New fiscal policy will boost economy - Koshi Mathai

The new policy regimen introduced in February with the tightening of the monetory policy and the devaluation of the rupee and the resulting volatility will affect the people en masse. But the underlying strength of the economy has been boosted and it is important to maintain sustainable growth, said IMF residential representative in Sri Lanka Koshi Mathai.

The IMF backs tight monetary policy to support the exchange rate and to strengthen external reserves. We are positive over medium-term sustainability of the economy as decisions have been taken in the right direction. Reserve money is not the main focus, it is a technical matter in our Technical MoU and not a substantial issue. Our focus is on continuously declining reserve levels and it is declining at an average of $ 500m a month, Mathai told the media in Colombo last week.

This year's economic growth will be below the anticipated eight percent but a figure cannot be predicted. Inflation will increase but will remain at single digit level. A sustainable seven percent growth rate is our concern. The Sri Lankan economy is not overheating as there is no higher inflation, wage pressure or property price increase. Credit is growing fast and the property market will pick up but not reach East Asian levels. As far as the exchange rate is concerned it will stabilise and the focus is on reserve money. The impact of new policies introduced in February will be seen with time. The important thing is flexibility of the Government's policies. We can pull back some policies if they are not working, he said.

In a press release issued by the IMF on the Executive Board's discussion on Sri Lanka, Deputy Managing Director IMF, Min Zhu, said that strong economic recovery continued in 2011, and inflation remained subdued, a combination of rapid credit growth and a tightly managed exchange rate caused the external current account deficit to widen and external reserves to fall sharply. As a result of higher oil prices, the state energy enterprises also continued to run significant losses.

Commenting on the new policy regimen Min Zhu said that authorities have recently introduced a broad package of measures to rein in the current account deficit, stem the reserve loss and bolster fiscal performance.

The Monetary and credit policy has been tightened, petroleum and electricity prices have been increased, petroleum taxes have been raised, and the rupee trading band abolished to allow the exchange rate to adjust more flexibly. The authorities are taking steps to mitigate the adverse impact on the most vulnerable issues. Fiscal policy will also continue on a consolidation path, with the 2012 Budget targeting a reduction in the deficit to 6.2 percent of GDP.“The authorities intend to use the forthcoming FSAP update to strengthen the financial system further. Continued structural reforms to place state-owned energy enterprises on a financially sound footing will reduce demands on the Budget.

The adjustment measures implemented by the authorities have placed the economy on a more sustainable trajectory.

However, it will take time for the new monetary and exchange rate regimen to be established, and the authorities will need to stand ready to adjust policies further to stabilise external reserves, especially if the global environment becomes less favourable,” he said.

Commenting on the tightly managed exchange rate policy maintained by the Central Bank up to February, Mathai said that it was not wrong. However, it takes time to materialise capital flow from abroad and it was difficult to mobilise capital flow. As a result reserves started to decline. However, very substantial corrective actions has been taken and the current account deficit will reduce and the December target of reserve money will be met, he said.

After completion of the seventh review of Sri Lanka's economic performance under a SBA program, the IMF has offered SDR 275.6 m (about $ 426.8 m) for immediate disbursement. This brings total disbursements under the arrangement to SDR 1.378 b (about $ 2.13 billion).

In addition, the Executive Board has approved an extension of the arrangement period to July 23, 2012, to allow time for the completion of the eighth and final review.

Mathai said that the interest rate of the IMF SBA facility is LIBOR plus 1.1 percent/ annum interest for up to $ 2 b and 2 percent surcharge will be added on the amount above $ 2 b. Accordingly, 3.1 percent interest will be charged on the excess amount.

Responding to questions raised by journalists Mathai said that the IMF did not discuss the tax on vehicle imports. However, we are happy that the Government is using all tools to address the BOP issue. Tax on goods is not always good. But vehicle imports is one of the reasons to increase BOP. Tax increase on selective items on a non discriminative basis can be acceptable to address some burning issues. Generally, the Government's tax policy has been consistent in the last few years and the business community is happy about it. The Government has implemented various measures to achieve revenue targets, he said.

He said that there are no hidden conditions attached with the IMF loan. IMF agreements with all countries are transparent and are on the web in black and white. Reserve position at $ 6 b is not bad but we are concerned over the rate of decline.

This $400 b will be helpful to the Government but it will not change the entire set up. What is important is where the economy is heading and whether it is in the right direction.

Rainfall and the oil price increase the main reason that led to this situation. Rainfall in 2011 was a mix, heavy rain in the first part of last year and drought in the latter part. This led to a shift from hydro electricity to costly thermal consumption. Oil prices increased from $75/barrel to $120. The IMF is concerned over ensuring the welfare of vulnerable groups. Kerosene coupons for Samurdhi beneficiaries is one measure the Government has taken. However, the Government cannot subsidise fuel for middle and upper income groups.

It would affect the economy as the Government will then have to print money which will lead to an increase in inflation or increase interest rates which will affect growth. Passing the cost to the consumer is the only way and this is the practice that all Governments are following.

Last year, Sri Lanka's exports had grown by 20 percent despite slow growth in the main markets the US and the EU. Slow growth will prevail in these markets and it is important to find new markets and reduce vulnerability, Mathai said.

-GW