Lanka for its ‘impressive record of economic growth over the past few years’ but called for a comprehensive package of reforms to tackle inflation and limited external risks.

It also said the directors of the board were concerned about the combined build-up of macroeconomic imbalances, balance sheet vulnerabilities, high inflation, and external financing pressures poses serious risks to economic stability. “The recent increases in international food and fuel prices and the global financial crisis have heightened the challenge facing the authorities,” it said in a report after the IMF’s Executive Board concluded the Article IV consultation with Sri Lanka on October 17. The report commended Sri Lanka for falling rates of unemployment and poverty indicators and bold decisions to adjust administered fuel prices, transport fares, and electricity prices which will reduce fiscal risks over the medium term.

It said the year-on-year (yoy) rate of inflation has edged down to 25 % in August, but core inflation has risen and headline inflation has remained well above the rates prevailing in Sri Lanka's major trading partners and in the region.

The external current account deficit is projected to widen sharply in 2008, it said.

The report said Sri Lanka's domestic financial markets have been largely immune to the global financial turbulence. Sri Lankan institutions reportedly have little or no direct exposure to U.S. sub-prime assets, while a significant portion of net foreign inflows reflects investments by non-resident Sri Lankans. Money markets have been volatile but have generally reflected domestic developments, as has stock and bond markets, the IMF added.

The directors noted the risks of public debt distress arising from the increasing reliance on dollar-denominated, short-term commercial debt. “While recognizing the authorities' efforts to strengthen debt management, the directors saw a need for further improvements in this area, in particular by lengthening the maturity profile of debt to reduce refinancing risks, and by facilitating non-debt finance for development spending,” the report said.

The directors commended the authorities for exercising significant restraint with respect to reserve money growth, and encouraged further monetary policy tightening to help anchor inflation expectations, and in this context, suggested that raising policy rates toward market interest rates would reinforce the authorities' quantitative strategy by signaling their commitment to disinflation.

“A few directors, however, were not convinced of the effectiveness of the interest rate channel in Sri Lanka, and cautioned that an increase in the policy interest rate might encourage capital inflows,” the report added.

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