Inteligencia y Seguridad Frente Externo En Profundidad Economia y Finanzas Transparencia
  En Parrilla Medio Ambiente Sociedad High Tech Contacto
Economia y Finanzas  
 

Significance: Following months of stalled negotiations, the IMF and Sri Lankan authorities agreed on a US$2.5-billion 20-month stand-by facility to alleviate acute pressure on external liquidity as substantial debt obligations loom.

Implications: Liquidity has been compromised by a marked increase in the current-account deficit in 2008 and by capital outflows in late 2008 and early 2009 forcing foreign reserves to critical lows. Total debt obligations in 2009 are estimated at US$1.6 billion. The financing should ensure that Sri Lanka continues to service its external obligations while providing budgetary support for the huge reconstruction effort required in conflict-affected areas.

Outlook: The conditionality of the loan is due to be finalised on 24 July. Fiscal consolidation, reform of the financial system and tight restraint on demand growth to allow for a correction in imports to rebalance the current account are set to feature heavily. The measures, which are vital to macro-economic stabilisation over the long-term, will act as a further constraint on already weakening growth in the near-term.

21/07/2009 | IMF Announces US$2.5-bil. Loan Agreement with Sri Lanka to Stave Off Default

Global Insight Staff

The International Monetary Fund (IMF) and the Sri Lankan government today agreed terms on a US$2.5-billion loan agreement to bolster external liquidity, but improvement in the sovereign risk rating will remain dependent on actual implementation.

 

IHS Global Insight Perspective 

 

Agreement Reached

The International Monetary Fund (IMF) confirmed today that it had reached a US$2.5-billion loan agreement with the Sri Lankan government. The financing will be disbursed through a 20-month stand-by facility with US$133 million made available immediately. The agreement followed months of torturous and stalled negotiations, which began in January. Disbursal of the loan was reportedly stalled by concerns among major shareholders in the IMF over the deteriorating humanitarian situation in the north as the government sought to crush the insurgent Liberation Tigers of Tamil Eelam. A political resolution to the conflict is still pending. The scale of the financing package exceeded expectations. The IMF had been expected to disburse around US$1.9 billion in loan financing.

Liquidity Drained

Emergency financing has been sought to relieve acute stress on external liquidity. Pressure on external liquidity was initially exerted by a rapid widening of the current-account deficit as imports surged. IHS Global Insight estimates that the current account rose to 7.0% of GDP in 2008 from 4.2% the year before. Sri Lanka, as a net oil importer, was acutely exposed to the spiral in global prices witnessed in the first half of 2008. However, import demand was also fanned by excess, aggregate domestic demand growth as both monetary and fiscal policy arguably remained overly lax. Untrammelled domestic demand growth was also reflected in surging inflation, which peaked at 29.9% in April 2008 although rapid disinflation has since set in with the consumer price index rising by a record low margin of 0.9% in June. Cooling domestic demand growth, base comparison effects and tighter credit conditions have supported the retreat in inflation. Buoyant liquidity growth supported rapid credit expansion in both the public and private sectors. Recent tightening of liquidity and the economy's looming slowdown could expose problems with asset quality generating potential stress in the domestic financial system. Government expenditure recorded robust growth as defence spending rose sharply to prosecute military operations against the Liberation Tigers of Tamil Eelam (LTTE) rebels in the north of the country and outlays on major infrastructure projects and civil service compensation increased. The budget deficit is estimated to have ballooned to around 8.0% of GDP in 2008, forcing already high public debt levels higher while constraining the latitude of monetary policy.

Concurrently, export growth has begun to decelerate as global demand retrenches and agricultural staple prices decline. Tourism earnings have also contracted as arrivals have been undermined by the escalating conflict. The deficit on the trade balance is estimated to have risen to over US$5 billion in 2008 from US$3.2 billion in 2007, only partially offset on the current account by robust remittance inflows. Economic growth slowed sharply in the first quarter of the year. The current account will remain in substantial deficit as falling exports offset the positive impact of declining imports on the net trade position and remittance inflows, which provide crucial offset to the trade balance, atrophy. Stabilisation of the current account will therefore remain dependent on a sharp correction in imports contingent in turn on reductions in deficit-financed expenditure supported by flexible adjustment in the exchange rate.

Additional stress on external liquidity was exerted by capital outflows in the fourth quarter in the broad flight of capital from high-yield but high-risk emerging market assets. The weak security environment and the increasingly acute macro-economic imbalances in Sri Lanka acted as a further deterrent to foreign capital inflows. Foreign reserves were depleted as the central bank intervened to support the rupee exchange rate as it came under severe depreciation pressure. The currency remains susceptible to significant volatility. Foreign reserves halved in the six months from September to critical lows of under two months of imports. The central bank now reports their level at US$1.7 billion following a modest recovery in foreign capital inflows.

Marked Deterioration in Debt Ratios

The drain on external liquidity has been juxtaposed by deterioration in solvency ratios. Historically, Sri Lanka's external debt structure, configured on a large share of concessionary financing and modest amounts of short-term debt generated relatively low annual debt-service obligations. However, the debt-service burden has increased, reflecting higher volumes of external liabilities and a greater propensity of commercial short-term loans as authorities resorted to dollar-denominated domestic loans in order to maintain foreign-exchange reserves and finance the budget deficit. Refinancing obligations are set to bunch over the next two to three years, exposing the sovereign to higher financing costs in the risk-averse global financial environment. The International Monetary Fund (IMF) estimates that US$1.6 billion of short-term dollar-denominated debt is expected to fall due over the next two years as external debt stocks have increased through financing of the widening current-account shortfall. There has also been a marked increase in U.S. dollar-denominated domestic debt to finance the fiscal deficit, which presents a potential claim on foreign reserves. The pincer-like deterioration in both solvency and liquidity ratios prompted IHS Global Insight to downgrade Sri Lanka's sovereign risk rating by 10 points to 60 on a negative outlook in March as the IMF loan programme financing failed to materialise.

Outlook and Implications

The IMF financing will provide immediate support to the foreign reserve position while providing a concrete framework for the re-engagement of other international donors. Sri Lanka has secured increasing levels of aid from China and Middle Eastern states, notably Iran in recent months, but volumes remain insufficient. Although the conventional war has concluded in the north of the country, huge reconstruction requirements and the ongoing humanitarian crisis, with almost 300,000 people displaced, continues to exert strain on the budget. Concurrently, imports of capital goods and material for reconstruction in conflict-hit areas could exacerbate imports, exerting fresh pressure on external liquidity. The announcement by the IMF refers explicitly to financing the reconstruction programme, potentially indicating that a multilateral framework may be instituted to support the political process. In 2001, when Sri Lanka teetered on the edge of another balance-of-payments crisis, a consultative group of international donors helped entrench the peace initiated by then-prime minister Ranil Wickremasinghe.

However, the loans will not come without conditions. The IMF board is due to discuss the provisions of the loan on 24 July. Central to the macro-economic consolidation programme is likely to be major fiscal adjustment. Expenditure will be restrained over the near term while reforms to broaden and deepen the tax base are vital to strengthening the budget position over the long term. Although inflation has subsided, the monetary stance is likely to remain tight to trammel credit growth and as the fiscal balance remains compromised, financial sector reform is also likely to be included in the package. Sri Lanka's financial system is overcrowded while prudential and regulatory oversight is weak.

Although consolidation of macro-economic imbalances is crucial to stabilising the economy over the long term, tight policy measures will add further constraints on growth in the short term particularly as government expenditure is cut. Growth braked sharply in the first quarter to 1.5% in year-on-year terms in the three months through March. Momentum was undermined by a sharp fall off in trading activity and cooling domestic demand growth. IHS Global Insight projects growth of less than 1.0% in 2009 although there is now upside potential to this forecast if the IMF intervention supports a recovery in IMF capital inflows. Finalisation of the IMF loan could also prompt a revision in IHS Global Insight's outlook on its sovereign credit rating from negative to stable. However, an actual rating upgrade will remain dependent on successful implementation of the loan conditions, particularly given Sri Lanka's fractious relations with the IMF in the past. The previous three-year loan agreement signed in 2001 lapsed prior to its conclusion following internal political opposition.

Global Insight (Reino Unido)

 


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