ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe met visiting International Monetary Fund team for a round of discussions as the country tries to strike a staff level agreement with a credible economic program to negotiate with creditors to re-structure their debt.
Senior Mission chief Peter Breuer, who is an expert in debt re-structuring, Sri Lanka mission chief Masahiro Nozaki, Resident Representative Tubagus Feridhanusetyawan met President Wickremesinghe, who is also Finance Minister on August 25.
The cabinet of minister on Monday has approved a budgetary framework which where 9.9 percent of Gross Domestic Product budget deficit in 2022 will be brought down to 6.9 percent by 2023.
Sri Lanka is also aiming to bring down the primary deficit, or the deficit without interest costs, a key performance criterion in an IMF fiscal framework from a negative 4 percent in 2022 to a deficit of 1 percent in 2023 in a 3 percent of GDP correction.
The IMF team will again meet central bank officials on August 26, the President office said in a statement.
Sri Lanka’s central bank has already raised interest rates, smashed domestic private credit to reduce outflows and restore the credibility of the an unstable soft-peg with the US dollar lost after two years of money printing, and forced dollars sales (surrender requirement) to the central bank.
A float is usually required to end contradictory money and exchange policies and turn the peg around allowing the central bank to re-peg it and buy dollars with domestic credit reduced.
Turning the peg around will lead to a gradual fall in interest rates. At the moment however the central bank is still intervening in the both directions of the broken peg and interest rates are high.
Sri Lanka’s printed money for two year ran record balance of payments deficits and defaulted on foreign debt in April 2022 and is seeking to re-structure the foreign debt.
There has also been speculation that domestic debt will be restructured, though Sri Lanka’s stand is that it is not required as the debt has been steeply depreciated and the economy has inflated in rupee terms.
A staff level agreement is a broad economic framework involving fiscal and monetary targets and reforms, which are needed to bring stabilize the economy and eventually allow the country to grow.
In this case Sri Lanka also has to re-structure debt to reduce gross financing needs to a manageable level.
Holders of International Sovereign Bonds which ratcheted up sharply after the end of the 30-year war amid monetary instability from flexible inflation targeting are the biggest commercial lenders.
China and Japan are among the biggest bilateral lenders.
A staff level lead is vetted by the IMF’s fiscal and monetary departments and eventually turned into a letter of intent with quarterly fiscal and monetary targets and sequenced reforms, called structural benchmarks.
However before the LOI is signed the IMF has said Sri Lanka will need “assurances from creditors” that they will restructure debt.
The LOI may be structured with fiscal or monetary prior actions, before going to the Executive Board of the IMF.
By the time an LOI is approved by the Board, a country has already restored monetary stability and reserves are no longer needed for imports, with available inflows and money printing ended.
Any IMF drawdowns are then kept in foreign reserves – usually invested in the US deficit – and more foreign reserves are collected from inflows under a Net International Reserve target.
Most soft-pegged central bank will usually get into currency crises every two Fed cycles (about 8 to 10 years) and go the IMF. Sri Lanka however has got into four currency crises over a decade under flexible inflation targeting with output gap targeting.
Soft-pegs which default will also tend to default again until the country either becomes a clean float or a hard peg. (Colombo/Aug25/2022)