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IMF loan essential to resolve BOP crisis

The government has asked the International Monetary Fund (IMF) for a bail out facility to resolve the current balance of payments crisis. A loan facility is urgently needed owing to the critical state of the balance of payments. This crisis in the external finances has been brought about by the mismanagement of the economy over several years.

Previous requests

In similar situations in the past, governments resorted to a rescue package from the IMF. In 1977 the government obtained a Structural Adjustment Facility (SAF) to undertake trade liberalisation and economic reforms. In July 2009 the IMF approved a 20-month Stand-By Arrangement (SBA) of approximately US$ 2.6 billion, as a Balance of Payments (BOP) support.

Macroeconomic weaknesses

Once again the severe difficulties in external finances have made the government request the IMF for a loan facility to resolve the critical balance of payments situation. This situation arose owing to fundamental macroeconomic weaknesses: high fiscal deficits, large foreign debt, and widening of the trade and balance of payments deficits. Recent capital outflows that accentuated the balance of payments problem were due to these weaknesses as well as international factors.

IMF facility

The current request for an IMF facility is absolutely necessary at this critical point in the external finances. The government is sensible in turning to the IMF rather than depend on higher cost commercial borrowing. There is a high probability that a facility would be given after the IMF processes the request and obtains approval of the IMF Board.Without such a loan the economy would be in a severe crisis. The economic instability caused by the balance of payments difficulties would impose severe hardships and disable an economic recovery.

Advantages

Had we resolved the crisis by international borrowing from commercial sources, the cost of borrowing would have been much higher and the repayment period much shorter. This would have meant that debt servicing, that is already a severe strain on the balance of payments, would be more onerous.

The IMF loan that is likely to be given in several instalments would support the balance of payments and boost the depleted reserves. The international confidence that it creates would stabilise the exchange rate, encourage more capital inflows and foreign investment into the country.

Conditions

The government must take the fiscal, trade and balance of payments problems seriously and implement remedial polices. The IMF should impose conditions that would lessen the complacency of the government in fiscal management and compel it to take adequate measures to reduce the high fiscal deficit and trade imbalance.

The IMF itself has had a complicity in the government’s complacency in fiscal policy in the past. The advice on fiscal policy has not been backed up by severe admonitions or withdrawals of later tranches of loans. IMF advice has been polite and diplomatic rather than stern and serious. IMF evaluations of the economy should be more forthright and ensure fiscal discipline in particular.

IMF assessment

In its latest statement, the IMF pointed out the serious weaknesses of the economy. It stated that “the government fiscal deficit for 2015 is estimated to have exceeded the original budget target. Based on the budget framework for 2016, IMF staff estimates suggest the fiscal deficit could widen further. Meanwhile, Sri Lanka’s public debt has risen to over 74 per cent of GDP by end-2015. Despite the narrowing of the current account, capital outflows have intensified and the overall balance of payments (has) deteriorated. These outflows were accompanied by downward pressure on the rupee and a decline in central bank gross foreign exchange reserves mainly due to short-term capital outflows as experienced in many emerging markets.”

These are serious flaws in the country’s economic policies and performance that are not indicative of a “positive economic performance”.

Fiscal weakness

The underlying cause of economic problems is the fiscal weakness. The IMF has stressed this: “The mission has advised the government to urgently make a stronger effort to narrow the fiscal deficit and put the public finances on a sustainable path. While several measures in the budget (such as elimination of several special purpose levies, and the commitment to eliminate tax exemptions and bolster the efficiency of tax administration) are welcome, the mission highlighted the macroeconomic and financial risks of a large deficit and the associated need to borrow from domestic and international markets.”

The IMF has advised the government to focus mainly on measures to raise revenues by broadening the tax base, simplifying and making equitable the tax system, and improving tax administration. However there is little evidence that steps have been taken to implement these.

Fiscal crisis

The government has not been disciplined in its fiscal policy to reduce the fiscal deficit. The amendments made to budget 2016 has forced the Treasury to introduce adjustments towards bridging the higher deficit by cutting down capital expenditure to cushion the impact of the amendments made to several revenue and expenditure proposals.

The revenue estimates in the 2016 budget were unrealistic. There was no way by which the targeted 40 per cent increase in revenue envisaged in the budget could have been realized. The subsequent amendments to revenue proposals made the revenue target even more unlikely. The Finance Minister himself admitted in parliament that the amendments made to the budget increased government expenditure by Rs.35.5 billion.

Less revenue

Instead of increasing income tax to generate more revenue to meet the increasing expenditure, the budget reduced taxes from both individuals and companies. There were other measures too that would bring down revenue. Due to these revenue shortfalls are likely. Since expenditure overruns are inevitable, the fiscal deficit is likely to increase much above 6 per cent of GDP, unless new revenue measures are introduced to increase revenue.

Conclusion

The serious balance of payments crisis left the government with no option but to turn to the IMF. It must use the new breathing space to correct the fiscal imbalance and reduce the pressures on the balance of payments. The IMF facility is yet another opportunity for economic reforms and realistic policies. Will the government take stern measures to reduce the fiscal deficit?