How Is Sri Lanka Navigating Its IMF Bailout Program?

In 2020, Sri Lanka went through its worst bout of macroeconomic instability since winning independence. The COVID-19 pandemic is not the only cause of this instability; the economy has long been beset by a number of structural problems. 

The question of whether Sri Lanka should obtain financial assistance from the International Monetary Fund (IMF) was hotly debated by the public during the pandemic. Sri Lanka received permission from the IMF board for an extended financial arrangement in March 2023, following months of discussions. The latest IMF bailout program is having an impact on the ongoing approaches to resolving Sri Lanka’s economic problems. The recent policy modifications pertaining to the bailout program are examined in this article.

Sri Lanka joined the IMF as its 50th member on August 29, 1950. Sri Lanka did not seek help from the IMF during the 1950s due to its solid external reserve position, which was established during World War II and reinforced by the Korean War commodity boom (1950–1951) and the tea boom (1954–1955). However, on June 15, 1965, Sri Lanka signed a $30 million standby agreement, marking the island nation’s first IMF assistance request. Sri Lanka is currently undergoing its 17th IMF assistance program, having previously participated in 16 of them.

On March 20, 2023, the IMF approved a 48-month Extended Fund Facility (EFF) for SDR 2.286 billion (about $3 billion) in order to assist Sri Lanka’s economic policies and reforms. There are six objectives listed in the 17th IMF program. Restructuring state-owned businesses, financial institutions, and social safety nets is the main objective, along with advancing revenue-based budgetary consolidation. Its second goal is to restore the public debt’s viability. The program also attempts to rebuild external buffers in order to bring pricing stability back. The project also seeks to offer public financial stability and safeguard against corruption. Enhancing sustainable economic growth is the final objective. The conditions of the 17th IMF bailout are consistent with every measure the Sri Lankan government has implemented to date to combat the economic crisis. 

Fiscal Targets and Their Significance

To achieve these objectives, the Sri Lankan government has committed to specific fiscal targets. The primary deficit was scheduled to decrease from 3.8 percent of GDP in 2022 to 0.7 percent of GDP in 2023 within the outlined budget in 2023. A target has been set to collect tax revenue equivalent to 10 percent of GDP. This involves implementing a comprehensive tax reform package, including adjustments to corporate income tax, the elimination of firm-specific tax holidays, and changes to value-added tax (VAT) policies. Adopting the policy goals of the IMF financial assistance program, the fiscal year 2024 appropriations bill aims to achieve a 0.8 percent GDP primary balance surplus. 

Several reasons underscore the importance of achieving a surplus in the primary balance. A country faces a primary deficit when it spends more on public goods and services than it collects in taxes, necessitating borrowing to cover these expenditures. Sri Lanka, grappling with an unsustainable foreign debt stock projected to reach 128 percent of GDP in 2022, aims to reduce public debt to below 95 percent of GDP by 2032. Failure to cover recurrent expenditures within tax revenue could lead to increased reliance on foreign debt, jeopardizing long-term fiscal sustainability.

The significance of maintaining a surplus in the primary balance is highlighted by its role in servicing debt and lowering overall debt levels. Achieving this balance creates fiscal space, allowing the government to finance projects that stimulate economic growth. Despite historical challenges, including significant deficits in the primary balance, notable progress was observed in 2018, showcasing the potential benefits of fiscal discipline.

Sri Lanka’s current endeavor involves reaching a surplus in the primary balance of 0.8 percent of GDP by 2024. While acknowledging the difficulty of this task, achieving this target holds key benefits. Success in this endeavor not only ensures continued support from the IMF for the nation’s recovery but also contributes to the restoration of investor confidence. 

In the long run, the discipline instilled by maintaining a surplus in the primary balance is expected to sustain the economic rebound. The overarching strategy involves increasing government revenue, rationalizing expenditures, and sustainably managing debt service obligations to enhance the country’s resilience to domestic and global economic shocks.

SOE Reform Strategies and Implementation

Reforming state-owned enterprises (SOEs) has also become a key policy priority in the economic recovery process of Sri Lanka. In the Sri Lankan context, the reform of SOEs involves various strategies aimed at enhancing efficiency, reducing fiscal risks, and improving financial viability. 

Several types of SOE reform are considered, each offering distinct benefits. These include corporatization, corporate restructuring, commercialization, public-private partnerships, and privatization. Corporatization involves consciously separating political and economic factors. By adopting this approach, SOEs aim to operate with greater autonomy and efficiency, minimizing interference from political influences. A corporate restructuring strategy encompasses reorganizing an entity’s ownership, legal, operational, or other structures to enhance its overall organization or increase profitability. It is a holistic approach to improving the efficiency and performance of SOEs. The focus of commercialization is to transform SOEs into profitable business enterprises without relying on government funding. Financial restructuring often accompanies this process to enhance the financial viability of SOEs. Public-private partnership (PPP) is a collaborative arrangement between a private company and a government organization to jointly provide a public good or service. This strategy leverages the strengths of both sectors to improve service delivery and efficiency.

The Sri Lankan government has committed to implementing these reforms, particularly after seeking assistance from the IMF for a 17th bailout program. Major reforms identified by the Central Bank of Sri Lanka include the introduction of cost-reflective pricing policies, improvement in strategic direction, enhancement of financial transparency and accountability, and strengthening corporate governance.

One notable area of reform is the energy sector, where retail fuel prices were increased in early 2022 to align with cost-recovery levels. Additionally, the inclusion of private sector firms such as Sinopec of China, United Petroleum of Australia, and RM Parks of the United States in the downstream petroleum industry aimed to enhance competition and fuel supply. The government also approved the fuel pricing formula from 2018, bringing transparency and consistency to fuel pricing.

IMF-assisted SOE reforms aim to achieve specific goals, including the restructuring of major SOEs’ balance sheets, prompt publication of audited financial statements, and restrictions on foreign exchange borrowing by nonfinancial SOEs. To execute these reforms, the Sri Lankan government established the State-Owned Enterprise Restructuring Unit (SRU) within the Ministry of Finance. The SRU plays a pivotal role in implementing SOE reforms, including divestments of certain SOE groups. Reputable firms, such as the International Finance Corporation (IFC), have been appointed as transaction advisors for key SOEs, facilitating the divestment process.

In conclusion, Sri Lanka stands at a critical juncture, navigating its economic resurgence amidst the aftermath of the unprecedented challenges faced in 2020. The decision to seek financial assistance from the IMF was a pivotal moment, reflecting the complexity of the economic crisis aggravated by structural issues predating the COVID-19 pandemic.

In this intricate process of economic recovery, Sri Lanka is poised to emerge resilient, equipped with strategic fiscal measures, sustainable reforms, and a commitment to transparency and accountability. The journey ahead involves not only overcoming immediate economic hurdles but also laying the foundation for a robust and adaptive economy. The outlined reforms, bolstered by international support and collaborative efforts, provide a roadmap for Sri Lanka’s economic revival, fostering confidence among investors, stakeholders, and the populace alike.