Sri Lanka's balance of payments was in bad shape due to slower foreign exchange earnings from low financial inflows and low export earnings and fast rising foreign exchange payments (financial outflows including repayment of government loans).
According to economist Sirimal Abeyratne, the Central Bank (CB) used its foreign reserves to neutralize this and prevent exchange rate depreciation, causing the reserve position to come down critically.
Dr. Abeyratne explained that when the IMF loan is made available in installments, it is a financial inflow so that the balance of payments improves first, reducing pressure on exchange rates and builds investor confidence. Secondly, the CB's foreign exchange reserve position improves. "Assume the CB currently has US$1.5 billion in reserves .. then with a few IMF loan installments it will rise to US$3 billion. When there are foreign exchange payments due and when there is no adequate amount of foreign exchange in the market, the CB can now use its reserves to meet those payments," he said.
Therefore, when there are debt repayments due this year and when there are no dollars in the market, Dr. Abeyratne said the CB has the ability to provide dollars from its reserves. He added that the IMF wants exchange rate flexibility as one of the conditions which means that if there are no dollars in the market, the IMF wants it to be corrected by exchange rate adjustments rather than using reserves to keep the exchange rate fixed, unlike what the CB has been doing over the past few months.
"What is important is not the IMF loan amount or the way it is used but the investor confidence that it will bring," Dr. Abeyratne said. "One important reason why financial inflows were low resulting in an acute foreign exchange problem is because there was no investor confidence as the balance of payments and fiscal positions were so weak even after the end of the war. If the IMF loan together with the way that the government uses it and government policies can improve the balance of payments, the CB will not be forced use this loan to repay past debt because there will be dollars in the market."
Dr. Abeyratne said improving the fiscal position is also necessary so that the government is not forced to borrow more. "This is a difficult and politically sensitive issue," he said. "Massive expenditure for the North and East is another problem adding to the fiscal burden. However as the IMF also said, there is still room for increasing revenue, not by raising tax rates which are already high but by expanding the coverage because the majority of our people still do not pay income taxes." On the expenditure side, Dr. Abeyratne explained that huge amounts of government transfers to maintain hundreds of public institutions which are supposed to contribute to government revenue can be rationalized by introducing some 'sense of commercial viability' once and for all.