"The Sri Lankan authorities now look forward to the continued close engagement with the IMF and intend to discuss the possibility of financial support for its economic development agenda under an Extended Fund Facility (EFF)," Sri Lanka's central bank said in a statement.
Sri Lanka is now a heavy borrower in international markets and the country has to avoid excessively strong state interventions that hurt the economy and people as they may get negative reactions from both international bond buyers and rating agencies.
Unlike domestic savers in banks or pension funds, who are cornered by draconian exchange controls and have no escape from economic mis-management, or expropriation through depreciation, foreign bond buyers have clout over rulers under existing laws.
Bond buyers limit the ability of rulers to intervene in markets and continue deceptive policies. Though they can be misled by high yields when the penny drops, they cut losses, which can have devastating effects on economies that do not work according ground reality.
During the last balance of payments crisis, triggered by energy price deceptions and worsened by sterilized foreign exchange sales, the existence of an IMF program probably helped avoid rating downgrades.A reduction of state interventions in the economy in the form of reducing energy price controls and ending contradictory monetary and exchange policies in February which resumed a suspended IMF program helped Sri Lanka retain its rating.
Deeper reforms, especially in state enterprises which are making massive losses and a burden on the poor, as well reducing state spending to curb deficits could result in the avoidance of future economic crises and result in rating upgrades.
"We may raise the sovereign rating on evidence of Sri Lanka's progress in addressing the external weaknesses and domestic problems," Standard and Poor's said in a statement during the launch a billion dollar bond this month.
"Fiscal or structural economic reforms that reduce the vulnerabilities from high debt and interest burdens and the still-narrow economic profile would indicate such improvement."
Standard and Poor's had rated Sri Lanka at a speculative 'B+', four levels below a 'BBB-' investment grade rating.
Downgrades earned during a 2008/2009 balance of payments crisis were largely reversed by rating agencies on the presence of the IMF, underscoring the importance of the watchdog's presence for outsiders.
"The outlook for the sovereign rating was changed to positive in 2011, reflecting an increasingly evident peace dividend reflected in greater macroeconomic stability, as well as a policy orientation of fiscal reform and economic growth that continues to be guided by an IMF program," Moody's, another rating agency said on the same day.
"In addition, the monetary authorities have established a regulatory and supervisory framework supportive of financial stability."
IMF also has a financial sector assessment program and regular so-called 'Article IV' consultations with the state though some of their reports have been suppressed by authorities. Transparency has increased lately.
An IMF staff report on the last review of the current program is also awaiting publication.
"It will be important to continue macroeconomic stabilization and structural reforms efforts, in particular maintaining exchange rate flexibility while building international reserves, given the uncertain global outlook," IMF's deputy managing director Naoyuki Shinohara said in a statement Friday.
"A successor arrangement with the Fund would provide valuable support to the authorities in these endeavors."
A Stand by Arrangement is aimed at solving immediate problems that led to creation of a balance of payments crisis.
Since the late 1990s the IMF has also stayed away from putting longer term reforms that prevent future crises into SBA's as specific performance criteria, focusing on immediate corrective measures.
Even in Sri Lanka there have been no performance criteria on market pricing energy and ending deceptive pricing, a simple reform that can eliminate perhaps the most important trigger of balance of payments crises in the island.
An Extended Fund Facility, a program originally started in 1974 shortly after the collapse of the Bretton Woods soft-pegs and the world was just coming into grips with floating exchange rates, can be used to support longer term reforms.
"Given that structural reforms to correct deep-rooted weaknesses often take time to implement and bear fruit, the EFF is longer than most Fund arrangements—the Fund remains engaged with the member country during the design and implementation of adjustment policies," the IMF says in an explanatory note on its website.
"However, a maximum duration of up to four years at approval is also allowed, predicated on, inter alia, the existence of a balance of payments need beyond the three-year period, the prolonged nature of the adjustment required to restore macroeconomic stability, and the presence of adequate assurances about the member's ability and willingness to implement deep and sustained structural reforms."
A new program is expected to be discussed with the next IMF mission to Sri Lanka due around September 2012.