COLOMBO: Sri Lanka’s has missed some structural benchmarks under outlined in a program with the International Monetary Fund for December, including processes for automatic market pricing of energy.
By December 2016 a price formula was to be introduced for pricing fuel which with no losses and a market to service debt, taken to cover past losses of Ceylon Petroleum Corporation.
Automatic pricing mechanisms were also to be introduced for electricity. In December the IMF concluded review of the program based on June targets, after a key tax hike on value added tax was brought to the parliament.
Improving revenues and cutting deficits to prevent the accumulation of future debt is a key goal of the program. Throughout 2016 the budget had improved, with no major salary hikes and better tax collections. The government should have also found a partner for SriLankan Airlines by December. So far there has been announcement on the matter.
Benchmarks can be missed and a review completed. In general targets called performance criteria are key which are not expected to be missed, though a request for an extension is possible on reasonable grounds.
The program also aims to re-build foreign reserves and keep inflation down. Inflation has been within targets. Though the central bank met the June 2016 net international reserve target, a September indicative target was missed by 426 million dollars, partly due to foreign investor sales in bonds.
In a revised program after the June review, forex reserve targets have been changed. Meanwhile the central bank has been told not to acquire forex through swaps and focus on outright purchases. In a November statement, the executive director and alternative executive director for Sri Lanka had already warned that the December reserve target was not easy.
“Our authorities are of the view that the developments in the external sector (especially in the government securities market) after signing of Letter of Intent had posed a significant risk of meeting the end December NIR target.” In late November the central bank also loosened monetary policy, buying Treasury bills outright and injecting long term liquidity, to push rates down, despite operating a loose peg with the US dollar.
A foreign reserve collection target (buying dollars) implies a peg, though the IMF has urged the rupee to be allowed to move when there are capital outflows. When rupees are printed and injected, import demand in excess of total inflows are generated when the money is loaned out to the economy by banks.
Outright purchase of Treasury bills – or even overnight liquidity to banks – pushes credit beyond deposits and can generate balance of payments pressure. With Treasury bills held by the banking system being recreated to money banks no longer have to seek real deposits to fund loans.
Meanwhile a key component of the domestic asset stock of the central bank shot up to 330 billion rupees from 219 billion rupees, which analysts say usually indicates a transfer of forex reserves to repay government debt.
Such reserve appropriations are standard practice under Sri Lanka’s monetary law. The central bank could potentially recover the dollars by selling down the Treasuries taken in return for the reserves and curbing domestic credit.
