By Shihar Aneez

COLOMBO, Nov 2 (Reuters) - The International Monetary Fund (IMF) has warned that Sri Lanka's "impressive economic growth" was at risk unless it shored up its balance sheet and trimmed reliance on short-term foreign debt amid the global credit crunch.
The IMF said it expects economic growth to slow to 6.1 percent in 2008, below the central bank's estimated 7 percent and the 6.8 percent recorded last year. It predicted growth of 5.8 percent in 2009.

"(IMF) directors expressed concern that the combined build-up of macroeconomic imbalances, balance sheet vulnerabilities, high inflation, and external financing poses serious risks to economic stability," the IMF said in its annual assessment of Sri Lanka. It said the global financial crisis, which has drastically cut the availability of credit, had made "Sri Lanka's external accounts ...vulnerable to a reduction in international investor risk appetite."
Sri Lanka has since October 2007 increasingly sought high-interest foreign commercial borrowings via syndicated loans and a sovereign bond issue to avoid local commercial loans that attract a rate of over 20 percent.

"(IMF) directors noted the risks of public debt distress arising from the increasing reliance on dollar-denominated, short-term commercial debt," the lender said in the review, released over the weekend.
That risk has grown more acute since the dollar has strengthened against other currencies in the last month. The IMF urged Sri Lanka to adopt a longer maturity profile to avoid refinancing risk.
"A widening current account deficit and bunching of near-term debt repayments imply sizeable gross external financing needs at a time when global credit markets are unsettled and likely to remain so," the bank warned.
It also urged increased financial oversight, and even tighter monetary policy. The bank for the last 19 months has dropped rate-setting in favour of reserve targeting to fight inflation.
Sri Lanka's annual inflation hit a record high of 28.2 percent in June this year, for which central bank blamed high oil and food prices. However, rating agencies have said increased government expenditure was also a main reason for high inflation.
Though inflation has slowed for the last four straight months, it is still over 20 percent.
IMF also said the real exchange rate of the rupee has been overvalued and the central bank's protection of it could create the risk of attracting short-term speculation and volatility.

"Additional exchange rate flexibility would help ward off destabilising short-term capital inflows, and encouraged the authorities to move in this direction as part of a comprehensive policy package that would underpin confidence in the currency."
But the central bank on Thursday said it had allowed 'limited depreciation' of the rupee, after exhausting 25 percent of its foreign reserve to protect the currency since mid-September.

And on Friday, it slapped in place new restrictions on commercial banking that essentially banned non-commercial foreign exchange forward transactions. Currency dealers said they were put in place to stop speculation.

(Editing by Bryson Hull and Jason Neely) Keywords: SRILANKA ECONOMY/IMF (shihar.aneez@thomsonreuters.com; +94-773-763-577; Reuters Messaging; shihar.aneez.thomsonreuters.com@reuters.net)

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