IMF Staff Mission Recommends Avoiding Further Monetary Policy Loosening in Sri Lanka

The International Monetary Fund (IMF) staff mission visiting Sri Lanka has concluded that further loosening of monetary policy could be detrimental to the country's economic recovery and advised against such measures.

The mission emphasized the need to avoid "a faster-than-warranted monetary policy loosening" due to the potential for elevated inflation risks.

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They cautioned that such a move might necessitate a policy reversal later on, hindering economic stability.

Commending the efforts of the Central Bank of Sri Lanka (CBSL) in meeting its Net Credit to Government (NCG) targets despite government liquidity constraints, the mission highlighted the importance of preserving the central bank's independence. They urged the CBSL to continue offloading government securities and refrain from primary market purchases.

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Additionally, the government needs to expedite efforts to recapitalize the CBSL.
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"As the recovery takes hold, efforts to improve revenue administration including through boosting compliance by large taxpayers and curbing corruption vulnerabilities in the tax system can support revenue collection," the mission said. "Reforms in Public Financial Management and energy pricing remain critical. Efforts to protect the vulnerable need to be preserved."

While acknowledging the near-term challenges, the IMF staff mission stressed the importance of Sri Lanka's continued reserve accumulation, supported by increased exchange rate flexibility. Rebuilding external buffers and restoring reserve adequacy are crucial to achieving program targets and ensuring debt sustainability.

Considering the current FX scarcity and financial system's needs, the mission acknowledged the need for a slower pace of reserve accumulation for the remainder of 2023. However, they emphasized the necessity for a faster pace of accumulation in 2024 and beyond to ensure achieving reserve adequacy by 2027.

The mission recommended that FX sales be limited to disorderly market conditions and should not prevent the exchange rate from adjusting according to economic fundamentals.

Program Risks: Risks to program implementation and financing are high and have increased since program approval. Implementation risks arise from Sri Lanka’s track record of reform implementation and the challenging political and social situation. A deeper crisis induced by delays in implementing the debt restructuring, a weakened banking sector, exchange rate pressure, and loss of market confidence could also complicate program implementation. In this regard, contingency plans are crucial, and policies should remain agile to adjust to the evolving circumstances.

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