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 COLOMBO 00000122 002 OF 002 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