ECONOMYNEXT – Sri Lankan President Ranil Wickremesinghe has met the visiting International Monetary Fund team for a round of talks as the country tries to hammer out a staff-level deal with a credible economic program to negotiate with creditors to restructure their debt.
Principal Head of Mission Peter Breuer who is an expert in debt restructuring, Head of Mission in Sri Lanka Masahiro Nozaki, Resident Representative Tubagus Feridhanusetyawan met with President Wickremesinghe who is also Minister of Finance on August 25.
The cabinet of ministers on Monday approved a budget framework in which the 9.9% gross domestic product budget deficit in 2022 will be reduced to 6.9% by 2023.
Sri Lanka also aims to reduce the primary deficit, or deficit without interest charges, a key performance criterion in an IMF fiscal framework, from a 4% deficit in 2022 to a 1% deficit in 2023 with a correction of 3% of GDP. .
Related Sri Lanka plans to reduce its budget deficit to 6.8% of GDP in 2023
The IMF team will meet with central bank officials again on Aug. 26, the president’s office said in a statement.
Sri Lanka’s central bank has already hiked interest rates, destroyed domestic private credit to reduce outflows and restore credibility to an unstable soft peg with the US dollar lost after two years of money printing, and forced dollar sales (repurchase obligation) to the Central Bank.
A float is usually needed to end contradictory monetary and exchange rate policies and reverse the trend allowing the central bank to re-anchor it and buy dollars with reduced domestic credit.
The reversal of the parity will lead to a gradual drop in interest rates. For the moment, however, the central bank continues to intervene in both directions of the broken peg and interest rates are high.
Sri Lanka’s printed money for two years ran record balance of payments deficits and defaulted on external debt in April 2022 and is seeking to restructure external debt.
There has also been speculation of domestic debt restructuring, although Sri Lanka’s position is that this is not necessary as the debt has been written down heavily and the economy has ballooned in rupee terms.
A personnel level agreement is a broad economic framework involving fiscal and monetary goals and reforms, which are necessary to stabilize the broken parity and ultimately allow the country to develop.
In this case, Sri Lanka also needs to restructure its debt to bring the gross financing requirement (GFN) down to a manageable level.
Holders of international sovereign bonds that rose sharply after the end of the 30-year war amid currency instability due to flexible inflation targeting are the largest commercial lenders.
China and Japan are among the largest bilateral lenders.
A staff-level direction is approved by the IMF’s fiscal and monetary departments and ultimately transformed into a letter of intent with quarterly fiscal and monetary targets and sequenced reforms, called structural benchmarks.
However, before the letter of intent was signed, the IMF said Sri Lanka would need “creditors’ assurances” that it would restructure its debt.
The Letter of Intent can be structured with prior fiscal or monetary actions, before being forwarded to the IMF Executive Board.
Sri Lanka has already started to set fuel prices in the market with a price formula, electricity prices have been increased and water tariffs are expected to be increased.
In an unexpected development, Sri Lanka lifted import controls on 300 items in a ‘Nixon shock’ style move the day before negotiations with the visiting team began despite high rates killing private credit.
It is unclear how the move will be perceived by the IMF, which generally wants import controls removed as soon as possible.
Sri Lanka has already hiked rates to kill private credit. As the private sector is a net saver, import pressure comes from domestic credit and deficits from credit refinanced by the central bank. A reduced deficit will also help moderate domestic credit.
Related Sri Lanka suspends imports of over 300 items
By the time a Letter of Intent is approved by the Board, a country has already restored monetary stability and reserves are no longer needed for imports, as available inflows and money printing have ended.
All IMF drawdowns are then kept in foreign exchange reserves – usually invested in the US deficit – and more foreign exchange reserves are collected from inflows under a net international reserve target.
Most loosely pegged central banks will typically enter currency crises every two Fed cycles (about 8-10 years) and go to the IMF. Sri Lanka, however, experienced four currency crises in a decade under flexible inflation targeting and output gap targeting.
Soft anchors that fail will also tend to fail again until the country becomes either a clean float or a hard anchor. (Colombo/August 25, 2022)