Columns - The Sunday Times Economic Analysis

IMF dilemma on the stand-by facility

By the Economist

The holding back of the third tranche of the IMF stand-by facility was as expected. How could any self respecting international institution that required a government to bring down the fiscal deficit to 7 per cent to continue the facility grant it when the deficit ballooned to 9.8 per cent? On the other hand, as some economists have pointed out, the IMF is eager to continue lending as they would otherwise be out of business. It appears that the IMF is keener to lend than the government is keen to borrow! That sounds strange indeed. Yet it is not a fanciful conjecture. The IMF is no doubt in a dilemma. Consequently, the postponement of the facility was the only option.

Diplomatic as the IMF is these days, they gave a good report of the economy that contradicts much that this column has said recently. According to the IMF “Overall economic conditions are improving as expected, and the economy is likely to show strong growth this year. External balances are strong, remittance inflows continue at a high rate, tourism prospects continue to improve rapidly, and gross reserves remain at comfortable levels. We continue to assess the central bank’s monetary stance as appropriate—with bank lending only slowly beginning to rebound, and economic growth still below potential, we see little signs of emerging demand-driven inflationary pressures.”

What they say of the economy in public statements does not perhaps matter in their dealings with the Central Bank and the government. They are friendly gestures with subtle contradictory hidden nuances. We are not privy to the internal discussions where the hard talk about the conditions for granting of the third tranche took place. The insistence of a Budget for 2010 is perhaps evidence of this. They are no doubt dissatisfied with last year’s high deficit and perhaps not hopeful of any significant difference this year. It appears from the IMF statement that the government has given certain assurances about the containment of the fiscal deficits from 2010 onwards.

Perhaps the targets earlier agreed to would be revised. A figure of a deficit of 7.5 per cent has been mentioned by government sources for 2010. This appears to be quite unrealistic in the context of last year’s 9.8 per cent and the fact that there are only six months left of the budget year 2010.There is hardly any time for the tax measures to take effect and increase revenue. At the same time reining in government expenditure in the six months is most unlikely to yield results.

Nevertheless the IMF statement appears to indicate that some serious assurances have been given. The IMF statement states: “In our discussions, the government has laid out a set of polices intended to correct the slippages and move toward sustainable deficit reduction while securing spending for protecting the most vulnerable in society. They expect to submit to parliament shortly a 2010 budget involving substantial deficit reduction for the year as a whole, driven primarily through savings in recurrent spending. The government is planning to begin undertaking a comprehensive tax reform, drawing on recommendations from the Presidential Tax Commission.”

We would have to await the truncated budget for 2010 to know what these measures are. There is reason to be skeptical about the results as all recent budgets have given figures that were way out of the realization and in the case of this budget, more than in the case of the previous ones, it is too short a period for adequate results to materialize. More than the figures presented in the Mini Budget 2010, the specific revenue and expenditure measures would be pertinent.

Irrespective of the IMF conditions, it is imperative that the fiscal deficit is brought down to about 7-8 per cent this year and then reduced progressively to 6 per cent by 2012. This is a tough task as government revenue is not even adequate to service the debt. In 2009 debt servicing costs absorbed more than the entire revenue of the government. Debt servicing alone absorbed 14 per cent more than revenue.

Beginning on such a slate it is an impossible task to bring down the deficit to the required proportions immediately. What we can hope for are measures on both revenue collection and government expenditure. There should be evidence of reforms in the correct direction.

It is interesting that the IMF itself says “the economy is likely to show strong growth this year’, yet “economic growth (is) still below potential”. The IMF has been ambiguous about the reserves. On the one hand, it says that the reserves are high and satisfactory. On the other hand it has on previous occasions pointed out quite correctly, that most of the reserves are borrowed short term funds that could go out as swiftly as they come in. It was the IMF’s willingness to lend to Sri Lanka that laid the strong foundation for international borrowing. If the IMF departs then the reserves would come down again.

The country is running a huge trade deficit with imports rising rapidly and export growth being inadequate. As we pointed out last week exports grew by 20 per cent mainly due to improvements in agricultural prices and some increases in volume.

In contrast imports grew by 60 per cent to leave a huge dent in the trade balance of over US$ 1000 million in just two months. This can hardly be considered a healthy external balance. As the IMF notes quite rightly, remittances continue to grow. Yet the 13 per cent growth in remittances is quite inadequate to offset the trade deficit of the magnitude that is developing, unlike what it was last year when the deficit was much lower than the remittances.

Tourist earnings are certainly healthy and it is hoped that these would be substantial this year to yield a balance of payments surplus.

The most likely scenario is that the IMF will give the third tranche on the basis of the budget figures. These will show a curtailment of the deficit just as the Budget of 2009 showed a deficit of 7 per cent when the outturn was nearly 10 per cent of GDP.

When the deficit exceeds the budgeted figure, the IMF will blame the government and withhold the next tranche. The government will then negotiate and promise to bring down the deficit and the IMF will remain in business. There are no losers in this game between the government and the IMF. It is the people, especially the future generations that will bear the burden.

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