Can Sri Lanka fulfill agreed reforms with IMF?

The International Monetary Fund (IMF) approved a $2.6 billion loan for Sri Lanka to help the country through the global financial crisis and rebuild following a 25-year civil war.

Sri Lanka will immediately be able to tap the first disbursement of $322 million under the 20-month programme but the rest will be phased in, subject to quarterly reviews.

Following are some questions and answers on key conditions and whether the government will be able meet them.

WHAT IS THE HARDEST CONDITION FOR SRI LANKA TO MEET?

Maintaining a 7 percent budget deficit in 2009. Latest Ministry of Finance data showed the deficit has already hit 4 percent in the first four months of this year and economists expected the full-year figure to reach at least 9 percent.

They say the government will be forced to revise its populist policies to more economically rational ones if it wants to receive the entire $2.6 billion loan.

The 5 percent fiscal deficit target in 2011 will also be a difficult task for President Mahinda Rajapaksa, who faces a parliamentary and presidential election before then.

Analysts say the Rajapaksa administration, which has already promised to cut military expenditure after the war, could introduce new indirect taxes to increase revenue.

But that might be unpopular with the electorate. So Rajapaksa could take advantage of his current high popularity and call for elections early and, assuming he wins, implement the less popular policies afterwards.

WHAT WILL IMF DO IF SRI LANKA FAILS TO MEET THE CONDITIONS?

Initially, the IMF is likely to be flexible, taking into consideration Sri Lanka's post-war situation. However, continued failures to meet conditions will compel the lender to stop disbursement of the loans, which would be negative for domestic markets. The IMF discontinued a previous loan programme due to Sri Lanka's failure in adhering to its conditions in 2001.

WHAT IMPACTS WILL THE CONDITIONS HAVE ON THE ECONOMY?

Inflation is expected to pick up. The government has agreed with the IMF to halt subsidies to loss-making state enterprises Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC). That is likely to lead to higher inflation via increased energy prices, raising pressure for policy rates to rise.

WILL THE EXCHANGE RATE POLICY BE AN ISSUE?

No. One of the conditions state that the central bank must allow flexibility in the foreign exchange rate and limit intervention to smooth volatility in the market. But the IMF has also said the flexibility should help maintain exporters' competitiveness, suggesting it is in line with the current central bank policy of intervening only when the rupee is depreciating.

Central bank Governor Ajith Nivard Cabraal told Reuters on Monday that the rupee is trading at a reasonable rate and it will continue to maintain a stable exchange rate.

Traders also expect the rupee remain steady.