Financial Times

IMF agreement will not stop spending increases for North and East – Central Bank

By Dilshani Samaraweera

The US$ 2.6 billion IMF loan agreement, despite controls on the government’s budget deficit, allows large increases in government spending for North and East reconstruction, Central Bank officials said
Under the IMF agreement, the government must control its budget deficit over the next two years. The budget deficit must be held at 7% of GDP this year and brought down further to 5% of GDP by 2011. These targets will be difficult to meet if the government has to increase its expenditure for North and East war-rehabilitation. But the Central Bank officials said the IMF conditions allow the government to increase spending for the North and East - through grants.

“There is flexibility in the budget deficit targets of the IMF agreement to allow the government to spend on North and East rehabilitation. If the government spends a certain amount for North and East rehabilitation and this amount comes from grants, then the budget deficit target will be raised by this amount,” said the Director of the Central Bank’s Economic Research Department, Dr P N Weerasinghe, at a forum on the IMF Stand by Arrangement, organised by the Institute of Chartered Accountants, this week.

About 2% of government expenditure for this year will go towards humanitarian assistance and resettlement. The government says it plans to resettle 70% - 80% of 270,000 displaced people by the end of the year. The resettlement includes supplying basic services like water, electricity, health services, education, and other economic infrastructure. These large cost increases for North and East rehabilitation will have to be met through loans and grants, in addition to the national budget.

However, North and East rehabilitation is also expected to benefit the entire country by helping to contain the cost of living. The rate of inflation is crawling up again from a historic low of 0.9% in June this year. In July, inflation rose to 1.1% and is expected to hit 4%-5% towards the end of this year. But increased outputs of essential food items from the North and East are expected to contain the rate of inflation.
“We would expect the rate of inflation to be around 4%-5% towards the end of this year. Outputs from the North and East, especially essential food items, will help to contain the rate of inflation even if oil prices increase again this year,” an Assistant Governor of the Central Bank, Dr Uthum Herat told the Sunday Times FT.

Before the cease-fire Agreement the North and East had growth rates of around 3% - 4%. After the cease fire, growth shot up to 10% – 12%. Now, with permanent peace and the entire North and East opening up, the Central Bank says the two provinces will add significantly to national outputs fairly soon.

IMF loan converting confidence into cash

By Dilshani Samaraweera

The US$ 2.6 million IMF Stand by Facility is already converting increased confidence in Sri Lanka, into cash, by making it easier for local banks to access foreign credit, said a senior banker this week. Both the cost of foreign credit and the amounts available to local banks, have improved since the arrival of the IMF funds.

“The IMF seal of approval is more than about money. It has made a huge difference in sentiment towards the country,” said the CEO of DFCC Bank, Nihal Fonseka, speaking at a forum on the IMF loan, organised by the Institute of Chartered Accountants of Sri Lanka this week.

Local banks were in a credit squeeze from the latter part of 2008, stemming from the global financial crisis. Sri Lanka’s rapidly diminishing external reserves made credit even more difficult for external transactions. However the IMF loan topped up national foreign exchange reserves and sent out signals of a favourable economic climate. This combination, say bankers, is already making foreign credit more accessible.

“Access to credit had suddenly become very difficult for many banks here. Some banks found it difficult to get letters of credit for imports without putting up some security to foreign banks. But now, after the IMF loan came through, the cost of foreign credit and the amounts they offer, have both improved. This is because they now know we have foreign currency to pay them,” said Mr Fonseka.

According to the Central Bank, the country’s gross official reserves had bounced to US$ 2.1 billion by the end of July, from a low of US$ 1.2 billion by the end of March. The 71% increase in reserves is mainly due to the first tranche of the IMF loan and also the absorption of foreign exchange from the domestic market during the past four months, said the Central Bank.

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