The International Monetary Fund (IMF) has approved Sri Lanka’s program review, allowing for the disbursement of $330 million. The IMF emphasized the importance of using monetary policy exclusively to ensure stability.
“Monetary policy should continue to prioritize price stability, supported by a commitment to avoid monetary financing and safeguard central bank independence,” stated Kenji Okamura, Deputy Managing Director and Acting Chair.
This guidance comes amid calls from inflationists for interest rate cuts to promote growth and initial discussions about positive real interest rates based on historical inflation data.
Currently, Sri Lanka’s inflation is low due to the absence of anchor conflicts, though critics argue that the monetary authority’s framework remains flawed without a credible anchor. Sri Lanka has legally established an inflation target of up to 7 per cent without a clean float, partially due to an explicit reserve collection target.
Since the end of the civil war, anchor conflicts have surfaced whenever private credit recovered from previous currency crises. Efforts to suppress rates along the yield curve using liquidity tools, including extensive sterilization of foreign exchange interventions, have been labelled as ‘monetary financing.’
The IMF also warned of risks to economic recovery. Growth is projected to recover moderately in 2024-25 due to constrained bank credit and fiscal consolidation, with uncertainties surrounding debt restructuring and policy direction post-elections. Inflation is expected to rise temporarily due to one-off factors.
“Significant vulnerabilities associated with the ongoing debt restructuring, revenue mobilization, reserve accumulation, and banks’ capacity to support recovery continue to obscure the outlook,” the statement noted. “Strong reform efforts, adequate safeguards, and contingency planning are essential to mitigate these risks.”
The IMF stressed the need for sustained revenue mobilization, prompt finalization of debt restructuring in line with program targets, and protection of social and capital spending to restore fiscal sustainability. It also recommended the gradual removal of external controls to rebuild external buffers and facilitate rebalancing.
Sri Lanka has had capital controls for decades due to flawed operational frameworks involving central bank refinancing operations or interest rate targeting without a clean float. This has led to exchange rate volatility, including during short periods of surplus balance of payments achieved through deflationary policy.
The IMF completed the second review under the 48-month Extended Fund Facility (EFF) Arrangement, allowing the disbursement of about $336 million. This brings total IMF financial support to about $1 billion so far. The EFF-supported program aims to restore macroeconomic stability and debt sustainability, mitigate economic impact on the poor and vulnerable, rebuild external buffers, safeguard financial sector stability, and strengthen governance and growth potential.
Signs of economic recovery are emerging, with real GDP expanding by 3 per cent year-over-year in the second half of 2023, inflation at 0.9 per cent in May 2024, and gross international reserves increasing to $5.5 billion by the end of April 2024. Despite improvements in non-performing loans, vulnerabilities remain in the banking sector.
Growth is expected to recover moderately in 2024-25, driven by improved tourist arrivals and remittances, while domestic risks could stem from waning reform momentum. External risks include regional conflicts, commodity price volatility, and a global slowdown. Slow progress in debt restructuring could widen financing gaps.
Kenji Okamura commended Sri Lanka’s strong performance under the program, noting that reforms are starting to yield positive results. However, he cautioned that the economy remains vulnerable and the path to debt sustainability is precarious. He emphasized the importance of continued strong reform efforts and safeguarding central bank independence to ensure long-term inclusive growth and stability.
In summary, the IMF urged Sri Lanka to maintain fiscal discipline, strengthen its debt management framework, ensure price stability, and support economic recovery through robust financial sector reforms and governance improvements.
