IMF in their recent Article IV Consultations on Sri Lanka, the contents of which were made public on Friday (25), warned of the possibility of Sri Lanka losing the GSP+ duty free access facility to the EU, Sri Lanka’s second largest merchandise export market after the US, with the third being the UK.
Generally, on such matters, the UK, works hand in glove with the EU. Therefore, it may be presumed that the possible loss of GSP+ vis-à-vis the EU may also mean the possible loss of duty free access status of Sri Lankan goods to the UK market as well. Such losses would further deal another crippling blow to the country’s existing US dollar crisis.
This newspaper remembers Urban Development State Minister Dr Nalaka Godahewa on the eve of the 2019 Presidential Poll telling the Media that they have factored in the possibility of losing the GSP+ facility. Obviously that factoring in has failed, going by the fact that his Government is actively pursuing an IMF programme currently, to tide over its dollar crisis.
IMF also projected that foreign exchange (FX) debt servicing to reach around USD7 billion this year, including the USD 1 billion international sovereign bonds (ISBs)maturing in July against critically low gross reserves and the lack of market access due to Sri Lanka’s junk credit rating.
“FX debt service is projected to remain around USD 7-8 billion over the medium-term,” IMF warned.
“Balance of payments financing of USD 2-3 billion (2-3 per cent of GDP) would become available each year, nonetheless gross reserves would stay critically low at around one month of imports over 2022-26, IMF warned.
“A severe debt overhang, heightened macro imbalances, prolonged FX shortages and the cut in Government capital spending to minimize expenditure as a whole would erode business and public confidence and deter investment, productivity growth and confidence in the currency,” IMF said.
And, should the unidentified external financing not be forthcoming, the country could experience a disorderly adjustment through severe import compression and potentially external arrears (debt default) in the near-term, IMF warned.
Relying on domestic sources to fill the fiscal financing gaps as intended by the Government, would however, either suffocate private credit growth or require further monetary financing (money printing) of the fiscal deficit, which can undermine monetary stability, it said.
Confidence in the currency and the financial sector could erode under such a downside scenario, leading to an even worse macroeconomic outcome, severely affecting life and livelihood of many segments of the population, and risking intensifying social discontent, IMF warned.
Among some of its recommendations to forestall such a possible eventuality, strengthen governance and reduce corruption vulnerabilities; upgrade legislation relating to Central Bank of Sri Lanka independence and fiscal rules, previously suspended after the 2019 regime change; uplift revenue mobilising by increasing corporate and personal taxes and VAT, minimise exemptions and ensure greater contributions from high-income earners. Given rising inflationary pressures and expectations, warranting near-term monetary policy tightening.
As the Government has no plans to bridge the loss of FX in the event GSP+ is lost in this critical situation as expressed by no lesser person than President Gotabaya Rajapaksa himself recently, the obvious solution is to switch the Government’s previous policy of discounting GSP+, by reengaging the EU and the UK, thus ensuring that this concession stays.
The President’s about turn to the IMF in recent times, after previously distancing himself from it, is a reflection of his malleability in the backdrop of a darkening horizon, should also be extended to the EU and the UK, vis-à-vis retaining GSP+.
A fiscal rule, ensuring that the budget deficit will not exceed five per cent in the near term should be implemented. This is in the backdrop that the IMF said that the fiscal deficit would remain elevated above nine per cent of GDP in the medium term, leaving fiscal financing gaps averaging five per cent of GDP to be filled every year.
A start has been made with the re-float of the exchange rate on 8 March and the raising of policy rates by one per cent each since 4 March. The challenge is to continue the “good” work by also addressing IMF’s above “concerns.”