Press Release No. 09/266

Press Release: IMF Executive Board Approves US$2.6 Billion Stand-By Arrangement for Sri Lanka

July 24, 2009

The Executive Board of the International Monetary Fund (IMF) today approved a 20-month Stand-By Arrangement for Sri Lanka in an amount equivalent to SDR 1.65 billion (about US$2.6 billion) to support the country's economic reform program.

Upon the Executive Board’s approval, an amount equivalent to SDR 206.7 million (about US$322.2 million) becomes immediately available to Sri Lanka. The remaining amount will be phased in, subject to quarterly reviews. The total amount of IMF resources made available under the arrangement equals 400 percent of the country’s quota.

The key objectives of the authorities’ economic reform program supported by the Fund are to strengthen the country’s fiscal position while ensuring the availability of resources for much needed post-conflict reconstruction and relief efforts. The program is also intended to rebuild international reserves and strengthen Sri Lanka’s domestic financial system, and to protect the most vulnerable in the country from the burden of the needed economic adjustment. The program aims to lay a strong macroeconomic foundation that will help the authorities approach the broader international community for financial support in post-conflict reconstruction.

Following the Executive Board discussion on Sri Lanka, Mr. Takatoshi Kato, Deputy Managing Director and Acting Chairman, stated:

“The global financial crisis has had a significant impact on Sri Lanka’s economy. Persistently high budget deficits forced the government to rely on short-term financing from international markets. The global shock resulted in a sudden stop to this financing. Capital outflows and intervention by the central bank to prevent the exchange rate from depreciating—exacerbated by a decline in demand for Sri Lanka’s exports—resulted in a significant loss of international reserves which, despite the recent rebound in capital inflows, remain very low.

“The government’s ambitious program, supported by the IMF, intends to restore fiscal and external viability and address the significant reconstruction needs of the conflict-affected areas, thereby laying the basis for future higher economic growth.

“Reducing the central government fiscal deficit, while preserving spending on health and education and protecting the most vulnerable in society from the economic downturn, is a central goal of the government’s program. To that end, the authorities have put in place revenue enhancing measures and intend to introduce reforms to reduce tax exemptions and broaden the tax base beginning in the 2010 budget. This, together with savings on military spending and possible concessional donor financing, should help finance the considerable reconstruction spending needs.

“The program aims to rebuild reserves to prudent levels while allowing the flexibility in the exchange rate necessary to boost the competitiveness of Sri Lanka’s exports. At the same time, the central bank’s policies will aim to control inflation while ensuring adequate credit to the private sector.

“The government has also moved quickly to address vulnerabilities in the banking system, implementing a plan to recapitalize the troubled Seylan Bank. The government intends to develop a contingency plan to deal with potential stresses in the financial system and put in place measures to improve regulation and address financial sector supervisory gaps.

“The government’s program will require difficult economic reform measures. Nevertheless, the government should take advantage of the opportunity created by the end of the conflict to ensure national reconciliation, restore macroeconomic stability, and promote strong and durable growth,” Mr. Kato said.

ANNEX

Recent Economic Developments

Sri Lanka has been hit hard by the global economic and financial crisis. After years of reliance on short-term financing from international markets to cover its fiscal deficit, Sri Lanka experienced a sudden stop of international capital flows as the global crisis hit. The central bank’s initial efforts to keep the exchange rate from depreciating led to a significant loss of reserves. Despite a rebound in short-term capital inflows following the end of the conflict, reserves remain low and foreign exchange needs remain acute. The economic growth outlook has deteriorated with growth of around 3 percent expected this year compared to 6 percent in 2008. The financial sector has also been put under increasing stress as the economic slowdown takes its toll.

The end of the conflict further added policy challenges to the authorities. The reconstruction and humanitarian relief efforts are a large undertaking. Significant spending priorities need to be met while debt sustainability is maintained.

Program Summary

Against this background, the Sri Lankan authorities have embarked on a program of economic reform and post-conflict reconstruction. They have requested IMF financial assistance to support their efforts.

The program includes the following key elements:

• Fiscal policy: The program aims at reducing the central government budget deficit to 5 percent of GDP by 2011, from a target of 7 percent of GDP this year, in line with the Fiscal Responsibility Act. Revenue increasing measures include broadening the tax base, reducing tax exemptions and improving enforcement, which are coupled with measures to rationalize expenditures. Cuts in military and other expenditures will help make room for post-conflict reconstruction and relief spendings.

• Exchange rate and monetary policy: The program envisions strengthening the country’s international reserve position and restoring external viability. Allowing greater exchange rate flexibility is also needed to facilitate external adjustment and ensure export competitiveness.

• Social protection: With 15 percent of the population living below the poverty line and a large number of people in the North and East of the country displaced by the conflict, the program envisions protecting expenditures on social transfers to the country’s most vulnerable. Spending on post-conflict humanitarian assistance will be also secured through savings from spending cuts and external financing and grants from multilateral institutions and the donor community.

• Financial system: To build confidence in the local financial system, the program includes measures to strengthen the banking system by improving the current regulatory framework and enhancing bank supervision.

Sri Lanka, which joined the Fund on August 29, 1950, has a quota of SDR 413.4 million (about US$644.4 million).