In addition to the 1.5 billion US dollars going to the central bank to boost reserves under IMF's Extended Fund Facility, another 650 million dollars in program loans will come from the World Bank, and other lenders to finance the budget directly.

Sri Lanka hopes to use the program to sell sovereign bonds in international capital markets. This year's budget gap is expected to be brought down to 5.4 percent from 7.4 percent in 2015.

Fiscal, Trade Reform

"The government’s economic program aims at fundamental changes to tax policy and administration to reverse a two-decade decline in tax revenues and put public finances on a sustainable medium-term footing," IMF mission chief Todd Schneider said in a statement.

"The macroeconomic stability and renewed market confidence from this fundamental re-set of policies will reduce vulnerabilities, boost growth, and foster sustainable job creation."

Sri Lanka will increase tax collections to 15 percent of gross domestic product by 2020, reduce the budget deficit to 3.5 percent of GDP and aim to generate a primary surplus (deficit before interest). Sri Lanka aims primary surplus in 2018 under IMF deal, to suspend BOI law: report

Sri Lanka will re-write the income tax and customs code and use information technology extensively to plug revenue leaks by reducing administrative discretion.

Trade will also be liberalized making the economy efficient. Analysts say trade liberalization will also liberate the most vulnerable sections of the population from the grip protected big business.

Tranches of the loan will start to come from June 2015, after the IMF's board approves the deal.

Prior Actions

Before that Sri Lanka has to complete a series of 'prior actions' to make sure that the economic reform program is not de-railed.

Sri Lanka has announced valued added tax hikes - amid concern for a 15 percent VAT on education and healthcare which will hurt plans for a knowledge economy and most vulnerable sick people in society including the ageing - from May 02.

Prime Minister Ranil Wickremesinghe Sunday also unveiled plans to take-over debt of Sri Lankan Airlines find a managing partner, and suspend sweeping tax holidays under a Board of Investment law which gives wide discretion for bureaucrats outside the finance ministry to give tax holidays. (Sri Lanka govt to take-over SriLankan debt; seek managing investor: PM)

"State enterprise reform will play a key role in both limiting future risk to public finances and enhancing the role of market forces in the economy," Schneider said.

"The government is committed to dealing quickly with the legacy of Sri Lankan Airlines, which continues to represent a drain on public finances after years of mismanagement.

"Going forward, key state firms - and the government’s financial relations with such firms - will be governed transparently by annually published statements of corporate intent."

Sri Lanka will market price fuel, with subsidies for the poor.

Monetary Policy

The central bank will is to move to a 'flexible inflation targeting regime' with a more 'flexible exchange regime.'

"The central bank will shift toward a flexible inflation targeting regime while also undertaking measures to help deepen foreign exchange markets and a support a durable transition to a flexible exchange rate regime," Schneider said.

Sri Lanka has a monetary regime where the central bank intervenes to prevent the currency going up generating money outside open market operations.

The central bank also prints money to repay Treasury bills outside open market operations which some analysts says will undermine any inflation targeting regime and re-create the 1980s danger of a permanently downward crawling peg (flexible exchange rate) and high inflation.

Sri Lanka's central bank has a strong track record in delaying rate hikes and de-stabilizing the credit system.

However unlike in the 1980s there is more public awareness and early warning about the central bank's tendency to follow loose policy and generate inflation and currency trouble.

The central bank triggered the 2015/2016 currency crisis by cutting rates in April 2015, while private credit took off and the budget deficit deteriorated. Currency defence rapidly mopped up excess liquidity and eventually forced interest rates up.

But the rupee also collapsed from 131 to 146 to the US dollar especially after currency defence was reduced and more money was printed. After the currency fell, and bank fixed deposit rates went up policy rates were raised to old level and a controversial statutory reserve ratio hike was also made.

Bank fixed deposit rates are now around 300 basis points higher from a year earlier. It also 15 months since salaries and subsidies were hiked, the economy has expanded since then and the collapsed rupee has also increased inflationary revenues.

The full text of the International Monetary Fund statement on reaching a staff level agreement is reproduced below. The deal has to be approved by its executive board.

IMF Reaches Staff Level Agreement with Sri Lanka on Three-Year $1.5 Billion EFF

Following discussions held between IMF staff and the Sri Lankan authorities during the 2016 Spring Meetings in Washington, staff-level agreement was reached on a three-year program to be supported by the IMF’s Extended Fund Facility (EFF).

Mr. Todd Schneider, IMF mission chief for Sri Lanka, made the following statement:

“I am pleased to announce that, in support of the government’s economic reform agenda, the Sri Lankan authorities and the IMF have reached a staff-level agreement on a 36-month Extended Fund Facility (EFF) for 185 percent of Sri Lanka’s quota in the IMF (about SDR 1.1 billion or US$1.5 billion). This agreement will be subject to completion of prior actions and approval by the IMF’s Executive Board, which is expected to consider Sri Lanka’s request in early June. Formal approval of the EFF is expected to catalyze an additional US$650 million in other multilateral and bilateral loans, bringing total support to about $2.2 billion (over and above existing financing arrangements).

“The EFF supports the authorities’ ambitious economic reform agenda for the next three years. The government’s economic program aims at fundamental changes to tax policy and administration to reverse a two-decade decline in tax revenues and put public finances on a sustainable medium-term footing. Stronger revenue performance will enable smaller fiscal deficits and lower borrowing, reduce the overhang of public debt, and ease pressure on the balance of payments—while at the same time preserving room for the government’s key social and development spending objectives. State owned enterprise (SOE) reform will reduce fiscal risk, increase transparency and facilitate commercially viable operations. The macroeconomic stability and renewed market confidence from this fundamental re-set of policies will reduce vulnerabilities, boost growth, and foster sustainable job creation.

“To this end, the authorities’ program supported by the IMF focuses on a comprehensive set of reforms to Sri Lanka’s tax system—eliminating exemptions, holidays, and special rates to broaden the tax base and create a tax system that is simple, efficient, and more equitable. The government will seek to raise the tax-to-GDP ratio to near 15 percent by 2020 by implementation of a new Inland Revenue Act, reform of the VAT and the customs code. These efforts on tax policy will be complemented by capacity building and reform in revenue administration—making full use of automated systems and information technology to bolster tax collection while also clamping down on corruption and discretionary tax treatment. Together with more efficient management of government expenditure, the program will support a steady reduction of the overall fiscal deficit to 3.5 percent of GDP by 2020— equivalent to a shift from primary (excluding interest costs) fiscal deficits to primary surpluses that will underpin a much-needed reduction of public debt.

“State enterprise reform will play a key role in both limiting future risk to public finances and enhancing the role of market forces in the economy. The government is committed to dealing quickly with the legacy of Sri Lankan Airlines, which continues to represent a drain on public finances after years of mismanagement. Going forward, key state firms—and the government’s financial relations with such firms—will be governed transparently by annually published statements of corporate intent. The government will also ensure that the pricing of electricity and fuels is guided by the market, with subsidies needed to protect the poor and vulnerable being better targeted and clearly reflected on the government’s budget. This will avoid the accumulation of un-funded subsidy bills and ensure SOE operations are conducted on a commercially viable basis.

“Important structural reforms will also support growth and competitiveness objectives. The government plans to review and reform the external tariff structure to reduce effective rates of protection while simultaneously pursuing new trade agreements. The central bank will shift toward a flexible inflation targeting regime while also undertaking measures to help deepen foreign exchange markets and a support a durable transition to a flexible exchange rate regime. Strengthening financial sector supervision and increasing the role of private credit and financial intermediation in the economy will remain important objectives.

“With the implementation of these policies, Sri Lanka will support growth and build resilience to future economic shocks. Overall, the EFF will help the government achieve ‘lift off’ of the economy and fully tap Sri Lanka’s significant economic potential.”

(economynext.com)