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Sri Lanka finance minister pledges fiscal discipline

Strict adherence to IMF's demand to cap budget deficit at 3.5% by 2020

Ravi Karunanayake, Sri Lanka's minister of finance, at an investment summit in Hong Kong on March 16. (Photo by Joyce Ho)   © Not selection

HONG KONG -- After a warning from the International Monetary Fund about its thin foreign-currency reserves, the Sri Lankan government has pledged its commitment to strong fiscal discipline in line with conditions stipulated for a bailout by the Washington-based organization.

"We should have a national vision to address burning issues in the economy, including fiscal-sector operations," Ravi Karunanayake, Sri Lanka's minister of finance, told the FinanceAsia Sri Lanka Investment Summit in Hong Kong on Thursday. He said the "best way" for the South Asian island nation to move forward is through "fiscal consolidation" supported by reforms in tax policy and administration.

"We set our target at 3.5% of budget deficit by the year 2020. And we gradually ensure the impacts of fiscal consolidation coming in," said Karunanayake, reiterating that the government is targeting a budget deficit of 4.6% this year -- 10 basis points below the IMF's projection.

Karunanayake indicated that the government could grow its revenue to 15.3% of the country's gross domestic product from 13.8% last year, made possible by a higher rate of value-added tax and by relying more on public-private partnerships to lessen the expenditure burden. He was confident that government expenditures would be "controlled" because projects would be implemented on the basis of "necessity" and would have to go through the "national plan system," whereby market-oriented analysis would be applied regarding their feasibility.

"For the first time, in 2017, the total revenue of the government [will] exceed the recurrent expenditure," said Karunanayake, adding that surpluses would be put toward debt repayments.

Last June, the IMF approved a three-year loan worth $1.5 billion to help the country ease its balance-of-payments stress, which stems partly from tighter liquidity conditions in the U.S. "The capital and financial account position has weakened due to foreign exit from government securities, lower [foreign direct investment] inflows, and slow implementation of externally financed public and private projects," commented the Washington-based organization on Sri Lanka's economic health.

Following an assessment visit to Sri Lanka, the multilateral lender noted in a review last week that there was a "resumption of capital outflows" and that the country's net international reserves fell short of the target -- a condition likely to be exacerbated by a more hawkish U.S. Federal Reserve, which on Wednesday raised its benchmark interest rate by a quarter point to a target range of 0.75% to 1%. At least two more hikes are expected this year.

Credit-rating agency S&P Global estimated that Sri Lanka's usable international reserves, which stood at $3 billion as of January, represented less than two months' coverage of current-account payments. It maintained its negative outlook on the country, citing the "vulnerability of public finances to any exchange rate shocks," among other reasons.

Fitch Ratings, which revised its outlook on Sri Lanka to stable from negative last month, said the country's exchange rate could face downward pressure in the case of a shift in investor sentiment and as authorities allow for greater exchange rate flexibility.

William Foster, senior credit officer at Moody's Investors Service, believed the interest rate hikes would have a limited impact on Sri Lanka's credit profile, considering the Fed had indicated the increases would be "well-telegraphed."

"Sri Lanka's exposure to dollar strength is really a result of its foreign-currency debt issuance, which is around 40% or so of its GDP," said Foster.

"But given that the pace of the tightening should be relatively slow, Sri Lanka has ample time to prepare for that. It should be able to withstand the incremental tightening that is expected by the market," he added, noting that the country has been extending the maturities of its foreign debts, with the IMF advising the country to borrow the foreign currencies it needed to stabilize its balance of payments.

But he thought the fiscal deficit target was ambitious, considering the country was suffering from its worst drought in 40 years, which was forcing the government to spend more. "The government has had to increase imports of oil because they cannot use the hydroelectricity that it typically would be using at this time of the year from dams because the water level is so low. They also had to provide some kind of support to farmers, particularly in the rice-farming industry," said Foster.

The natural disaster has dimmed Moody's economic forecast for Sri Lanka. It is expecting a 5.2% fiscal deficit and 5% real GDP growth for 2017.

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