SRI LANKA BADLY MISSES IMF DEFICIT TARGET; LIKELY

C O N F I D E N T I A L SECTION 01 OF 02 COLOMBO 000122

SIPDIS

DEPARTMENT FOR EEB JENNIFER PETERSON AND TANYA SPENCER
DEPARTMENT OF TREASURY FOR MALACHY NUGENT AND ATTICUS WELLER

E.O. 12958: DECL: 02/18/2020
TAGS: CE ECON ETRD PGOV
SUBJECT: SRI LANKA BADLY MISSES IMF DEFICIT TARGET; LIKELY
DELAY IN IMF DISBURSEMENTS

REF: 2009 COLOMBO 1053

Classified By: DCM Valerie C. Fowler fro Reasons 1.4 (b,d)


1. (C) Summary. An IMF staff mission currently in Sri
Lanka is finding that the country has badly missed its 2009
government deficit target, with the budget deficit reaching
9.5% of GDP, well over the 7% IMF target. The IMF staff team
plans to recommend no further disbursements until Sri Lanka
gets back on track with the program. Sri Lanka will have
Parliamentary elections in early April, and will present its
budget and tax reform plan in April or May, so we anticipate
IMF disbursements will be delayed until at least May. The
Government of Sri Lanka (GSL) claims that they want to stay
with the IMF program, but the IMF is unsure of the
government's true commitment. Post expects that Sri Lanka
will seek to keep the IMF program in place, albeit without
any new IMF disbursements, as long as the GSL can pursue its
policy objectives without much IMF interference. End
Summary.

Sri Lanka Misses Government Deficit Targets


2. (U) Sri Lanka reached an agreement with the IMF in
July 2009 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. Sri
Lanka agreed to meet government deficit targets of 7% for
2009, and further reduce the deficit until it reaches 5% in

2011. The GSL also agreed to increase tax revenue by 2% of
GDP by 2011. The IMF has disbursed three tranches, and the
IMF team arrived in Colombo for their next review on February

16.


3. (C) The head of the IMF mission, Brian Aitken,
briefed econoff on February 17 that Sri Lanka's government
budget deficit would likely reach 9.5% of GDP, well over the
7% IMF target. Aitken said that the excess expenditure came
from capital spending, with the capital projects were already
in the pipeline, not from new post-war reconstruction
projects. Aitken also said that military expenditures were
flat, so that did not cause the increased budget deficit.
The IMF is pleased with Sri Lanka's foreign exchange
reserves, which stand at over $5 billion USD, or six months
of import cover. Sri Lanka has not made any progress on tax
reform.


4. (C) The exact cause of the increased government
spending is not clear. The Central Bank released statistics
for the first 10 months of 2009, from January to October,
which show that current expenditures rose by 27% and capital
expenditures went up 19%, so although revenue rose by 11%,
the budget deficit through the first ten months was 8.4%. It
is possible that capital spending surged in November and
December, which would also account for the budget deficit
rising 1% in the last two months.


5. (C) Although he was only on the second day of the
review, Aitken said that he plans to recommend to the IMF
board to delay any additional disbursements until Sri Lanka
takes substantial steps to get back on track. Aitken said
that the IMF staff and board are both skeptical of Sri
Lanka's commitment to reach the targets, implying that the
staff recommendation is likely to be followed.


6. (C) The IMF should know by May if Sri Lanka will move
toward meeting the targets. Sri Lanka has not yet presented
a 2010 budget, because of Presidential elections in January
and Parliamentary elections in April, but instead is
operating under a Vote on Account, similar to a continuing
resolution (see reftel). The GSL will present its 2010
budget in April or May. Moreover, President Rajapaksa has
appointed a Presidential Tax Commission to make
recommendations to reform the tax laws. Econoff heard that
Presidential Tax Commission is drafting its proposals, which
will be submitted to the new Parliament in April or May. The
GSL could get back on track with an austere 2010 budget, an
ambitious tax reform, or better yet, both. The IMF expects

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to return to Sri Lanka between April and June to assess the
country's progress.

Will Sri Lanka Stick to the IMF Program?


7. (C) The GSL has assured Aitken that they are committed
to the IMF program, but Aitken was not certain. Central Bank
Governor Cabraal and Finance Secretary Jayasundera both
assured Aitken that they will continue the IMF program. Sri
Lanka needed the IMF last year because their foreign exchange
reserves were very low. Sri Lanka now has over $5 billion
USD in foreign exchange reserves, amounting to over six
months of import cover, so they do not need additional IMF
disbursements to increase their reserves. The IMF program is
still valuable to Sri Lanka because it increases the
confidence of international investors and the ratings
agencies, and for other international financial institutions.
On the other hand, the IMF could interfere with GSL spending
priorities. Econoff heard that the GSL plans to sell another
$500 million in government bonds on international markets,
and plans to use the money for post-war reconstruction.
Aitken said that the IMF would insist that any government
bond revenue should be placed in foreign exchange reserves,
setting up a possible conflict between Sri Lanka and the IMF.



8. (C) Aitken had an interesting observation on internal
GSL support for the IMF program. Central Bank Governor
Cabraal originally pushed for the IMF program, and he is
likely to continue to support it. Finance Secretary
Jayasundera, who was out of the GSL when the IMF agreement
was reached, has no stake in the program, and he is likely to
push for continued spending on large infrastructure projects.
In post's view, Jayasundera is closer to President
Rajapaksa, and he is likely to be the more influential
advisor in a difficult situation.


9. (C) Comment. Although Sri Lanka does not need the IMF
disbursements to build up its foreign exchange reserves, post
expects that the GSL will continue the IMF program in order
to bolster investor confidence up until the point that the
IMF program interferes with an important GSL goal. The GSL
economic strategy has championed state-led economic
development, featuring huge infrastructure projects, and GSL
officials have been disdainful toward Western neo-liberal
economics. We do not believe that the GSL will alter its
priorities to satisfy the IMF. Therefore, the IMF program
is likely to continue, without any further IMF disbursements,
until there is a real conflict between the GSL and the IMF.
End Comment.
BUTENIS