Sri Lanka is still grappling with negative sentiments despite the end of the war and the Central Bank is hopeful the IMF loan will go a long way to erase the negative publicity Sri Lanka still continues to get.

A senior Central Bank official said the US$ 2.5 billion IMF facility will be presented to IMF Executive Board for approval for formalities sake and that there is a strong likely hood the first tranche of US$ 313 million will follow soon after.

"The IMF staff has agreed in principle that Sri Lanka is deserving of the US$ 2.5 billion loan considering the country’s potential for post war economic development and the challenges of reconstruction and reform," the official said.

"When the Executive Board meets on Friday it is likely it is for formalities’ sake and we could expect the first tranche to come in soon after that," he said.

He said Sri Lanka’s foreign reserves had increased to US$ 1.7 billion after the war and the IMF loan will further boost investor confidence in Sri Lanka.

"The most important thing about the IMF loan is that other multilateral agencies and donors will have a renewed confidence in Sri Lanka and the Central Bank expects more foreign direct investments," the Central Banker told the Island Financial Review, preferring not to be named.

The Sri Lanka Economic Summit 2009 organised by the Ceylon Chamber of Commerce and another confab organised by the Business for Peace Alliance both highlighted the need for the Foreign Ministry to better communicate with the outside world, even suggesting that professional PR personnel be employed to do the job.

Despite the hype created about positive sentiments on Sri Lanka’s post-war economic potential the performance of the Colombo Stock Exchange in recent times proved that investors were still shy.

For the first five months of the year the stock exchange had a net inflow of foreign investments but from May 22 onwards there has been a net outflow. As at July 2, the net foreign investment was an outflow of US$ 373.3 million. By last Monday, however, it eased down to Rs. 171.5 million.

The exchange had a Rs. 1.4 billion net inflow before the end of the war last May.

Although unaware of the contents of the Letter of Intent, he said the government has proposed several measures to bring down the budget deficit as it was the ‘most prudent thing to do’.

Governor Ajith Nivard Cabraal is reported in the press saying that the government will target to maintain the deficit at 7 percent of GDP.

The government is having a tough time with the budget deficit given the falling revenues and escalating expenditure.

According to the Treasury, during the first four months of the year, revenue collection had declined by 10 percent with contractions in the domestic manufacturing and service sectors severely affecting indirect taxes such as VAT and excise duties; expenditure during this period increased by 28 percent compared to the same period last year.

According to IMF Managing Director, Dominique Strauss-Kahn, the IMF staff support Sri Lanka’s bid for a US$ 2.5 billion loan based on the potential for the country to undertake reforms and reconstruction would lead to higher economic growth.

Strauss-Kahn said in a statement that the government of Sri Lanka had an ambitious programme aimed at restoring fiscal and external viability.

According to commercial bank dealers, foreign investors are waiting on the side lines to invest on Sri Lanka’s rupee denominated Treasury bonds, if and when the IMF loan comes through.

Meanwhile, long term debt interest rates have also come down by 20 to 30 basis points.

"If the IMF loan comes through interest rates are going to come down further because the government will be less compelled to borrow from the domestic market through state-owned banks.

"Benchmark rates for three and four year bonds have already showed a tendency to come down based on positive sentiments on the IMF loan," a dealer said.

The rupee money market held a surplus of about Rs. 14 billion ending Monday and for the most part of yesterday.

The exchange rate continued to hold out about the 114 range with the Central Bank still intervening to keep the rupee at this level without letting it appreciate.

"We still see intervention to keep the rupee stable but this is good because exporters have a better return and the Central Bank can also build up the reserves," a dealer said.

The rupee is under pressure to appreciate with news of the strong likely-hood of the IMF loan and other investments coming in.

There are concerns that the government may be compelled to allow the exchange rate to move more freely according to market conditions. Last year, when the rupee was staved off depreciating through intervention, economists pointed out that the IMF may ask for the intervention to cease.

However, now the rupee is seeing a reversing trend and is under pressure to appreciate, but dealers say the IMF is unlikely to lay down any conditions on the exchange rate now.

"For one thing, our exporters must be given a better rate if they are to compete. The IMF also knows if the rupee is allowed to reflect market forces without allowing prudent intervention it could cause problems when the IMF loan is being repaid," a dealer said.