By Devan Daniel

The IMF says Sri Lanka’s monetary outlook is sound but the country faces medium term risks driven by the fiscal position and the country faces medium term risks on this front and fiscal imbalances could make it difficult for the Central Bank to maintain price stability.

“Sri Lanka has come out from a short term risk position where there was balance of payments crisis to a position where there is medium term risks to the macro economy coming from fiscal imbalances.

“We are yet to see the latest figures but from what we have seen up to last September, both monetary policy and fiscal policy was sound,” IMF Resident Representative of Sri Lanka Dr. Koshy Mathai.

An IMF review mission is due in the island shortly to appraise Sri Lanka’s performance in the US$ 2.6 billion standby facility programme with the IMF for the disbursement of the third tranche amounting to US$ 326 million.

“Our programme is very simple. We have targets for money reserves, monetary policy of the Central bank and public debt and deficit positions,” Dr. Mathai said.

Speaking as the guest of honour at the 51st AGM of National Chamber of Commerce of Sri Lanka earlier this week, Dr. Mathai explained how Sri Lanka faced a balance of payments crisis when the Central Bank sold dollars from its reserve in order to keep the rupee stable in an environment of high import prices and how inward remittances were effected due to the global economic crisis.

However mid-2009 Sri Lanka experienced a dramatic change.

The trade deficit began to contract as a result of low global prices on commodities such as oil, remittances began to recover while foreign investors underwent a ‘dramatic change in sentiment’ and invested in the country’s equities and government securities.

“Of all the emerging markets investors perceived Sri Lanka to hold a unique, once-in-a-generation potential for growth,” Dr. Mathai said.

The rupee which was under pressure to depreciate was now under pressure to appreciate with more foreign inflows and the Central Bank intervened in the market, this time buying dollars to prevent a sharp appreciation which could hurt exporters, already going through a torrid time.

Dr. Mathai said inflation was now under control which allowed the Central Bank to reduce policy rates and although commercial banks had been reluctant to reduce lending rates at first, they were compelled to comply after a presidential directive to state-owned banks.

“Credit to the private sector is picking up and from what the banks are telling us these loans are for long term projects and not for consumption, so this is a good sign because it would not lead to inflation,” he said.

All in all, Dr. Mathai said the policy framework of Sri Lanka looked solid. But there is a caution.

“We believe the underlying risks to the macro economy are from the fiscal side and these fiscal imbalances need to be addressed for even the Central Bank’s monetary policies to be effective. The government itself has said that fiscal consolidation is going to be a challenge and we would have to wait and see,” Dr. Mathai said.

Earlier this year, Central Bank Governor Ajith Nivard Cabraal warned that reckless spending of the state could undo all the good work done to reign in inflation and bring down interest rates. He said such reckless spending would threaten the private sectors ability access bank credit to finance development activities.