Sri Lanka needs prudent fiscal policy to retain confidence, refinance debt: Economist

ECONOMYNEXT - Sri Lanka needs prudent fiscal management to retain confidence of debtors amid a peak in upcoming repayments which needs refinancing and elections which may undermine policy, an economist has said.

"Retaining foreign investor confidence is going to be the most important thing, and one critical area is that we must have a fiscally responsible regime in place," Dushni Weerakoon, the Executive Director Institute of Policy Studies, a Colombo-based think tank said.

But Sri Lanka is facing convergence of political economic events in 2019 which is increasing the risk of policy slippage, she said. Global interest rates were also rising.

"It’s a little unfortunate that all of this are converging next year," Weerakoon said at the launch of the IPS's flagship publication, the State of the Economy 2018.

"There’s the more near to medium term risk of fiscal discipline that comes mostly through the political channel related to elections, but clearly we need to ensure that there is a fiscal sustainable regime in place."

"There is likely to be a pressure that will build up for policy backsliding."

Successive regimes in Sri Lanka have had a habit of spending government finances to win votes.

At the moment Sri Lanka is in a stabilization program with the International Monetary Fund, which is currently in limbo with the last review yet to be completed over the failure to meet forex reserve targets.

Budget deficits have been brought down and taxes raised. State spending was raised in a budget in 2015, which contributed to undermining the fiscal framework.

Despite better fiscal policy, analysts say policy errors by the central bank involving contradictory policy have led to monetary instability.

Analysts who closely track the central bank has said that a sudden halt in mopping up inflows in the first quarter of 2018 (failed term repo auctions) as the economic recovered a little, led to a weakening of a de facto soft-peg with the US dollar (Sri Lanka injects Rs123bn to sterilize dollar outflows). A liquidity spike in August was similarly unsterilized.

Trade controls have been put in place as part of efforts to stabilize the currency peg.

Weerakoon said that the curbs on high value imports put in place to halt further currency depreciation will reduce taxes for the government.

It is not clear why the administration place trade controls to correct monetary instability. Under the IMF deal Sri Lanka has pledged not to resort to trade controls to fix balance of payments troubles, which are a result of monetary instability.

Weerakoon said that so far, the government has had better management of public finance.

She said monetary policy and foreign exchange management has been prudent within the constraints placed on the country.

Weerakoon said that political room will be small to push through required structural reforms next year, and will keep growth at around 4 percent.

"Fiscal policy is in a bit of a straightjacket but Sri Lanka also has to focus on growth, because it is important to increase GDP growth to lower our debt leverage ratio," she said.

“Debt accumulation is accelerating rather than decelerating."

Rise of international interest rates are also reducing favourable borrowing terms, she said.

But there were several positive developments.

She said exports and foreign direct investments have turned around in 2018 which was a positive development and tourist earnings are growing, but they will not increase massively in a short period.

The increasing oil prices and currency induced inflation will on the other hand require the central bank to be watchful and conduct monetary policy appropriately going forward, she said. (Colombo/Oct16/2018)