“The ongoing FSAP update is assessing potential vulnerabilities in the financial sector. The authorities should remain vigilant for systemic risks, and recommendations in the update can be used to strengthen the financial system further.“The Sri Lankan authorities have undertaken substantial macroeconomic policy adjustments to stabilize reserves. It will be important to continue macroeconomic stabilization and structural reforms efforts, in particular maintaining exchange rate flexibility while building international reserves, given the uncertain global outlook. A successor arrangement with the Fund would provide valuable support to the authorities in these endeavors.” Following the Executive Board’s discussion on Sri Lanka, Naoyuki Shinohara, Deputy Managing Director and Acting Chair, stated: “The current monetary policy stance is appropriate, and monetary conditions should remain firm in the near term given high headline inflation and possible second-round effects. With a flexible exchange rate regime, monetary policy can increasingly focus on inflation control to achieve broader macroeconomic stability while allowing the exchange rate to act as a buffer for external shocks. Foreign exchange market intervention should thus be limited to smoothing excessive volatility, and steps should be taken to gradually deepen the foreign exchange market.“The slowdown in economic activity and declining imports are adversely affecting fiscal revenues, while interest payments on government debt are higher than budgeted. The authorities are committed to meeting their 2012 deficit target by restraining expenditure, but a redoubling of effort to strengthen revenue administration is needed. Furthermore, continued structural reforms are required to put state-owned energy enterprises on a sound financial footing. The Executive Board of the International Monetary Fund (IMF) on Friday completed the eighth and final review of Sri Lanka’s economic performance under a program supported by a Stand-By Arrangement (SBA).The completion of the review enables the immediate disbursement of an amount equivalent to US$ 415.0 million, bringing total disbursements under the arrangement to an amount equivalent to US$ 2.49 billion. “Following robust growth in the first quarter of 2012, activity has started moderating in response to policy tightening and weakening global demand. Headline inflation has increased, but core inflation remains relatively stable, while tighter monetary and credit policies have begun slowing credit and import growth. The external current account deficit is narrowing, and international reserves have stabilized.