The IMF offers Sri Lanka a $2.6 billion loan with relatively few strings attached
The IMF on July 24th approved a US$2.6bn loan to the Sri Lankan government. The 20-month standby facility is intended to bolster dwindling foreign-exchange reserves, and may indirectly relieve the country’s burgeoning fiscal crisis. Despite intense speculation to the contrary, human-rights concerns have not prevented the loan from being made. In some respects the IMF has been remarkably lenient in the conditions it has attached to the loan. However, the budget projections on which the agreement is based are overoptimistic, and the government will struggle to fulfil this part of its obligations.
The US$2.6bn loan, of which US$322m will be available immediately, is considerably more than the US$1.9bn that Sri Lanka had originally requested. This reflects the deteriorating macroeconomic situation on the island, which faces acute fiscal and balance-of-payments (BOP) problems. The IMF stand-by arrangement formally targets the BOP position only, and is intended to help the central bank shore up foreign-exchange reserves. Such reserves declined by 59% between August 2008 and January 2009—reflecting a doomed effort to prop up the currency and a big outflow of foreign portfolio investments. According to the IMF, administering BOP support should help to create a macroeconomic climate more conducive to Sri Lanka receiving support from other donors.
In the past few weeks, there has been much debate in the international media as to whether the concerns over possible human-rights abuses—including alleged atrocities during the final stages of the war, as well as the government’s treatment of hundreds of thousands of displaced ethnic Tamils—would make the IMF reluctant to approve the loan. In the event, the US and the UK were among a number of countries that abstained from voting to approve the loan, indicating that the government’s triumphalist and nationalistic stance since its defeat of the Tamil Tigers has not gone down well with the international community. But the money has gone through nonetheless.
Indeed, for all the expectation of traditionally tough IMF conditions, Sri Lanka seems to have got a relatively easy ride in terms of the policy adjustments it will be expected to make. There is no privatisation target, and little on reform of the state-owned electricity provider beyond improving its debt position. That said, Sri Lanka was never going to be a candidate for draconian loan conditions, as its macroeconomic policies are already liberal by the standards of most emerging markets that seek IMF support. The government’s agreed targets and structural benchmarks include developing action plans for widening the tax base, strengthening the finances of state-owned enterprises, and expanding financial-sector regulation. The IMF also expects Sri Lanka to boost exchange-rate flexibility, which could suggest that further unwelcome (from the Sri Lankan perspective) depreciation lies ahead.
The main exception to the above is the IMF’s budgetary targets, which look very tough. According to its letter of intent to the IMF, the government will seek to achieve a budget deficit of 7% of GDP in 2009, falling to 5% by 2011. These targets are optimistic, to say the least. The Economist Intelligence Unit’s own forecasts, which predate the IMF loan but which take into account the likelihood of the Fund pushing for fiscal consolidation, are for a budget deficit equivalent to 8.3% of GDP this year, narrowing to 6.7% in 2011. Our GDP growth projection for 2009, at 2.9%, is almost identical to the government’s forecast of 3%, suggesting that the problem—at least this year—will not so much be an overestimate of revenue but an underestimate of spending. Despite promises to the IMF to exercise "expenditure restraint", in other words, the government will be hard-pressed not to overspend.
The budgetary targets may not, in reality, prove to be as tough as they appear. All depends on whether Sri Lanka is penalised for failing to meet them. Spending on post-conflict reconstruction will be costly. A key potential area of controversy will be military spending. The current budget crisis stems in part from the loss of revenue from import duties, but heavy military spending has also played a key role. The IMF expects cuts in defence spending to contribute to deficit reduction (making room for spending on reconstruction and humanitarian relief), and the government’s letter of intent also mentions a likely reduction in military spending in the 2010 budget. Yet the government of Mahinda Rajapakse, the president, may well baulk at curbing military expenditure significantly, especially if it considers itself to be under foreign pressure to do so.
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