SRI LANKA MEETS IMF TARGETS IN SEPTEMBER; CONCERN

UNCLAS SECTION 01 OF 02 COLOMBO 001053 SENSITIVE SIPDIS DEPARTMENT FOR EEB JENNIFER PETERSON AND TANYA SPENCER DEPARTMENT OF TREASURY FOR MALACHY NUGENT AND ATTICUS WELLER USTR FOR MICHAEL DELANEY AND VICTORIA KADER E.O. 12958: N/A TAGS: CE ECON EFIN PGOV SUBJECT: SRI LANKA MEETS IMF TARGETS IN SEPTEMBER; CONCERN OVER BUDGET DELAY REF: A. A) COLOMBO 1000 ¶B. B) COLOMBO 977 COLOMBO 00001053 001.6 OF 002 ¶1. (SBU) Summary. An IMF team has found that Sri Lanka is meeting its foreign reserve and government deficit targets for September, although the Government of Sri Lanka (GSL) will need to restrain expenditures to meet the December deficit targets. The GSL has submitted a Vote on Account in place of a budget (similar to a continuing resolution),and they will not submit their budget until May. The delay in submitting the budget makes it difficult for the IMF to determine if the GSL is implementing the long term structural changes required for a sustainable macroeconomic policy. The IMF believes that the GSL is serious in its efforts to raise government revenue and to move the operations of state owned enterprises to a commercial basis. Although the IMF team believed that Sri Lanka was meeting its targets, the IMF team lead seemed more cautious than in the prior review. End Summary. IMF Mission Background ¶2. (SBU) Sri Lanka reached an agreement with the IMF in July to disburse $2.6 billion in eight separate tranches, with the provision that the IMF would conduct quarterly reviews of Sri Lanka's progress to IMF goals. The IMF conducted the second such review in November, and the results are likely to be presented to the IMF board in January. The IMF has also established an office in the Central Bank to help monitor compliance. Econoff met privately with Brian Aitken, head of the IMF team, to discuss the team's findings. Sri Lanka is Meeting the IMF Targets ¶3. (SBU) Sri Lanka is on track to meet its IMF targets for September. There have been large inflows of foreign exchange into Sri Lanka (see reftel A),so Sri Lanka will easily meet its goals for foreign exchange reserves and net reserves. According to Aitken, Sri Lanka is also on track to meet its government deficit goal of 7% of GDP from January to September 2009. Sri Lanka had run a government deficit of 10-11% of GDP from January to June, primarily due to falling government revenue, so meeting the September goal is an accomplishment. According to press reports, government revenue collection is projected to decline by 13% for the year. Aitken expects it to be harder to meet the December deficit goals, and commented that the GSL must restrain spending for the rest of the year. ¶4. (SBU) Sri Lanka must make structural reforms to meet the IMF 2010 target to reduce its budget deficit to 6% of GDP. The GSL has two possible changes: projected declines in defense spending; and increasing government revenue. Aitken was told that Sri Lanka will hold its defense expenditure flat in rupee terms next year, but considering GDP growth, military spending will decline from 3.8% of GDP in 2009 to 3.2% in 2010. Aitken expected that the GSL could reduce spending on arms procurement with the end of the war. (Note. The Embassy calculates that with the 2009 defense supplemental bill that defense spending will total 4.3% of GDP in 2009 (see reftel B). End Note.) Aitken also believes that the GSL is serious about raising revenue. Under the IMF Letter of Intent, Sri Lanka agreed to raise its revenue by 2% of GDP by 2011. The Presidential Taxation Commission appears to be doing serious work, and it is examining ways to simplify the tax structure and broaden the base, rather than raise tax rates. According to Aitken, the GSL understands that its current tax policy discourages economic growth. The Commission is not expected to release an interim report until after the elections, possibly in May. ¶5. (SBU) Finally, Aitken was optimistic that the GSL was also moving two key state-owned enterprises to a commercial COLOMBO 00001053 002 OF 002 footing. Under the IMF letter of intent, the Ceylon Electrical Board (CEB) and the Ceylon Petroleum Company (CPC) should become break-even enterprises by 2011. The CEB and CPC have large past due debts that they are struggling to overcome. The CEB and CPC have not made structural changes, but again, Aitken thought that they had many good ideas and were serious about reforms. Aitken thought that the CEB had agreed to pay very high prices for electricity to independent power producers, but they may be able to cut costs or renegotiate their contracts. Sri Lanka also has a hydroelectric plant and several coal plants coming on line, which should reduce costs, so he thought that they could be on better financial footing within several years. (Note. Post is in contact with an American independent power producer which has chronic late payments from the CEB, which we understand is a problem across the board. End Note.) ¶6. (SBU) Comment. Although the IMF assessment team concluded that the GSL was meeting its targets, Econoff noted that the IMF team seemed more cautious than in the September review. The IMF team acknowledged that it is difficult to determine if the GSL is on track without a budget, and the GSL budget is not expected until May. Post is more skeptical than the IMF: we anticipate that there will be great pressure to increase spending in the upcoming election season. We will also wait until we see real reforms of CEB and CPC and actual plans to increase tax revenue before we conclude that the GSL will meet its final IMF targets. End Comment. FOWLER