As Sri Lanka inches towards its presidential elections, the economic road ahead remains a fragile journey marked by potential shifts in policy and deep-seated financial challenges. The International Monetary Fund (IMF) has been a pivotal player in this narrative, recently completing its 2024 Article IV Consultation and Second Review under the 48-month Extended Fund Facility (EFF) with Sri Lanka.

This review resulted in an immediate disbursement of $336 million, bringing total IMF financial assistance to approximately $1 billion. The latest IMF briefing offered critical insights into the recovery efforts, the looming elections, and the contentious debate over potential tax cuts before and after polls to attract votes.

Senior Mission Chief for Sri Lanka, Peter Breuer underscored the IMF’s commitment to respecting the democratic process. “The timing of our mission will adapt to fit the electoral schedule”. Breuer’s statement comes amid discussions about potential tax cuts as a strategy to win votes.

While the IMF remains open to considering different approaches within the economic recovery programme, Breuer stressed the necessity of any tax adjustments being both realistic and achievable. “The reduction in government revenues had contributed to this very severe crisis in Sri Lanka. Historical data showed a significant decline in government revenue from around 20% of GDP in the 1980s to 8% in 2022.

The programme aims to rebuild revenue to around 15% of GDP by 2025 to support essential government services and stabilize public finances,” Breuer stated. The core objective should remain to stabilize public finances without compromising the economic recovery process.

Vulnerable Recovery

Significant strides have been made since the EFF programme’s inception. Breuer highlighted a modest economic recovery, with real GDP growth of 3% year-on-year in the second half of 2023, a drastic reduction in inflation to 0.9% by May 2024, and a rise in gross international reserves to $5.5 billion by April 2024. Improved tax revenue collection, now at 9.8% of GDP, has contributed to a primary budget surplus.

Yet, despite these positive indicators, Breuer issued a cautionary note about ongoing vulnerabilities. “Important vulnerabilities associated with ongoing debt restructuring, revenue mobilization, reserve accumulation, and banks’ ability to support the economic recovery continue to cloud the outlook,” he warned.

The transition from economic stabilization to full recovery necessitates sustained reform efforts, particularly in revenue mobilization, debt restructuring finalization, and protection of social and capital spending to restore fiscal sustainability.

Delays in finalizing Memorandums of Understanding (MOUs) with official creditors and agreements with the Export-Import Bank of China have also been points of concern. However, Breuer expressed optimism that these procedural hurdles are close to resolution, which is crucial for restoring debt sustainability and ensuring long-term economic stability.

Structural Reforms and Governance

The IMF’s review also spotlighted critical structural reforms in sectors such as state-owned enterprises (SOEs), labour markets, and trade liberalization. Deputy Mission Chief Katsiaryna Svirydzenka highlighted ongoing SOE reforms aimed at financial viability and efficiency.

“What we are supporting under the IMF programme is cost recovery for fuel and electricity,” she explained. These measures are part of broader efforts to improve governance and transparency, supported by the World Bank and the Asian Development Bank.

The briefing also addressed the progress of the Governance Diagnostic Report, a pioneering effort in Asia. Sarwat Jahan, Resident Representative in Sri Lanka, noted that while some structural benchmarks, such as the publication of the government action plan and the semi-annual disclosure of public procurement contracts, have been met, others, like the comprehensive asset recovery law, have been delayed. “We have reprogrammed this structural benchmark with a new target date of end-November 2024,” Jahan stated.

Jahan elaborated on new structural benchmarks aimed at addressing governance vulnerabilities and enhancing anti-corruption measures in tax-collecting agencies. “Our new structural benchmark is to develop an implementation plan in each revenue department to launch a programme of anti-corruption measures to strengthen the code of conduct, risk management, and automation,” she explained, with an August deadline for implementation.

Social Protection

Social protection remains a cornerstone of the IMF’s programme, especially in shielding vulnerable populations from the economic fallout. Breuer highlighted the drastic reduction in inflation from 70% to 0.9% as a key achievement in mitigating the impact on the poor. “Bringing down inflation to these low single-digit levels was crucial to ensure that the poor are not being further punished by high inflation,” he said.

Other measures include maintaining a minimum spending floor on social protection and improving the efficiency of cash transfer programmes. Addressing administrative challenges in cash transfers, Jahan noted that efforts are underway to overcome bottlenecks and ensure smooth provision to those in need. “We have strongly encouraged the authorities to address these issues so that cash transfers can be smoothly provided. The data validation for about 450,000 applicants is underway,” she remarked.

The Road Ahead

As Sri Lanka gears up for elections, the IMF’s message is clear: realistic and achievable reforms are essential for continued economic stability. Breuer and his colleagues expressed cautious optimism about the progress made so far but warned against complacency. “

Sri Lanka has made good progress in terms of getting the recovery going, but the country really isn’t out of the woods yet,” Breuer concluded. 

Meanwhile, the Ceylon Chamber of Commerce issuing a statement on the review completion noted on the prevailing vulnerabilities and uncertainties in light of the ongoing debt restructuring and the upcoming elections. “We highlight the importance of collective action, urging Sri Lankan citizens to take ownership of the reform agenda. Collective action is vital to navigate the country’s financial challenges and set Sri Lanka back on a growth path,” the Chamber said.

The coming months will be crucial in determining whether Sri Lanka can maintain its delicate balance between political changes and economic recovery, with the  IMF programme remaining a critical component of this challenging journey.