IMF warns Lanka facing higher financial risks

The Executive Board of the International Monetary Fund (IMF) has warned that despite continued access to international debt markets, trends in Sri Lanka suggest that financial risks for the country have increased.

To mitigate these risks, the IMF says the authorities should take appropriate corrective actions to safeguard macroeconomic stability and lay the foundation for durable and inclusive growth. Improvements in the business climate, reform of state owned enterprises, and a more open trade regime are key to boosting competitiveness and growth.

In a statement on the the Fourth Post-Program Monitoring (PPM) with Sri Lanka, the IMF Executive Board said that in view of high public debt, fiscal developments this year pose a risk to the economy and call for ambitious measures in the 2016 budget to put Sri Lanka?s fiscal position on a more sustainable footing.

Sri Lanka has a very low tax-to-GDP ratio, and high levels of current expenditure constrain needed development spending, limit policy space, and threaten debt sustainability. Therefore, a comprehensive reform of tax policy and administration, and a prompt resumption of fiscal consolidation supported by increased revenues should be a key policy priority.

Economic growth continued to be fairly strong in 2015, while headline inflation has remained low. The external current account deficit is projected to narrow moderately in 2015, due largely to lower oil prices. Private sector credit growth has picked up sharply in 2015. At the same time, deterioration in the overall balance of payments, the loss of central bank foreign exchange reserves, the weak state of public finances, and growing public debt are reasons for concern.

With the recent acceleration in private sector credit growth and rising core inflation, there is now little scope for further monetary easing. Most factors?including the deterioration in the balance of payments and pressures on the rupee?suggest that the CBSL should be prepared to tighten monetary policy in the coming months, albeit at a gradual pace.

Another policy challenge the IMF proposes is to reduce external vulnerabilities and address the deterioration in the balance of payments. Tighter fiscal and monetary policies could help restrict aggregate demand, contain the recent sharp rise in imports, and strengthen the external balance. However, to be more effective, these policies should be supported by greater exchange rate flexibility, reduced foreign exchange intervention, and efforts to deepen the foreign exchange market, as well as structural reforms to enhance competitiveness.

The financial sector remains relatively stable, and the authorities are taking measures to tackle remaining vulnerabilities in the nonbank financial sector. However, there is the need for continued progress in consolidated bank supervision and in developing a more robust stress testing framework. (Colombo Gazette)