Sri Lanka—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Colombo, Sri Lanka
April 1, 2002

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. The Sri Lankan authorities held discussions with Fund staff on the first and second reviews of the Stand-By Arrangement (SBA) between February 1-14, 2002. Based on these discussions, the attached updated Memorandum on Economic and Financial Policies (MEFP) discusses the revised macroeconomic framework for the government's economic program for 2002.

2. Sri Lanka's economic performance in 2001 has been severely affected by the adverse effects of the global economic slowdown and severe drought. Moreover, the political turmoil that occurred in the second half of 2001 hampered the previous government's ability to adopt appropriate corrective policies, and this together with the airport attack and the events of September 11 reduced market confidence and exacerbated the slowdown. Thus, although external and monetary policies were on track, macroeconomic performance was disappointing and the economy contracted for the first time since independence in 1948. Moreover, fiscal consolidation also did not take place as envisaged in the program partly due to external shocks.

3. Nevertheless, the new government of Sri Lanka is committed to taking corrective fiscal measures by passing a 2002 Budget, which seeks to stabilize the economy while initiating structural reforms that will enhance growth in the medium term. On this basis, the government requests the completion of the first and second reviews of the current SBA, and a waiver for the non-observance of the end-December performance criterion on net claims on government by the banking system and an extension of the SBA by two months.

4. The government will continue to provide the Fund with such information as the Fund may request in connection with Sri Lanka's progress in implementing policies and achieving the objectives of the program. We believe that the policies set out in the attached MEFP and the Technical Memorandum of Understanding (TMU) are adequate to achieve the objectives of the revised program. However, the government stands ready to take any additional measures appropriate for this purpose, and will consult with the Fund in accordance with the policies of the Fund on such consultations.

Sri Lanka

Supplementary Memorandum of Economic and
Financial Policies (MEFP) For The First and Second Reviews
Under the Stand-By Arrangement

I. Introduction

1. This Memorandum of Economic and Financial Policies (MEFP) reviews economic developments and policy implementation during 2001, updates the macroeconomic framework and discusses the stabilization policies and structural reform program for 2002. It supplements the MEFP and amends the TMU dated March 19, 2001.

II. Recent Economic Developments and Performance Under the Program

2. The economic program for 2001 has yielded positive results in terms of halting reserve losses and achieving external adjustment and financial stability. At end-December 2001, net international reserves (NIR) were over $250 million higher than at end-May 2001, despite shortfalls in external financing. The current account deficit narrowed because of a significant contraction of imports, which more than offset weaker exports. Having gained experience with the flexible exchange rate system, the Central Bank of Sri Lanka (CBSL) removed most of the precautionary measures that were enforced after the float and the exchange rate has stabilized.

3. The CBSL maintained a broadly prudent monetary stance in 2001, reducing interest rates cautiously. Nonetheless, real interest rates on loans remained significantly positive. Reserve money target was met comfortably—an adjusted actual of Rs 116 billion, compared with the end-December ceiling of Rs 120 billion.

4. However, macroeconomic performance was mixed. Real GDP is estimated to have fallen by 1¼ percent in 2001, compared with projected growth of 4¼ percent under the program. This reversal reflects weak external demand, severe drought, the July airport attack, and the events of September 11. Notwithstanding weak demand conditions, inflation was in the 9¾-10¾ percent range, compared with the original program projection of 8 percent, reflecting mainly higher food prices due to the drought.

5. The pace of fiscal consolidation was the weakest policy area during 2001. The revenue shortfall was in large part due to the severe economic slowdown. However, the political turmoil also precluded corrective policies. Moreover, in the run-up to the December parliamentary election additional outlays and tax cuts contributed to a further fiscal slippage. As a result, all the fiscal targets were missed at end-December 2001, including the performance criterion on net claims on government by the banking system for which we request a waiver. Progress on structural reform was also insufficient and administered price adjustments were delayed. As a result, there were major problems for Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB). All of these difficulties contributed to the delay in the first and second reviews that were originally planned to be completed by August and November 2001 respectively.

6. Thus, the economic challenge is immense. Nevertheless, following the December elections, the government has the mandate and is resolved to rejuvenate the economy, improve governance and encourage private sector led growth. We hope that our economic reform policies will help recover lost ground, and strengthen the foundations for the sustainable, and sharply increased, growth that is needed to advance Sri Lanka to become a medium-income country.

III. Macroeconomic Objectives and Policies for 2002

A. Overall Objectives and Revised Macroeconomic Framework

7. Against this background, the government's economic program for 2002 focuses on stabilization policies--in particular reserve accumulation and fiscal consolidation--while initiating a radical program of reform measures to tackle structural weaknesses. At the same time, the CBSL will continue to pursue an appropriately prudent monetary policy to lower inflation.

8. Consistent with these objectives, we have revised our macroeconomic framework for 2002. Real GDP is expected to recover in 2002 to about 3¾ percent, less-than-originally anticipated because the drought continues to affect adversely agricultural sector while prolonged power shortages will hinder the manufacturing sector, still weakened by subdued external and domestic demand. Inflation is targeted at 7-8 percent, slightly above the 5 percent in the original program, because of the need to further increase the administered price of several key items. The current account deficit is targeted at about $0.4 billion (2½ percent of GDP) in 2002, reflecting the continued impact of the global slowdown on exports (especially garments), and a rebound in imports. Gross official reserves should reach close to the original program target of 3 months of imports by end-2002, with a recovery in financing under the program.

B. Fiscal Policy

9. On March 22, 2002, the new government announced its first Budget, which focuses on stabilizing the economy, while taking substantial structural reforms to enhance medium-term fiscal sustainability and achieve high growth. Thus, the 2002 Budget aims at an overall fiscal deficit target of 8½ percent of GDP—over 2 percent of GDP less than last year—through tax reforms and targeted expenditure savings.

10. The budget measures are designed to increase revenue significantly in 2002 and to develop a sustainable resource envelope in the medium term. In this context, total revenue is expected to increase more than 1 percent of GDP and we have also announced a major simplification of the tax system and reform of tax administration.

• The main reform is the transformation of the current GST and NSL into a new VAT, with two rates, 20 percent, and 10 percent. The top rate includes all those goods currently liable for both GST and NSL, as well as most items only liable for GST. The lower rate applies mainly to essential goods and services currently subject to NSL. Petroleum products and water are taxed at the lower rate, as is consumption of electricity above 30 kwh. The Budget also announced that the retail sector would be brought under VAT during 2003, once the required legal steps have been completed.

• The income tax base has been broadened by phasing out special tax incentives. From the budget, all existing exemptions, including those granted under the Board of Investment (BOI) law will be included under the revised Inland Revenue Act, with the BOI focusing on investment promotion and facilitation. No new differential tax holidays will be granted. The corporate tax surcharge has been removed. In the medium term, as the tax base widens, the government intends to lower the corporate tax rate on all enterprises. In the Budget speech, the government has also noted that while government servant's salaries remain exempt from income tax, any income derived from other sources beyond the threshold continues to be liable to taxation.

• We also have introduced a 10 percent final withholding tax on deposit interest and dividends, and a 10 percent withholding tax on nonresidential rent; and will simplify the capital gains tax and abolish the Advance Corporate Tax (ACT) mechanism.

   

• To simplify the tax system, all stamp duties levied by the central government have been eliminated. To guard against revenue loss, we are introducing a bank debit tax of 0.1 percent on travelers checks and bills of exchange, credit cards, and debits of bank accounts for a temporary period. Further, to replace partly the lost stamp duty on imports, we have imposed a 1 percent levy on imports (a "ports and airports development levy"). From April 15, 2002, the temporary import duty surcharge will be halved, and the plan is to remove it from the beginning of 2003.

• The administrative function of the large taxpayer unit has been consolidated under a single commissioner. In line with IMF and AsDB recommendations, we will develop short and medium-term measures to strengthen the IRD's legal framework for tax administration, its organizational structure, and staffing arrangements, taxpayer services and enforcement procedures, and information technology. In the medium term, a modern revenue authority will be created by merging all of the tax administration bodies; the legal framework for this will be prepared in 2002. Under the new revenue authority, the customs regime for BOI and non-BOI enterprises will be harmonized.

11. Expenditure control is a key pillar of fiscal policy in the 2002 Budget. Expenditure is set to decline by 1 percent of GDP in 2002. The civil service wage bill will be kept under control by maintaining the current embargo on hiring, and granting no further wage increases; this applies to the central government, provincial councils, and public institutions. The controls on other recurrent expenditure will be maintained. Security-related spending will decline to 4 percent of GDP in 2002 from 5 percent in 2001, and we stand willing to undertake offsetting measures in the event of any unavoidable increases in such expenditure. We have appointed a monitoring committee to enhance accountability of security-related expenditure and ensure proper recording of all transactions and adherence to budgeted limits. We have also requested a fiscal ROSC from the IMF. To reduce the burden of subsidies and transfers on the budget, we are raising postal tariffs and will adjust other administered prices as necessary. To better target agricultural support, within a fixed allocation of Rs 2 billion, including fertilizer subsidy, a support grant for farmers inputs has been introduced. We have abolished the flour subsidy as of February 2002. We have proposed a major new initiative on youth training, while the Samurdhi social safety net scheme will be rationalized by ensuring better targeting. To ensure that out-goings are properly used, eligibility, exit criteria, and management procedures under the Samurdhi program will be specified by a new Welfare Benefit Law, to be enacted shortly, and tightly monitored. We also intend to achieve savings by closing a number of redundant public institutions. Within the overall capital budget, we have increased the allocation for foreign financed projects to $525 million. However, we have rationalized provisions for transfers to inefficient public corporations and institutions.

12. As part of our medium-term strategy, efforts will be made to reduce the wage and pension bill from 2003. Every department and agency will be required to rationalize their cadre significantly over the next three years, starting with the elimination of vacant positions, and to consolidate functions. For this year, the government has set aside Rs ½ billion to finance one-off expenses from this consolidation and rationalization of functions within government. The government has also initiated pension reform by moving towards a funded system for civil servants. All new public servants will contribute 8 percent of their salaries into a pension scheme, while the government will contribute 12 percent. Starting salaries will be adjusted accordingly.

13. To strengthen the framework for public debt management, the statutory limit on the net issuance of domestic public debt is being made comprehensive to encompass all types of government financing, including overdrafts from commercial banks. With the assistance of the IFIs, further significant reforms of debt management policies and functions are envisaged during the year.

C. Public Enterprises

14. The government is committed to improve the finances of public enterprise, and where applicable, corporatize them and bring in private sector expertise. As part of the 2002 Budget, we have initiated a major privatization program while accelerating private sector participation in other state-owned enterprises, which is in line with the new government's policies of encouraging market-based reforms.

15. The CEB is facing a financial crisis, linked to the continuing drought and past failures to invest sufficiently to meet domestic power demand. To address the immediate losses, the government has announced increases in electricity tariffs averaging about 35 percent, effective April 1, which is sufficient for cost recovery under normal operating conditions. Meanwhile, under the auspices of a new Board and its new Financial Restructuring Plan, steps are being taken to separate out and corporatize the distribution and generation business. Private sector participation is planned for all future power generation.

16. On December 29, 2001, we introduced the automatic petroleum pricing formula. The formula base pricing mechanism was published on February 22 with a revision in petroleum prices. The new mechanism also incorporates a strategy for reducing the existing debt buildup within a two-year period. More fundamentally, the plan is to restructure CPC, splitting out refining, and selling off the large fleet and filling stations in the course of 2002. In addition, the exposure of CPC to foreign exchange risk will be brought down by a reduction of foreign currency borrowing. CPC is now free to conduct foreign exchange business with any commercial bank, based on competitive market prices.

17. Other public sector entities to be restructured include the port (now a public limited company), railways, and the postal department. Meanwhile, the privatization program is being accelerated, with plans to divest shares in Sri Lanka Telecom and Sri Lanka Insurance Company, both to be well under preparation by mid-year—and the sale of shares in Shell Lanka, Lanka Marine, some plantations and the sugar company. Progress on this program is a structural benchmark for the final SBA review.

D. Exchange Rate and Monetary Policies

18. The exchange rate will remain freely floating—with the CBSL standing ready to intervene only in a limited manner in the foreign exchange market to maintain orderly market adjustment and without moral suasion. To strengthen the functioning of the interbank market, banks will participate as market makers in foreign exchange and the limits on foreign exchange positions will be gradually restored in line with banks' capacity to participate in the foreign exchange market and manage risk. With effect from March 1, we have relaxed the limits on commercial banks' net open positions from 10 percent to 15 percent of capital and reserves. In addition, the limit of six months for forward foreign exchange transactions has been removed.

19. Monetary policy will remain tight until fiscal consolidation can be credibly advanced. Reserve money will continue to be the nominal anchor and its growth in 2002 will be limited to about 12 percent, consistent with a broadly constant money multiplier.

20. On the conduct of monetary policy, progress has been made in enhancing the transparency and credibility of the CBSL's monetary policy framework and in improving the effectiveness of instruments. In this connection, the reserve money target and progress in meeting that target will be made public on the CBSL website. By mid-year, we are moving to use active open market operations, including the possible use of the interest rate corridor as the main tool to signal a change in monetary stance. Its setting would be evaluated on regular pre-disclosed basis and decisions announced to the public.

E. Other Structural Issues

21. As outlined in the 2002 Budget, we have presented a major structural reform agenda for Sri Lanka. We hope that such an agenda for the SBA would serve as a bridge to a PRGF arrangement later this year. In addition to the fiscal and public enterprise reforms outlined above, our structural reform strategy will focus on financial sector restructuring, labor market and trade issues. To this end, the 2002 Budget has laid out the foundations of these reforms, including necessary legislative changes. We are also preparing a growth and poverty reduction strategy in support of which we will request a PRGF arrangement later this year. To this end, we are making progress towards our document, Connecting to Growth: Sri Lanka's Poverty Reduction Strategy, which is expected to be discussed at the Development Forum and completed by June 2002.

• The government is considering the options for deepening state bank reform. The two state banks submitted business plans in September 2001. Options for more decisive reform of these institutions are being considered, along with evaluation of the major nonperforming loans and transactions with the government and state enterprises. By June of this year, action plans for all key areas of the two banks, with specified and measurable targets, will be submitted to the government. Furthermore, the government will put its banking relationships with the state banks at arm's length. The state banks will include an audited summary of transactions with the government in their annual reports.

• Labour market reform is being initiated with the introduction of strict time limits for the processing by the Labour Commissioner of dispute resolution, arbitration, and termination cases. These efforts to reduce delays will be linked to the establishment of a binding formula for compensation of terminated employees.

• We have announced the removal of the remaining limits on inward foreign direct investment, which are mainly in construction, financial, and utilities sectors, other than those maintained for national security. We understand this was a prior action for completion of the first and second reviews.

• In order to strengthen banking supervision, the CBSL plans to increase the capital requirements for commercial banks to 10 percent of risk-weighted assets by 2003.

• In order to improve the transparency of its financial reporting in its books, the CBSL is committed to implementing the recommendations of the Stage Two Safeguards Assessment Report. Specifically, we have completed the preparation of an IAS-compliant financial reporting template, restated FY 2000 financial statements in accordance with IAS and prepared IAS-compliant financial statements for FY 2001—prior actions for the current review of the SBA. We have appointed an audit firm to conduct the financial audit of the CBSL for financial year 2001, and we understand that this was also a prior action for the current SBA review. The review of the high-level internal control systems at the CBSL, the development of a formal risk management process, the adoption of a new internal audit charter by the Monetary Board, and the external review of the Management and Audit Department will be completed by September 2002.

F. External Financing

22. The policies described above and our commitment to the Stand-By Arrangement will help to galvanize external financing for our economic program.

23. Following the successful placements of Sri Lanka Development Bonds, which yielded about $160 million, the government plans to mobilize further private sector financing in 2002. However, as part of prudent debt management we would continue to limit our nonconcessional and domestic foreign-currency denominated borrowing.

24. The government understands that in order for the current reviews to be completed, satisfactory assurances will have to be received from both the World Bank and the AsDB that their PSD loans are on track for disbursements in 2002. A project for SME development, which includes program financing amounting to $20 million, was approved by the AsDB in December, 2001, while the second tranche ($25 million) of the AsDB's private sector development loan (PSD) is expected in June 2002. Disbursement of the World Bank PSD credit is now expected later in 2002, with the first appraisal expected to take place in June.

25. The proceeds from our privatization program discussed in paragraph 17 will also contribute significantly to the financing of the Budget. To this end, the program is fully financed and the new government's privatization and asset sale agenda would help limit financing of the budget through debt creating flows.

IV. Medium-term Outlook

26. Consistent with the program set out above, the current medium-term framework envisages annual growth of real GDP increasing to at least 6½ percent, with inflation moderating to below 5 percent, the external current account deficit declining to below 3 percent of GDP, and the overall fiscal deficit to below 5 percent of GDP by 2005. The external current account deficit will be financed principally by private capital inflows, and official reserves could be brought back to an appropriate level (4 months of import cover). Government spending will be in line with the overall objectives set out in the PRSP; transfers to public corporations will be gradually eliminated. Domestic financing will be reduced, including from nonbank sources, to enable development of the domestic capital market.

27. If the ongoing efforts of the government are successful in establishing a lasting solution to the civil conflict, we would expect to initiate a much more ambitious public capital expenditure program, principally financed by donors focusing on rehabilitating the North and East, and on health, education, and other infrastructure. As a result, under this scenario, the overall fiscal deficit would be higher, but not domestic budgetary financing. Private sector participation would also be key to this drive to generate employment and lower poverty across the whole nation.

V. Program Monitoring

28. We request that the current Stand-By Arrangement be extended by two months to allow for completion of the final review. Currently the SBA would expire on June 19, 2002.

29. In order to strengthen monitoring of the fiscal program, net domestic financing of the budget would become a performance criterion and net credit to government from the banking system would be amended to an indicative target. During 2002, some progress was made on improving the expenditure control system, but we have also taken steps to strengthen it further. To this end, the newly appointed monitoring committee on security-related spending will ensure accountability of defense spending and ensure that procurement is properly authorized and all transactions are recorded within the Budget.

30. The government is aware that the final purchase under the SBA would be conditioned on the observance of end-April, 2002 performance criteria and completion of the final review. Performance criteria, indicative targets, and precise definitions of quantitative variables monitored under the program are set out in the attached updated Technical Memorandum of Understanding. The standard clauses on overdue financial obligations to the Fund, accumulation of external payments arrears, exchange restrictions, multiple currency practices, bilateral payments agreements inconsistent with Article VIII, and import restrictions for balance of payments purposes are also applicable as performance criteria. We also understand that prior actions for the reviews would have to be implemented at least five days before the Board meeting.

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Sri Lanka

Technical Memorandum of Understanding
on the Program Supported by Stand-By Arrangement

April 1, 2002

1. This memorandum sets out the understandings between the Sri Lankan authorities and the Fund relating to the monitoring of the program for 2002 supported by the Stand-By Arrangement. It specifies the quantitative performance criteria and indicative targets, and the content and frequency of the data to be provided for monitoring the financial program.

I. Fiscal Targets

A. Performance Criterion on Net Domestic Financing of the Central Government Budget
		Ceiling (In billions of rupees)
Flows of net domestic financing at the end of:
	September 31, 2001-December 31, 2001 (indicative)	41
Flows of net domestic financing at the end of:
	January 1, 2002-April 30, 2002 (performance criterion)	40

2. For the purpose of program monitoring, the flow of net domestic financing (NDF) of the central government budget would be the sum of the net receipts (in book value terms) of the following government debt instruments (a) Rupee securities, (b) Treasury Bills, (c) Treasury Bonds, (d) Treasury Certificates of Deposits, (e) Other rupee-denominated government paper (f) Provisional advances from the CBSL, (g) and the net change in the stock of debt of other instruments-which consist of overdraft, import bills, syndicated loans with People's Bank and Bank of Ceylon and loans with the foreign currency banking units (FCBUs) of People's Bank and Bank of Ceylon less government deposits with the CBSL, People's Bank, and Bank of Ceylon. The reporting requirement for NDF appears in Table 6. The data on the instruments (a) through (e) will be provided by the public debt office and data on (f) and (g) will be based on the balance sheet data of CBSL, People's Bank, and Bank of Ceylon as provided by the CBSL. For program purposes, from January 1, 2002, foreign-currency denominated bonds issued by the government and held by domestic residents will be excluded from net domestic financing.

The following adjustments will apply:

3. The ceiling on net domestic financing will be adjusted downwards by the full amount of excess rupee equivalent of privatization receipts and upward by shortfall of rupee amount of privatization up to limits as set out in Table 1; adjusted upward/downward by the shortfall/excess of rupee equivalent of foreign program assistance as set out in Table 2 (memorandum item). However, the upward adjustment for shortfalls in foreign program financing will be limited to a maximum of $10 million end-April 2002 as described in Section III below using program exchange rate in Table 4. Moreover, foreign program financing that increases NIR of the Central Bank of Sri Lanka (CBSL) but does not affect net credit to government (NCG) from the banking system and net domestic financing (NDF) of the budget (such as the DST's Yen Revolving balance), would be excluded from foreign program financing when determining the adjuster for both NCG and NDF.

4. The ceiling will be adjusted downwards by the full amount of any privatization receipts from residents in rupee equivalent amount using the program exchange rates if receipts are in foreign currency. The same adjusters on changes in net domestic financing of central government will also apply to the indicative target on net claims on government in Table D below.

B. Indicative Target on the Primary Fiscal Balance
		Ceiling (In billions of rupees)
Cumulative balance from January 1, 2001 to:
	December 31, 2001 (indicative target)	-32
	(actual)	-58
Cumulative balance from January 1, 2002 to:
	April 30, 2002 (indicative target)	-10

5. Government primary fiscal balance is defined as the overall central government fiscal deficit minus interest payments and the ceiling on government primary balance will be monitored according to this definition. For monitoring purposes, primary fiscal balance excludes grants and privatization receipts. The ceiling on government primary balance is cumulative from the start of the fiscal year. However, the government's primary balance should also broadly equal the sum of net foreign financing (including grants), net bank financing, and nonbank financing and privatization proceeds as recorded by the Public Debt Department and Economic Research Department, Central Bank of Sri Lanka, minus interest payments. For program purposes, interest payments in the Budget will include interest payments on all government debt (including overdraft).

C. Indicative Target on the Central Government Revenue
		Floor (In billions of rupees)
Cumulative balance from January 1, 2001 to:
	December 31, 2001 (indicative target)	258
	(actual)	231
Cumulative balance from January 1, 2002 to:
	April 30, 2002 (indicative target)	83

6. Central government revenue is defined as the central government revenue as reported in the treasury accounts (economic classification), and excludes foreign grants and privatization receipts. The floor on central government revenue is cumulative from the start of the fiscal year.

D. Indicative Target on Net Claims on the Government by the Banking System
		Ceiling (In billions of rupees)
Outstanding stock as of :
	December 31, 2001 (performance criterion)	133
	(actual)	201
	April 30, 2002 (indicative target)	208

7. Net claims on government by the banking system is defined as the difference between banks' claims on government, the deposits of government, and the central and provincial governments with the banking system. The ceiling on net claims on government is cumulative from the start of the fiscal year. The adjusters to net domestic financing will also apply to the indicative target net claims on government. In addition, the foreign currency denominated debt component of net claims on government (with the exception of foreign currency-denominated bonds) will be converted to rupees at the programmed exchange rate in Table 4. For program purposes, from January 1, 2002, foreign-currency denominated bonds issued by the government and held by resident banks will be excluded from net claims on government as reported in the monetary survey.

E. Indicative Target on Credit to Public Corporations by the Banking System
		Ceiling (In billions of rupees)
Outstanding stock as of :
	December 31, 2001 (indicative target)	32
	(actual)	41
	April 30, 2002 (indicative target)	41

8. Credit to public corporations by the banking system is defined as credit of the banking system to public corporations. It comprises both credit from deposit banking units and from foreign currency banking units. The foreign currency denominated debt component of credit to public corporations will be converted to rupees at the programmed exchange rate in Table 4. The list of public corporations refers to those companies that are currently classified as public corporations under the CBSL's classification in the monetary survey (Table 3).

II. Monetary Targets

A. Performance Criterion on Net Domestic Assets of the CBSL
		Ceiling (In billions of rupees)
Outstanding stock as of :
	December 31, 2001 (performance criterion)	12
	(actual)	25
	April 30, 2002 (performance criterion)	32

9. Net domestic assets of the CBSL is defined as the difference between reserve money and net foreign assets of the CBSL valued in rupee. Reserve money is defined below in Section II.B. Net foreign assets of the CBSL are the net claims on nonresidents, in all currency denominations and government (net). For program monitoring purposes, net foreign assets will be calculated using the exchange rate given in Table 4.

The following adjustments will apply:

10. The NDA ceiling is based on a baseline path of NFA that excludes reserve losses on forwards (III.A). The NDA ceiling will be adjusted downwards by the full amount of excess rupee equivalent of privatization receipts and upwards by shortfall of rupee amount of privatization up to quarterly limits as set out in Table 1; adjusted upward/downward by the shortfall/excess of rupee equivalent of foreign program assistance as set out in Table 2 using the program exchange rate in Table 4. However, the upward adjustment for shortfalls in foreign program financing will be limited to a maximum of $10 million end-April 2002 as described in Section III below using program exchange rate in Table 4. Foreign program financing is as defined in subsection III(A) below. The NDA ceiling will also be adjusted for DST's Yen Revolving balance that are kept abroad and thus affect NIR but does not affect NDA of the CBSL.

11. The NDA ceiling will be adjusted downward by the full amount of any privatization receipts from residents in rupee equivalent amount using the program exchange rates if receipts are in foreign currency.

12. Changes in required reserve regulations will modify the NDA ceiling according to the formula:

NDA = r B₀ + r₀ B + r B

where r₀ denotes the reserve requirement ratio prior to any change; B₀ denotes the programmed reserve money base in the period prior to any change;  r is the change in the reserve requirement ratio; and  B denotes the immediate change in the reservable base as a result of changes in its definition.

B. Indicative Target on Reserve Money of the CBSL
		Ceiling (In billions of rupees)
Outstanding stock as of :
	December 31, 2001 (indicative target)	120
	(actual)	113
	April 30, 2002 (indicative target)	119

13. Reserve money of the CBSL consists of currency in circulation (with banks and with the rest of the public), and financial institutions' deposits at the CBSL, and government agencies deposits (as defined in CBSL's balance sheet in Table 5). As of end-December 2000, reserve money defined in this manner stood at Rs 105 billion (including government agencies deposits which were less than Rs 50 million).

14. The ceiling on reserve money will be adjusted for changes in reserve regulations in line with the adjustment generated to the NDA limit.

III. External Sector Targets

A. Performance Criterion on Net International Reserves of the CBSL
		Floor (In millions of U.S. dollars)
Outstanding stock as of :
	December 31, 2001 (performance criterion)	1,195
	(actual)	970
	April 30, 2002 (performance criterion)	983

15. For the purpose of monitoring the current SBA, net international reserves of the CBSL is defined as the difference between its gross foreign assets and liabilities, both expressed in historical costs. Gross foreign assets of the CBSL consists of (i) gold, foreign exchange balances held outside Sri Lanka, foreign securities (valued in market prices), foreign bills purchased and discounted, net IMF position and SDR holdings, Crown Agent's credit balance, DSTs' Special Dollar and Yen Revolving balance and (ii) the net forward position, if any, of the CBSL, defined as the difference between the face value of foreign currency denominated CBSL off-balance sheet claims on nonresidents and foreign currency obligations to both residents and nonresidents. All non-dollar denominated reserve balances will be converted into U.S. dollars at programmed exchange rates specified in Table 4 below to reflect valuation adjustment. Excluded from gross foreign assets will be participation in international financial institutions, holdings of nonconvertible currencies, holdings of precious metals other than gold, and claims on residents (e.g., statutory reserves on foreign deposits of commercial banks) pledged, collateralized or otherwise encumbered assets (such as the government's war risk insurance deposit with Lloyds), claims in foreign exchange arising from derivative transactions (such as futures, forwards, swaps and options). Gross foreign liabilities are all foreign currency denominated liabilities of contracted maturity up to one year, the use of Fund credit, and Asian Clearing Union debit balance.

The following adjustments will apply:

16. The NIR floor will be adjusted upward by the full amount of excess privatization receipts and downward by shortfall in privatization receipts up to quarterly limits as set out in Table 1; adjusted downward/upward by the shortfall/excess of foreign program financing as set out in Table 2 but the downward adjustment for shortfalls in foreign program financing will be limited to a maximum of $10 million at end-April 2002. Foreign program financing is defined to include balance of payments support, including adjustment loans from multilateral creditors other than the Fund, balance of payments support from bilateral creditors, loans from private creditors (including commercial banks) and rescheduling of medium- and long-term public and publicly-guaranteed debt. Thus, foreign program financing as defined above, is expected to augment CBSL's reserves without an immediate expected corresponding payment outflow. For program purposes, from January 1, 2002, foreign-currency denominated bonds issued by the government and held by domestic residents will be treated as foreign program financing.

B. Performance Criterion on New Nonconcessional External Debt
		Ceiling (In millions of U.S. dollars)
Cumulative balance from January 1, 2001 to:
	December 31, 2001 (performance criterion)	400
	(actual)	127
	April 30, 2002 (performance criterion)	400

17. Contracting or guaranteeing of new medium- and long-term nonconcessional external debt is defined as contracting or guaranteeing new nonconcessional external debt by the public sector (all central and provincial government ministries and departments, public corporations and institutions, and the CBSL) with an original maturity of more than one year. From January 1, 2002, this debt will include foreign currency denominated bonds contracted with residents. Nonconcessional debt is defined as borrowing containing a grant element of less than 35 percent on the basis of currency-specific discount rates based on the OECD commercial interest reference rates. This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000) but also to commitments contracted or guaranteed for which value has not been received. Excluded from this performance criterion are credits extended by the IMF and from the program financing assistance envisaged under the program, including from IBRD and AsDB, and other bilateral creditors as specified in Table 2. Debt contracted with the private sector as part of the program financing assistance will also be subject to this ceiling. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time of the contract is entered into, or guarantee issued.

C. Performance Criterion on Stock of Short-Term External Debt
		Ceiling (In millions of U.S. dollars)
	December 31, 2001 (performance criterion)	150
	(actual)	3
	April 30, 2002 (performance criterion)	150

18. Stock of short-term external debt outstanding is defined for debt with original maturity of up to one year owed or guaranteed by the public sector (as defined above). The term debt is defined as set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000), but excludes normal import-related credits, forward contracts, swaps, other future market contracts, and short-term liabilities of the banking system. The ceilings also apply to debt instruments with put options that would be triggered within one year after the contracting date. From January 1, 2002, short-term debt will also include short-term foreign currency denominated bonds contracted with residents.

IV. Data Reporting Requirements

19. For the purpose of monitoring the fiscal performance under the program, data will be provided in the format as shown in Table 7 and 8:

20. For the purpose of external sector performance under the program, data will be provided in the format as shown in Table 9 and 10.

21. All the program monitoring data would be provided by the Ministry of Finance and the Central Bank of Sri Lanka (CBSL). The data on net domestic financing will be reported to Fund both in terms of net receipts of domestic financing (as in I. A above) and the stock of net domestic debt (as earlier reported). Data on gross foreign assets and gross foreign liabilities would be provided both at historical costs and market prices. All the data relating to the above programmed targets will be furnished within six weeks after the end of each month. For the primary balance, preliminary estimates will be available within six weeks and firmer estimates after 10 weeks.

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