IMF's $2.9 billion loan for crisis-riddled Lanka: terms and conditions apply

After months of negotiations, the International Monetary Fund (IMF), under a preliminary agreement, has sanctioned a loan of $2.9 billion to Sri Lanka, which is grappling with its worst-ever economic crisis, for a period of four years.

The agreement, however is in its initial stages, and needs the nod of the IMF management and its executive board to translate into action.

So far, the decision to provide an Extended Fund Facility (EFF) of around US $2.9 billion has been worked out between Sri Lankan authorities and IMF staff to support the island country’s economic policies for a period of 48 months.

IMF’s objectives and conditions  

Through the funding, the IMF aims at stabilising the macroeconomics and debt sustainability of the Lankan economy, protect financial stability and ensure that structural reforms are made on governance level to protect the economy against any corruption-related vulnerabilities in the future.

“Debt relief from Sri Lanka’s creditors and additional financing from multilateral partners will be required to help ensure debt sustainability and close financing gaps,” the IMF said in a statement on Thursday (September 1).

Also read: IMF provisionally agrees on USD 2.9 billion loan for crisis-hit Sri Lanka

“Financing assurances to restore debt sustainability from Sri Lanka’s official creditors and making a good faith effort to reach a collaborative agreement with private creditors are crucial before the IMF can provide financial support to Sri Lanka,” the statement added.

The monetary body also called for action to raise fiscal revenue of the island country through the implementation of tax reforms, introduction of cost recovery-based pricing for fuel and electricity, raising spending to alleviate the problems of the poor during the economic crisis, restoring flexible exchange rate, implementing a capitalized banking system and most importantly framing strict anti-corruption laws.

It also proposes tax reforms including more progressive personal income tax and broadened tax base for corporate income tax and VAT. The IMF plans to reach a primary surplus of 2.3 per cent of the GDP by 2025.

Statin that inadequate external buffers and an unsustainable public debt dynamic has led to an economic crisis, which has affected the poor and the vulnerable the most, the IMF said that its programme would help “stabilize the economy, protect the livelihoods of the Sri Lankan people, and prepare the ground for economic recovery” besides promoting sustainable and inclusive growth.

“They have worked out the contours of a restricting programme. We have commercial debt, bilateral  and multilateral debt, and domestic debt…so how to balance this…Then there are some upfront measures to take, and then we move into the programme,” Indian Express quoted Milinda Moragoda, the High Commissioner of Sri Lanka to India as saying on Thursday, soon after IMF made the announcement.

The programme also proposes to restore price stability through data-driven monetary policy action, fiscal consolidation, phasing out monetary financing, and implementing stronger central bank autonomy to allow the functioning of a flexible regime with its goal to target the inflation. A new central bank legislation is also on the cards.

The IMF also plans to rebuild the country’s foreign reserves by restoring a market-determined and flexible exchange rate, which in turn will be supported by the policy package under the loan programme.

Why IMF stepped in

The talks for the loan with the IMF began in June, two months after Sri Lanka announced its international debt default due to the forex crisis in mid-April.

The country owes $51 billion in foreign debt and $28 billion of it have to be paid by 2028.

The IMF has predicted that the country’s economy will contract by 8.7 per cent in 2022 when the inflation rises to above 60 per cent.

In April, when the country saw violent protests demanding the ouster of then President Gotabaya Rajapaksa, its government had reached out to friendly nations seeking bilateral credit of at least $4 billion as the IMF fund was under process and was expected to take six months to finalise.

The credit was meant to help the country ease hours-long power cuts, tide over the fuel crisis, and pay toward the import of food and lifesaving drugs.

The talks with the IMF, however, were stalled due to widespread protests in the country where irate citizens stormed the residence of Gotabaya Rajapaksa, occupied government buildings and set ablaze the residence of current President Ranil Wickremesinghe.

The IMF’s staff-level agreement was reached after a senior delegation visited Colombo in the last week of August.

In an indication that the his government was ready to walk the IMF line, Wickremesinghe on Tuesday presented his first budget that was aimed to increase revenue to around 15 per cent of the GDP by 2025. He also proposed to slash public sector debt, control inflation and increased VAT to 15 per cent from the current 12 per cent.

The President also revised Lanka’s deficit projection for 2022 from the earlier 8.8 per cent to 9.8 per cent of the GDP.

In the interim, countries including India, China and Bangladesh have lent a helping hand to the island country to tide over the crisis. India so far has provided a financial assistance of $3.8 billion in form of currency swaps, credit lines, grants, humanitarian supplies and infrastructure development in the island country. Similarly China has provided around $31 million in ‘urgent emergency humanitarian aid’ to the country, after it requested for an aid of $2.5 billion dollars. Bangladesh helped Sri Lanka by providing $200 million through a currency swap.

How the loan will help Lanka?

The loan which would be disbursed to Sri Lanka over a span of four years will help the government raise its revenue to support fiscal consolidation, revise fuel and electricity tariff, boost the country’s social spending, strengthen the autonomy of the central bank and replenish its dried-off foreign reserves.

This will be possible through the IMF’s proposal to implement major tax reforms including the introduction of progressive personal income tax and broadening the tax base for corporate income tax and VAT.

The IMF’s loan, however miniscule it may be compared to the country’s debt burden, will also encourage investors to look at the economy with a fresh perspective.

Will Sri Lanka use the IMF loan to alleviate poverty?

This will not be directly possible. The IMF’s role is to oversee the stability of the global monetary system, and take steps as and when required to ensure this.

While its sister organisation World Bank offers loans to alleviate poverty by financially aiding development projects (via debt and equity), the IMF has a rather narrow mandate to just ensure the global economic balance is not ruffled. This it does by offering loans to nations with balance of payments difficulties.

Also read: Crisis in neighbourhood: Bangladesh joins Pak, Lanka in seeking IMF loan

Hence, in this case, the IMF would monitor Sri Lanka’s economic activity and offer it policymaking tools and analyses. Its financial assistance comes with the condition that Sri Lanka implements IMF initiatives.

Basically, Colombo is accepting a huge loan loaded with conditions. If its balance of payments issues get mitigated and it’s able to focus its resources on rebuilding the economy, it’s a plus. On the contrary, it may end up paying hefty interest rates that would only stabilise international trade and do little for the island nation’s people.