IMF positive on Sri Lanka but warns of deficit challenge

The International Monetary Fund (IMF) is upbeat about Sri Lanka's economy but has warned of a growing fiscal deficit, saying that stable policies are essential to spur growth, according to a statement on Wednesday.

The IMF Executive Board in its latest monitoring report insisted the outlook is broadly stable but set against heightened downside risks.

Real GDP growth is projected at 6.5 percent in 2015 and beyond -- in line with IMF staff's estimate of potential output. "While there is considerable growth momentum, downward pressure may emerge from such factors as lower public and private investment due to budget cuts and an uncertain policy environment, a crowding out of private sector credit, and the potential for negative spillovers from slower economic recovery in Europe -- one of Sri Lanka's two most important export markets,"it said.

The external sector outlook for 2015 appears favorable, but there are several risks.

The sharp drop in oil prices will likely generate a substantial windfall for Sri Lanka's import bill -- equivalent to about 2 billion U.S. dollars for 2015 as a whole.

Assuming goods exports remain in the current range, the improvement in the trade balance should provide a cushion to the overall balance of payments and allow for further accumulation of central bank foreign exchange reserves. "With capital flows at comparatively normal levels, net inflows should be sufficient to keep central bank foreign exchange reserves in the range of around 4 months of imports."

The IMF also warned risks to this outlook including an eventual reversion of the oil price shock; a slowdown in goods exports in the event growth in key export markets stalls; and less optimistic assumptions regarding net capital flows.

Sri Lanka's 60 billion U.S. dollar economy grew at 7.4 percent in 2014 but is expected to slow to 6.9 percent in 2015 on policy shifts rising from a new government that came into power after elections in January. Endi