Sri Lanka: IMF-Sponsored Reform Programme, Overview & Update (September 2017)
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1 Sri Lanka: IMF-Sponsored Reform Programme, Overview & Update (September 2017) Inwa Advisers Pte Ltd. Incorporated in the Republic of Singapore. Co Reg No D.
2 Contents IMF s Comments on the Progress of Reform (September 2017) Summary of the IMF s June 2016 Reform Programme Programme Peformance, Outlook and Risks Economic Background: - Growth and Inflation - Fiscal Balance, BoP, Reserves, Credit Selected Economic & Financial Indicators (June 2017) Monetary and Exchange Rate Policy International Competitiveness Debt Sustainability Aanalysis Summary of Agreed Economic and Financial Policies 1
3 IMF s Comments on the Progress of Reform (September 2017) Growth has been affected by the weather, but should rebound next year as agriculture normalizes and infrastructure projects pick up The current account is expected to widen this year because of the weather, but capital inflows continue, supported by improving confidence from the progress in reforms As weather-related supply disruptions dissipate, inflation should stabilize All quantitative performance targets to the end of June 2017 have been met The passage of the landmark Inland Revenue Act is a major achievement Progress on structural reforms especially on SOEs and public financial management has been mixed Fiscal consolidation based on stronger revenues remains essential The Central Bank should be vigilant on inflation, and should stand ready to tighten monetary policy, if needed The Central Bank s commitment to flexible inflation targeting and a flexible exchange rate regime is welcomed Source: IMF Press Release No.17/378, 29 th September Please refer to the Sri Lanka pages on the IMF s website for full details. 2
4 Summary of IMF s June 2016 Programme In June 2016, the IMF approved a three-year USD 1.5bn extended arrangement under the Extended Fund Facility (EFF), to support Sri Lanka s economic reforms Objective: to meet balance of payments needs arising from a deteriorating external environment and pressures that may persist until macroeconomic policies can be adjusted The linchpin of the programme is a reduction in the overall fiscal deficit to 3.5% of GDP by 2020 Rebuild tax revenue through reform of tax policy and administration Steps for more effective control over expenditures Putting state enterprise operations on a more commercial footing Support for growth from a greater role for the market and a decisive shift to an outward orientation Exchange rate flexibility to allow the central bank to build FX reserves and focus more on maintaining price stability Comprehensive trade reform and improvements to the investment environment to support competitiveness and greater integration with international markets The reform programme was adopted by the coalition government, which came to power in 2015, led by President Sirisena and Prime Minister Wickremesinghe 3
5 Programme Performance, Outlook and Risks PROGRAMME PERFORMANCE Quantitative Targets End-2016 and March 2017 targets for primary balance and tax revenues were met End-2016 and March 2017 targets for net int l reserves and reserve money were missed Inflation remained within the target band Structural Benchmarks 6/15 benchmarks were not met by April 2017 Progress on most, except the introduction of automatic fuel and electricity pricing mechanisms The cabinet now targets automatic pricing for fuel and electricity by March/September 2018 OUTLOOK Real GDP growth of 4.7% forecast for 2017, supported by construction and services Inflation to remain above 5% for much of the year (high food prices and 2016 s VAT rate hike) Growth projected to reach 5.2% in the medium-term, in line with potential RISKS External: capital outflows with USD strength or a weakening of the external position Domestic: further delays in revenue mobilization and SOE reforms; the effects of the weather Risks to public debt sustainability remain high. (Public debt at 94% GDP incl. SOE debt) Source: IMF June 2017 Staff Report. For full details, please refer to IMF Country Report on Sri Lanka (17/253), posted to the IMF s website in August
6 Economic Background - Growth and Inflation Growth expected to recover to 4.7% in # 16.0# 14.0# 12.0# 10.0# 8.0# 6.0# 4.0# 2.0# 0.0# Q2# 2011# Q4# 2011# Q2# 2012# Q4# 2012# Real%GDP%Growth%(%%YoY)% Q2# 2013# Q4# 2013# Q2# 2014# Q4# 2014# Q2# 2015# Q4# 2015# Q2# 2016# Q4# 2016# supported by construction & services 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%!2.0% 2011% 2011% 2012% Real%GDP%Growth%by%Sector%(%%YoY)% 2012% 2013% 2013% 2014% 2014% 2015% 2015% Agri,%Forestry,%Fishing% Industry% Services% Taxes%less%Subsidies% 2016% 2016% with net exports likely to remain a drag. 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%!5.0%!10.0%!15.0%!20.0% 2011% 2011% Real%GDP%Growth%by%Type%of%Expenditure%(%%YoY)% 2012% 2012% 2013% 2013% 2014% 2014% 2015% 2015% Final%Consump7on% Gross%Capital%Forma7on% Net%Exports% 2016% 2016% CPI likely peaked in March, but is expected to stay above 5% for much of the year 12# 10# 8# 6# 4# 2# 0# Consumer)Price)Indices)(%)YoY))!2# Jan!15# Mar!15#May!15# Jul!15# Sep!15#Nov!15# Jan!16# Mar!16#May!16# Jul!16# Sep!16#Nov!16# Jan!17# Mar!17# Colombo#CPI# Core#CCPI# Na>onal#CPI# due to weather-induced high food prices and the effects of the VAT increase in Source for all charts / data: IMF June 2017 Staff Report. For full details, please refer to IMF Country Report on Sri Lanka (17/253), posted to the IMF s website in August % 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%!1.0%!2.0% Colombo&CPI&(Contribu/on,&%&YoY)&!3.0% Jan!15% Mar!15% May!15% Jul!15% Sep!15% Nov!15% Jan!16% Mar!16% May!16% Jul!16% Sep!16% Nov!16% Jan!17% Mar!17% Food% Housing%&%UDlity% Transport% Other% - Growth averaged c.5.5% in ( ), but slowed recently as a result of weaker productivity. TFP was 1.4% in ( ) compared with 2.8% in ( ) - Following the 2002 ceasefire, growth rose to c.6% in ( ), despite the end of the Multi-Fibre Agt. and worsening security - Post 2009, growth averaged 8.5% ( ), despite the global financial crisis. It has since slowed to 4.4% ( ) - M-T growth is estimated at c.5%, conditional on an investment and a productivity rebound - Strong progress in the economic reforms enshrined in the EFF programme (to drive greater trade openness, more infrastructure and regulatory support, increased FDI) could further enhance Sri Lanka s growth potential. 5
7 Economic Background Fiscal Balance, BoP, Reserves, Credit Fiscal deficit down from 7% to 5.4% of GDP. Current a/c deficit steady at 2.5% of GDP but large portfolio outflows in Q4 meant 15.0% 10.0% 5.0% 0.0%!5.0%!10.0% Central(Government(Opera/ons((%(GDP)( 2011% 2012% 2013% 2014% 2015% 2016% 6000% 4000% 2000% 0%!2000%!4000%!6000%!8000%!10000%!12000% Current'Account'Cons,tuents'(USD'bn)' 2014% 2015% 2016E% 2017P% 2018P% 2019P% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%!1.0% Financial'Account'(%'GDP)' 2006% 2007% 2008% 2009% 2010% 2011% 2012% 2013% 2014% 2015% 2016% Tax%Revenue% Other%Revenue% Capital%Spending% Primary%Balance% Overall%Balance% Goods% Services% Net%Other%Income%(inc.%RemiBances)% Current%Account% Direct%Investment% Other%Investment% Por=olio%Investment% gross int l reserves fell to $6bn (3 months of import cover) at year end # 7000# 6000# 5000# 4000# 3000# Dec,15# Jan,16# Feb,16# 2016%NIR%and%GIR%(US$%mn)% Mar,16# Apr,16# May,16# GIR# Jun,16# Jul,16# NIR# Aug,16# Sep,16# Oct,16# Nov,16# Dec,16# Despite some slowing, credit growth remains high at 20.4% YoY in March Source for all charts / data: IMF June 2017 Staff Report. For full details, please refer to IMF Country Report on Sri Lanka (17/253), posted to the IMF s website in August " 25" 20" 15" 10" 5" Credit'Growth' 0" Jan*15" Mar*15" May*15" Jul*15" Sep*15" Nov*15" Jan*16" Mar*16" May*16" Jul*16" Sep*16" Nov*16" Jan*17" Mar*17" - Public finances have strengthened under the EFF programme - Drop in primary deficit (of 2% GDP) supported overall deficit reduction, as tax / GDP held steady at 12.4% and goods and services spending was rationalized - Goods deficit sizeable at 11% of GDP, but strong tourism and remittances contained the current account to a deficit of 2.5% of GDP - EM sell-off and an unwinding of an official swap line of $700mn, pressured the financial account in Q CBSL intervened to defend the Rupee, causing international reserves to decline to a level below 2017 claims at end However, a placement of 10yr bonds (at 6.2%) added $1.5bn to reserves in May
8 Selected Economic & Financial Indicators (June 2017) E 2017E 2018P 2019P 2020P 2021P Real/GDP/Growth/(YoY,/%) Inflation/(Average,/%) Inflation/(End/of/Period,/%) Core/Inflation/(End/of/Period,/%) National/Savings/(%/GDP) National/Investment/(%/GDP) National/Savings/Balance,2.4,2.4,2.5,2.3,2.1,2.0,2.0 Government/Savings/Balance,7.7,8.3,6.7,6.1,5.0,4.7,4.5 Private/Savings/Balance Govt./Revenue/&/Grants/(%/GDP) Govt./Expenditure/(%/GDP) Primary/Balance,2.2, Central/Govt./Balance/(%/GDP),7.0,5.4,5.2,4.7,3.7,3.5,3.5 Public/Debt/(Period/End,/%/GDP) Broad/Money/Growth/(YoY,/%) Dom./Credit/Growth/(YoY,/%) Current/Account/Balance/(%/GDP),2.4,2.4,2.5,2.3,2.1,2.0,2.0 ///Export/Value/Growth/(%),5.2, ///Import/Value/Growth/(%), Gross/Official/Reserves/(USD/bn) ///GOR/(Months/of/Imports) External/Debt/(USD/bn) ///as/%/gdp Source: IMF, Second EFF Review, 27 th June 2017, page 22 7
9 Monetary and FX Policy Policy rate raised by 25bps in March 2017 Gross Int l Reserves behind target at end 2016 Rupee judged to be overvalued on REER basis 13.5# Sri$Lankan$Interest$Rates$ 12000# Projected)GIR)Path)(USD)mn)) 110.0$ REER# 12.5# 11000# 105.0$ 11.5# 10.5# 9.5# 8.5# 10000# 9000# 8000# 100.0$ 95.0$ 90.0$ 7.5# 7000# 85.0$ 6.5# 6000# 80.0$ 5.5# Jan/16# Mar/16# May/16# Jul/16# Sep/16# Nov/16# Jan/17# Mar/17# Policy#Rate# 3yr#Govt#Bond#Yield# WA#Prime#Lending#Rate# 5000# 2015# 2016# 2017# 2018# 2019# 2020# 2021# 2022# Current#GIR#Projec7on# GIR#Path#Agreed#at#First#Review# 75.0$ 70.0$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$ 2013$ 2014$ 2015$ 2016$ Sri Lanka needs to rebuild reserves to strengthen external sustainability. 9.0# 8.0# 7.0# 6.0# 5.0# 4.0# 3.0# 2.0# 1.0# 0.0# Adequacy)of)Gross)Reserves)vs)FX)Claims)(USD)bn)) GIR at start of period 2015# 2016# 2017# Other#Liabili7es# Swaps#to#be#Rolled#Over# FX#Market#Liabili7es# Loans,#Securi7es,#Deposits# (Interest)# Loans,#Securi7es,#Deposits# (Principal)# Intervention caused the SLR to outperform most EM currencies post the US election Source for all charts / data: IMF Staff Report for 2017 Article IV Consultation, 5 th July IMF s website for full details 9.0# 8.0# 7.0# 6.0# 5.0# 4.0# 3.0# 2.0# 1.0# 0.0# (Nominal)*Exchange*Rate*Deprecia6on*vs*USD* Between end September and end 2016 Sri#Lanka# India# Vietnam# Philippines# China# Indonesia# Malaysia# Mexico# Between#US#ElecIon#and#end#2016# Please refer to the - IMF favours tightening monetary policy, as inflation is at the upper end of the target band and credit growth exceeds 20% - Interest rate increases have lagged US since the end of The Central Bank has resumed net FX purchases since March/April. The 2017 target for GIR of $7.2bn has been reaffirmed - IMF advocating greater FX flexibility in the event of a return to capital outflows, as there is a need to build Gross Int l Reserves and the Rupee is judged to be overvalued relative to fundamentals - GIR at end-2016 covered only 80% of FX claims falling due in 2017, leaving Sri Lanka reliant on rollovers - Periods of REER appreciation tend to coincide with reserve losses. 8
10 International Competitiveness C/A improvement due to lower oil & services exports. Non-oil trade balance a challenge. Sri Lanka lags behind peers in export performance reflecting the challenge in diversifying the components of exports, which are unchanged. Non$Oil(Trade(Balance( Goods%Export%Value%(2002=100)% Export'Structure'(%'Share)' 24# 700# 50" 22# 600# 45" 40" 20# 500# 35" 30" 18# 400# 25" 16# 300# 20" 15" 14# 200# 10" 5" 12# 2011# 2012# 2013# 2014# 2015# 2016# 100# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012# 2013# 2014# 2015# 2016# 0" Tea" Other"Agri" Tex3les/Garments" Rubber"Prods" Other" Non-Oil#Imports# Goods#Exports# Sri#Lanka# Malaysia# Philippines# India# Thailand# Indonesia# 2007" 2016" Savings from lower oil prices have been spent on higher consumer goods imports. 60" 50" 40" 30" 20" 10" 0" Import'Structure'(%'Share)' Consumer" Intermediate"6"Fuel" Intermediate"6"Non"Fuel" Investment" 2007" 2016" Labour market rigidities are one of the factors hindering investments. What%labour%factors%are%most%problema1c%?%(%%of%firms)% Finding"workers"with"previous"experience" High"employee"turnover" TVET"of"workers" Labour"availability" Pay"taxes"&"EPF,"contribu8ons" Total"salary"cost" Employment"protec8on"legisla8on" General"educa8on"of"workers" Minimum"wage"rate" Source for all charts / data: IMF Staff Report for 2017 Article IV Consultation, 5 th July IMF s website for full details 0" 10" 20" 30" 40" 50" 60" Please refer to the - With REER appreciation, Sri Lanka s competitiveness challenges have deepened. - The non-oil trade deficit has risen in the last two years, and now stands at 7.2% of GDP - IMF estimates cyclically adjusted C/A gap norm of -1% vs current -2.4%, and suggests the Rupee is overvalued by 8% to 18% - Despite a favourable geographical location, FDI averages only around 1% of GDP - Alongside labour rigidities, the World Bank s Doing Business report suggests enforcement of contracts, paying taxes and registering property hamper inward investment - FDI concentrated in construction, utilities & services which supports infrastructure, but creates few opportunities for technology transfer, import replacement, or exports 9
11 Debt Sustainability Analysis Public debt was 79.3% of GDP at end 2016 (84.2% with guarantees & Fund credit)... and the ratio of gross financing needs, at 17.6% of GDP, is the 3 rd highest in GEM. External debt is 56% of GDP, although rollover risks are low, as 83% is medium or long term Public'Debt'(%'GDP)' Gross%Financing%Needs%(%%GDP)% 80.0% 30.0# Central#Govt.#External#Loans#8#Maturity#Profile#(2015)# 0%# 78.0% 76.0% 74.0% 72.0% 70.0% 68.0% 66.0% 64.0% 25.0# 20.0# 15.0# 10.0# 5.0# 33%# 5%# 40%# 6%# 16%# <=1Yr& 1Yr&'&2Yr& 2Yr&'&3Yr& 3Yr&'&5Yr& 5Yr&'&10Yr& >10Yr& 62.0% 2008% 2009% 2010% 2011% 2012% 2013% 2014% 2015% 2016% 0.0# 2008# 2009# 2010# 2011# 2012# 2013# 2014# 2015# 2016# Baseline scenario: real GDP growth recovers to 5.2% by 2022, with inflation staying at around 5%. Primary fiscal spending reaches a surplus of 2.2% in 2020, with a current a/c deficit of 2%. 15.0& 10.0& 5.0& 0.0&!5.0&!10.0&!15.0& Debt%Crea)ng%Flows%(%%GDP)% 2006& 2007& 2008& 2009& 2010& 2011& 2012& 2013& 2014& 2015& 2016& 2017& 2018& 2019& 2020& 2021& 2022& Primary&Deficit& Real&GDP&Growth& Real&Interest&Rate& FX&DepreciaEon& Other&Debt!CreaEng&Flows& Residual& - Fiscal consolidation as envisaged under the EFF programme would steadily reduce public debt - Debt / GDP would fall by 2%-3% annually from 2018, to 70.2% by Gross financing needs rise to 20% of GDP in 2018, and then fall to 13% of GDP in However, if the primary deficit holds at the historical level of 1.5% of GDP, debt to GDP would remain at around 2016 levels - Other risks include slower real GDP growth, the exchange rate, higher interest rates, and the performance of SOEs. Source for all charts / data: IMF Staff Report for 2017 Article IV Consultation, 5 th July IMF s website for full details Please refer to the 10
12 Summary of Agreed Economic and Financial Policies Fiscal Policy: Durable reduction in fiscal deficit and debt reduction through revenue mobilization Broaden tax base; improve the efficiency of collection & expenditure, rather than cut spending State Enterprise Policies: Improvements in oversight and financial discipline Secure strategic partner for SL Airlines. Establish automatic fuel, electricity pricing mechanisms Monetary & Exchange Rate Policy Focus monetary policy on keeping inflation in the mid-single digits Establish inflation as nominal anchor; move away from using exchange rate as de-facto anchor Programme to strengthen reserve coverage, supported by regular FX purchases Financial Sector Policies Measures (eg. Basel III capital standards) to strengthen the financial system Steps to strengthen CBSL s autonomy and governance Policies to Strengthen Trade and Investment: Greater integration into global supply chains; higher FDI, enhanced private sector investment Reduction in costs (eg. para-tariffs, nontariff barriers) to reduce protection & support exports Improve trade facilitation, remove barriers to foreign investment (access to land, finance etc.) Source: Attachment to Letter of Intent to IMF in Appendix to IMF Staff Report for 2017 Article IV Consultation, 5 th July Please refer to the IMF s website for full text 11
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