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The International Monetary Fund has approved a 1.5 billion US dollar (1.1 billion special drawing rights) loan to Sri Lanka under an economic program that will improve state finances, with 168 million dollars being disbursed as the first tranche.
Sri Lanka's foreign reserve dropped through 2015 as the central bank unwound over 200 billion rupees of temporarily mopped up liquidity and cut rates in April loosening monetary policy as the budget deficit deteriorated, spooking foreign investors who started selling bonds.
The IMF program seeks to raise revenue through new taxes, to finance the additional spending to finance state worker salaries and a large cabinet of ministers as well as new subsidies.
The rupee fell as liquidity was released and money was printed through failed Treasury bill auctions. The central bank eventually bought about 1.5 billion US dollar (220 billion rupees) of Treasury bills to finance the deficit and also to accommodate fleeing investors, after releasing 300 billion rupees of liquidity.
"The overall balance of payments deteriorated significantly in 2015 despite an improvement in the terms of trade," the IMF noted in a statement.
'Terms of trade' refers to import prices and is part of a mistaken Mercantilist doctrine that blames balance of payments troubles on rising import prices, instead of monetary stability created by loose policy of the central bank.
The doctrine was shattered during this balance of payments crisis, as it was created by the central bank despite collapsing international oil prices.
The rupee collapsed from 131 to 147 rupees over the past year.
"A clear commitment to exchange rate flexibility will enable adjustment to a shifting external environment while allowing the central bank to rebuild foreign exchange reserves and focus more closely on its key mandate of price stability," Min Zhu, Deputy Managing Director and Acting Chair, said in a statement.
The central bank has had a series of successful Treasury bills auctions in the last few weeks.
But analysts say if the IMF program does not contain ceilings on domestic assets of the central bank which move down in step with rising net international reserve targets, the rupee can continue to fall until domestic demand is slowed though a fall in living standards rather than a slow down in credit.
Backed by the IMF program, Sri Lanka is shorty expected to go to international markets for a 1.5 billion US dollar loan.
The IMF will disburse 168 million US dollar as the first tranche. In addition to 1.5 billion US dollars coming to the reserves, the program also has another 650 million dollars in budget finance from the World Bank and other lenders.
The IMF money itself goes to foreign reserves, and as Sri Lanka is a soft-dollar pegged nation, most of the money will be used to buy dollar securities effectively bridging the US deficit.
The corrections to the balance of payments comes through the ending of money printing involving tighter monetary policy and stronger state revenues as well as increased investor confidence that will make foreign investors buy Sri Lankan debt.
If monetary policy had been tightened in the first place and the budgets managed better investor confidence would have been retained as happened during the so-called 'taper tantrum."
"Tougher external conditions in the wake of China rebalancing and unwinding of unconventional monetary policies were not outside Sri Lanka’s past experience," the IMF noted.
"However, spillovers were magnified by domestic imbalances, as evidenced by higher volatility around the two elections (January and August 2015), and the official budget passed in November 2015.
"The rupee continues to face downward pressure—largely reflecting capital flow developments. The foreign exchange and government bond markets were volatile in March 2016. highlighting rigidities in both systems."
The IMF program has not yet been published. Sri Lanka has also suppressed IMF reports on recent post program monitoring missions. Sri Lanka domestic bonds saleves have also been a source of concern amid fears of auction rigging. The central bank this week said it will make the auctions more transparent.
ECONOMYNEXT
Sri Lanka's foreign reserve dropped through 2015 as the central bank unwound over 200 billion rupees of temporarily mopped up liquidity and cut rates in April loosening monetary policy as the budget deficit deteriorated, spooking foreign investors who started selling bonds.
The IMF program seeks to raise revenue through new taxes, to finance the additional spending to finance state worker salaries and a large cabinet of ministers as well as new subsidies.
The rupee fell as liquidity was released and money was printed through failed Treasury bill auctions. The central bank eventually bought about 1.5 billion US dollar (220 billion rupees) of Treasury bills to finance the deficit and also to accommodate fleeing investors, after releasing 300 billion rupees of liquidity.
"The overall balance of payments deteriorated significantly in 2015 despite an improvement in the terms of trade," the IMF noted in a statement.
'Terms of trade' refers to import prices and is part of a mistaken Mercantilist doctrine that blames balance of payments troubles on rising import prices, instead of monetary stability created by loose policy of the central bank.
The doctrine was shattered during this balance of payments crisis, as it was created by the central bank despite collapsing international oil prices.
The rupee collapsed from 131 to 147 rupees over the past year.
"A clear commitment to exchange rate flexibility will enable adjustment to a shifting external environment while allowing the central bank to rebuild foreign exchange reserves and focus more closely on its key mandate of price stability," Min Zhu, Deputy Managing Director and Acting Chair, said in a statement.
The central bank has had a series of successful Treasury bills auctions in the last few weeks.
But analysts say if the IMF program does not contain ceilings on domestic assets of the central bank which move down in step with rising net international reserve targets, the rupee can continue to fall until domestic demand is slowed though a fall in living standards rather than a slow down in credit.
Backed by the IMF program, Sri Lanka is shorty expected to go to international markets for a 1.5 billion US dollar loan.
The IMF will disburse 168 million US dollar as the first tranche. In addition to 1.5 billion US dollars coming to the reserves, the program also has another 650 million dollars in budget finance from the World Bank and other lenders.
The IMF money itself goes to foreign reserves, and as Sri Lanka is a soft-dollar pegged nation, most of the money will be used to buy dollar securities effectively bridging the US deficit.
The corrections to the balance of payments comes through the ending of money printing involving tighter monetary policy and stronger state revenues as well as increased investor confidence that will make foreign investors buy Sri Lankan debt.
If monetary policy had been tightened in the first place and the budgets managed better investor confidence would have been retained as happened during the so-called 'taper tantrum."
"Tougher external conditions in the wake of China rebalancing and unwinding of unconventional monetary policies were not outside Sri Lanka’s past experience," the IMF noted.
"However, spillovers were magnified by domestic imbalances, as evidenced by higher volatility around the two elections (January and August 2015), and the official budget passed in November 2015.
"The rupee continues to face downward pressure—largely reflecting capital flow developments. The foreign exchange and government bond markets were volatile in March 2016. highlighting rigidities in both systems."
The IMF program has not yet been published. Sri Lanka has also suppressed IMF reports on recent post program monitoring missions. Sri Lanka domestic bonds saleves have also been a source of concern amid fears of auction rigging. The central bank this week said it will make the auctions more transparent.
ECONOMYNEXT
