June 10, Colombo: The International Monetary Fund (IMF) on Friday advised the Central Bank of Sri Lanka to allow the exchange rate to reflect market forces flexibly and avoid sustained sales of foreign exchange to ensure the reserves remain healthy and the economy competitive.
Releasing a statement on Friday following the completion of its 7th review on the US$2.5 billion Stand-By Arrangement (SBA) with Sri Lanka, the Executive Board of the global monetary institute said the macroeconomic situation of the country is satisfactory.
Although the economic growth slowed somewhat in the first quarter of 2011 reflecting flood-related damage, the IMF said leading indicators suggest the growth is currently strong across all sectors.
"Inflation is expected to remain in single digits as food prices have begun to decline," the statement said.
The Executive Board said it made a decision to conduct reviews of the SBA, approved on July 24, 2009, on a semi-annual basis instead of quarterly and under the arrangement a staff mission led by Brian Aitken visited Colombo May 31-June 10 to conduct discussions for the 7th review.
Issuing a statement following the conclusion of the discussions with government and Central Bank officials, the IMF team said the government has implemented the tax reforms initiated in the 2011 budget.
Fiscal performance to date remains consistent with the government's 2011 deficit target of 6¾ percent of GDP while the tax revenue is strong, the statement noted.
Although the government has appropriately shifted investment promotion away from granting tax concessions, the team suggested the government to take more steps to institutionalize this policy by revising investment guidelines and regulations to provide more clarity to prospective investors while safeguarding tax revenue.
The IMF warned the Central Bank to be on the lookout for signs of overheating, and be prepared to adjust monetary policy accordingly despite that private sector credit growth has been rapid and there are not yet signs of demand-driven inflationary pressures.
Banks and finance companies should also guard against a relaxation of lending standards and the accompanying risk of non-performing loans, the IMF advised.
While strong export growth and continued large remittance inflows have supported reserves, rapid import growth, and high oil prices could put pressure on the balance of payments, the IMF pointed out.
"In this event, the Central Bank should allow the exchange rate to reflect market forces flexibly and avoid sustained sales of foreign exchange, ensuring that reserves remain healthy and the economy competitive," the IMF team urged.
While acknowledging that the government has started a comprehensive process to address legal and bureaucratic barriers to investment and the high cost of doing business in Sri Lanka, the IMF cautioned the government against sending conflicting signals about the role of the private sector in economic development which can deter investment and asked the government to increase transparency and improve governance to boost market confidence to lead to higher investment.