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“IMF program addresses corruption vulnerabilities”

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The IMF reform agenda for Sri Lanka in addition to focusing on several key areas also addresses long-standing issues such as corruption, said Central Bank Governor Dr. Nandalal Weerasinghe at the recently held Kautilya Economic Conclave in New Delhi.

He also said due to this reform process focusing on curbing corruption, Sri Lanka is becoming the first country in Asia to undergo an independent corruption diagnostic study by the IMF and World Bank. “The goal is to reduce corruption, vulnerabilities, and foster sustainable growth over the next four years.”

As the country navigates through an IMF program for the 17th time, the focus remains on restoring economic stability, ensuring debt sustainability, and rebuilding external resources. The Central Bank’s recent legislative changes, promoting monetary policy independence and transparency, underscore the commitment to learning from past mistakes. He also said that tracking historical data showcased that budgetary deficits were closely correlated to the worsening Current Account, the sum of net income from abroad, net current transfers, and the balance of trade.

The Governor provided insights into the historical context, noting, “Sri Lanka is one of the countries that opened up and liberalized its economy earliest in the region, back in 1977. The growth was relatively higher, averaging about 4.5% until 2013, but then fiscal populism set in, leading to a downward spiral.”

Highlighting the correlation between fiscal deficits and external current deficits, the Governor explained, “Sri Lanka is a classic example of the twin deficit hypothesis. There is empirical evidence that fiscal deficits and budget deficits are closely correlated with the external current deficit.”

The root cause lies in a history of fiscal excesses, especially during election years, leading to a series of economic crises. The fiscal deficit hypothesis, linking budgetary imbalances with external deficits, has proven to be a defining feature of Sri Lanka’s economic landscape. Historically, Sri Lanka enjoyed high growth and low inflation during the early years of liberalization, fueled by concessional financing and grants. However, a shift towards fiscal populism and high public expenditure, often directed towards domestic projects, led to a troubling pattern of inflation spikes and an inward-oriented economy.

Notably, the country’s reliance on external financing, particularly commercial borrowings, soared after 2007, resulting in a debt crisis. The government’s debt burden escalated rapidly, with service payments accounting for a staggering 70% of revenue in recent years. This fiscal imprudence, coupled with a lack of market access, triggered rating downgrades and a suspension of external debt servicing.

The crisis prompted a swift response from the Central Bank, including a 700-basis point interest rate hike. The government, now under a stable administration since July 2022, is actively engaged in a comprehensive reform agenda. The five pillars of this strategy include revenue-based fiscal consolidation, structural reforms, energy pricing adjustments, and a commitment to monetary policy independence. (TP)

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