Sri Lanka eyes IMF first tranche in March 2023

Last year’s economic contraction expected to be around 7.5%- 8.0%

This year expected to see stability without a contraction

Sequencing of policy action to be continued

By Sanath Nanayakkare

I clearly see that by the end of the year, inflation will fall to single digit, and I can say that with confidence as the Governor of the Central Bank, Dr. Nandalal Weerasinghe said during an interview recently.

“At the time the IMF staff and the Sri Lankan authorities reached a staff-level agreement in September 2022 to support Sri Lanka under an Extended Fund Facility (EFF) of about US$ 2.9 billion, their forecast was Sri Lanka’s inflation would exceed 70% by December 2022. Many people thought inflation would increase by 100%. In fact, food inflation soared to 95%. But having noted the higher than expected escalation of headline inflation and the increased persistence of high inflation, we increased interest rates to contain it. Now inflation has been trending down steadily since September 2022. I clearly see that by the end of the year, inflation will decline to single digit,” he said.

When he was told that some people accuse him for the economic contraction triggered by high interest rates, he replied,” When economic contraction takes place, it hurts everyone. Trade volumes decline, industrial outputs decline and the impacts are felt at all levels. However, for the country to get out of the economic crisis, painful measures needed to be taken which could lead to economic contraction, but that’s the only way out to stabilize the economy. If there hadn’t been an economic crisis, there would have been no need for contracting the economy. Imagine what would have happened if we hadn’t increased interest rates. Interest rate is a tool we use to contain high inflation,” he said.

“Businesses suffer mainly because of high inflation that has a direct impact on their cost of production. When upward inflation is controlled, the cost of production can be controlled and the businesses can operate well with consumers’ purchasing power intact. Inflation is the main enemy of any economy. So tackling inflation is our main responsibility and that’s what we have done. When inflation goes down, interest rates will also go down. And also when the uncertainty in the market abates, interest rates will go down. It is not logical to assume that interest rates will remain at the same level for ever. We controlled the inflation by increasing interest rates. It was like systematically preventing the blowing up of a highly inflated balloon. If it hadn’t been done, the economy would have been in smithereens. Talks with the IMF, debt sustainability, increasing interest rates, balancing of monetary expansion should have been done when the circumstances demanded to do so. If those actions had been taken at the correct time, inflation wouldn’t have been this high. But now there is no other way to get out of the situation we are in, “he said.

Asked whether he hoped the first tranche of the IMF would be released soon, he said,” We strongly hope that we will get the IMF facility’s first tranche in March, 2023. And when we get that, it will instill the confidence of multilateral bodies such as the World Bank and ADB in our financial discipline to give us loans at concessionary rates. They have already agreed to do so. In addition to that, there will be more foreign inflows to our equity market and foreign investment portfolio. These will ease our balance of payment issue, help lower our interest rates and rationalize our exchange rate. Then the 3-month T-Bill yield rate which is still high will move in line with Central Bank’s policy rates.

With the realization of the IMF facility, uncertainty-driven market interest rates will dissipate and will come down to normal levels. This can’t still happen because risk-free government security rates are still at 30% – though down from its previous 33%. Prime lending rates are still affected by this. Many have complained to me that interest rates are too high, and therefore, it’s difficult to do business and they find it very difficult to repay their loans. That is true. The reason for this situation is the lack of foreign currency.

So when we have more foreign currency, interest rates can be lowered without affecting our foreign reserves, while keeping our imports under control. We can’t go back to a chaotic situation like in June 2022. Last year could have seen an economic contraction of 7.5- 8.0%. This year we need to stabilize the economy and achieve stable performance in all four quarters. This has to be done very carefully with proper sequencing so that all sectors can operate smoothly. Although the situation appears to be normal on the facade, it is still not so. There is still a deficit. That’s why the constant sequencing of our policy action is crucial,” the Governor said.