20220324-IMF-Sri_Lanka_2021_Article_IV_Consultation-Press_Release_Staff_Report_and_Statement_by_the_Executive_Director_for_Sri_Lanka_95页_4mb

Summary of IMF Article IV Consultation with Sri Lanka (February 2022)

Context

Sri Lanka faced significant economic challenges, including high public debt, low external reserves, and vulnerabilities to external shocks before the COVID-19 pandemic. The Easter Sunday terrorist attacks in 2019 exacerbated pre-existing structural weaknesses, limiting fiscal space and institutional reforms. The 2019 tax cuts further eroded revenue potential.

Pandemic Impact (2020-2021)

• Economic Contraction: Real GDP fell 3.6% in 2020 due to lockdowns, reduced tourism, and disruptions in manufacturing and services.
• Fiscal Deficits: Fiscal deficits reached 11.4% of GDP in 2021, driven by pandemic-related revenue losses and increased expenditure on social safety nets and health.
• Debt and Reserves: Public debt surged to 119% of GDP, and international reserves depleted to just 1.5 months of imports.
• Inflation: Inflation reached 14% in 2021, fueled by supply shocks, administered price controls, and loose monetary policy.

Policy Response

• The authorities implemented COVID-19 relief measures, including tax forbearance, social safety net expansions, loan moratoria, and monetary policy support.
• Despite these measures, Sri Lanka lost access to international capital markets due to downgraded ratings (to CCC) and failed to roll over $2-3 billion in sovereign debt.

Outlook and Risks

• Fiscal and Debt Sustainability: Public debt is unsustainable under current policies. Annual fiscal deficits remain high, and external debt service requirements are around $7-8 billion annually through 2026.
• Economic Growth: Growth is projected at 2.6% in 2022, constrained by high debt, external financing gaps, and macroeconomic imbalances.
• Downside Risks: COVID resurgence, rising commodity prices, supply chain disruptions, and potential banking sector vulnerabilities pose significant risks.

Staff Recommendations

1. Fiscal Consolidation:

• Implement revenue-based consolidation through tax reforms (increasing VAT rates, broadening tax base, minimizing exemptions).
• Revamp the fiscal rule and strengthen expenditure management.

2. Monetary Policy:

• Tighten policy to contain inflation (target 4-6%).
• Phase out central bank budget financing and gradually restore a flexible exchange rate.

3. Social Safety Nets:

• Strengthen coverage, targeting, and benefit levels to protect vulnerable groups.

4. Structural Reforms:

• Promote female labor force participation, reduce youth unemployment, liberalize trade, and improve investment climate.

Staff Assessment

Sri Lanka's prompt policy response mitigated the pandemic's impact, but persistent fiscal and external challenges have constrained growth and stability. The authorities' plans are insufficient to restore debt sustainability and macroeconomic stability without comprehensive reforms and fiscal consolidation.

Authorities' Response

The authorities acknowledged the risks and agreed with the need for fiscal consolidation, monetary tightening, and structural reforms. They emphasized the importance of preserving COVID-related relief measures and addressing vulnerable groups.

Conclusion

Sri Lanka is in a "combined debt and balance of payments crisis," requiring urgent implementation of a credible strategy to restore macroeconomic stability and debt sustainability.