Q+A - Will Sri Lanka's high deficit further delay IMF loan?

COLOMBO (Reuters) - Sri Lanka is planning to reduce its budget deficit to 8 percent of GDP this year, well short of an IMF target for a $2.6 billion loan and the government's own official estimate, a top treasury official said.

Here are some questions and answers on the implications of the higher than expected deficit for the IMF loan that was delayed after Sri Lanka failed to achieve a deficit target last year.

WHAT IS THE IMF DEFICIT TARGET FOR 2010?

Sri Lanka agreed to reduce its fiscal deficit to 6 percent of gross domestic product as a condition of the $2.6 billion IMF loan. However, this 6 percent excludes spending on rebuilding after the end of a 25-year war. Officials at the central bank have said the IMF has never defined the limit of the reconstruction spending, while IMF officials have said their expected limit was around 1 percent. That means the IMF's total deficit target for 2010 is around 7 percent, 1 percentage point lower than what Sri Lanka is working on for this year.

WILL THE HIGHER DEFICIT CAUSE ANY LOAN DELAY?

The global lender following its assessment last month said it was encouraged by Sri Lanka's economic numbers. Sources close to the IMF have said the global lender wants Sri Lanka to be committed to fiscal prudence rather than sticking to numbers in a rigid manner.

The IMF mission last month said it will reassess the situation and respond flexibly. The lender also welcomed government tax reforms early this week. It has also stated that steps to cut the deficit should not include imposing unaffordable taxes or cutting planned capital spending.

Going by these, analysts say, the IMF is likely to disburse the third tranche worth around $320 million within a month.

Analysts say many investors will extend their wait-and-see approach until they are sure about a degree of a prudent fiscal management under the IMF programme, despite the best performing bourse in Asia and booming post-war economy.

IS THERE A POSSIBILTY OF THE LOAN BEING SUSPENDED?

Officials at the central bank and Finance Ministry have said the IMF is convinced of Sri Lanka's successful economic turnaround since it approved the loan and it is highly unlikely to suspend the 20-month programme. However some pro-government economists have called for the loan to be suspend loan since Sri Lanka does not need IMF money anymore to boost its reserves which are now at over $5 billion. Suspension of the IMF loan by the government could lead to rating downgrades, volatility in macroeconomic fundamentals, withdrawal of foreign funds from government securities, and an increased borrowing cost for a planned 10-year, $500 million sovereign bond later this year.

(Editing by Jason Webb)