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'Higher wages may push inflation'

An IMF staff mission led by Todd Schneider commended the measures taken by the Government to create a conducive environment for economic growth, good governance and transparency.

"We welcome the Government’s commitment to good governance, increased transparency and financial discipline," they said. The mission and the authorities agreed that medium term fiscal consolidation should remain a linchpin in macroeconomic policy, ensuring a durable reduction in Sri Lanka’s public debt, Schneider said.

“Real GDP growth is estimated at 7.4 percent for 2014 and will continue in the relatively robust range of 6-7 percent in 2015. Inflation will remain in the low single digit range, although some upward pressure may emerge as higher wages and salaries translate into increased demand," he said.

The external current account improved in 2014 and will strengthen further in 2015 given lower oil prices and further growth in exports, service trade and inward remittances. The mission agreed with the authorities that prospects remain favourable and that sustaining robust growth over the medium term will need continued commitment to policies in support of macroeconomic stability and structural reforms to enhance productivity and competitiveness, Schneider said.

The IMF staff mission was in the country from February 23 to March 4 to conduct post-program monitoring discussions. The mission met Government and Central Bank officials and civil society and private sector representatives. This form of enhanced surveillance is a routine practice in countries which have had ‘exceptional access’ to IMF resources as is the case for Sri Lanka, which successfully completed a US $ 2.6 billion IMF program in 2012.

The outstanding balance stands at 1.2 billion and the repayment is expected to run up to 2018.

The mission also highlighted a number of concerns with respect to the interim Budget. In the mission’s assessment, achieving a deficit of 4.4 percent of GDP will be a challenge and the authorities should consider contingency measures should revenue fail to materialise as projected.

The one-off tax measures introduced to finance the interim Budget do not, in the mission’s view, constitute a step towards a more effective tax system.

The mission and the authorities agreed on the need for more comprehensive reforms to streamline the tax system and reduce or eliminate exceptions to put revenue on a steady upward path.

Future technical assistance from the IMF will focus on these areas. A succession of steps to ease monetary policy over 2013-14 helped facilitate a recovery of private sector credit late in 2014 and early this year.

The current stance of monetary policy appears appropriate, but the Central Bank should monitor credit, inflation and liquidity development closely in the coming months.

The mission said there has been a decline in Central Bank foreign exchange reserves over the past six months.

"We highlighted the need to preserve Sri Lanka’s cushion of foreign exchange reserves and in this context emphasised the need for exchange rate flexibility. Intervention should be limited to dealing with excessive short-term volatility. The exchange rate does not appear out of line with fundamentals, particularly given the projected improvement in the balance of payments," he said.

A discussion on post-program monitoring by the IMF’s Executive Board is expected in April.

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