Analysis – Dissanayake's push for Sri Lanka economic change leaves IMF deal, debt rework in limbo

By Uditha Jayasinghe, Sudipto Ganguly and Libby George

COLOMBO/LONDON (Reuters) - Sri Lanka's new president won the election decisively, but his toughest task still lies ahead as he seeks to balance promises to aid the nation's poor against the need to keep crucial supplies of cash flowing from the International Monetary Fund.

Marxist-leaning firebrand Anura Kumara Dissanayake, whose tax cut pledges won over many of the two-thirds of his people mired in poverty, takes power as Sri Lanka emerges from its most punishing economic crisis in 70 years and its first international debt default.

But jumpstarting the economy while making good on promises to expand welfare, rework the $2.9-billion IMF bailout and negotiate better deals with debtors, presents a difficult conundrum for the Indian Ocean nation and its investors.

Adding to the challenge, the prime minister's resignation on Monday meant the cabinet has been dissolved.

"We've never had such a situation," said Bhavani Fonseka, senior researcher at the Colombo-based think tank Centre for Policy Alternatives.

Dissanayake's pledge to take a tough approach to corruption appealed to millions desperate for a fairer future.

But his promises to change the parameters of the IMF bailout and, crucially, the way it determines how much debt is sustainable, could delay new money from the Fund and also force lenders to renegotiate debt deals.

"There's no doubt that the election outcome creates uncertainty, given Dissanayake's willingness to renegotiate the IMF terms," said Emre Akcakmak, head of frontier markets with East Capital.

The Fund was set to review progress on reforms by Oct. 1, usually done with a staff visit to the country, before its board paves the way for payout of the next tranche, which had been expected in November. Few now expect this timeline to hold.

Sri Lanka and its bondholders had inked a preliminary deal to restructure $12.5 billion in debt on Thursday, after months of delay and objections from the IMF and official lenders to a previous deal. It is now unclear if the deal will be executed.

Bond prices staged their steepest slide in five months in early trading on Monday, but rebounded later in the day.

How much support Dissanayake can command to support any controversial move is also unclear.

His National People's Power (NPP) coalition holds only three seats in the 225-member parliament and can barely muster the numbers for a fully-fledged cabinet.

During his campaign Dissanayake promised to dissolve parliament within 45 days of taking office and call for a snap general election.

While a general election could, of course, help bolster his support it also inevitably means more delays in tackling key questions around the economy and debt.

"Now we'll have to wait for the parliamentary elections, while the restructuring will be pushed out into early next year," said Viktor Szabo, portfolio manager at abrdn, who does not expect big changes to the IMF parameters.

Sources said Dissanayake's team had not reached out to bondholders.

The IMF said it would work with Dissanayake and discuss the timing of its third review of the current programme with Sri Lanka "as soon as practicable".

"We look forward to working together with President Dissanayake and his team towards building on the hard-won gains that have helped put Sri Lanka on a path to economic recovery," a Fund spokesperson said via email.

COMMITTED TO CHANGE

Also still unclear is the likely shape of the relationship with Sri Lanka's bilateral lenders grouped in the official creditor committee (OCC).

A source close to the creditor group said it was still assessing the preliminary deal the previous government struck with bondholders last week and would respond within days.

"The OCC is of course available and would be interested in a call with the new finance minister and his team," added the source, who spoke on condition of anonymity.

Legislation guided by former President Ranil Wickremesinghe to enshrine IMF targets in law, such as cutting debt to 95% of GDP by 2032 and achieving a primary account surplus of 2.3% by 2025, is seen as barrier to drastic change.

"It is unlikely that Dissanayake will meddle too deeply with the IMF programme and certainly not the Debt Sustainability Analysis because it will be digging a hole," said Udeeshan Jonas, strategy head at Colombo-based equity research firm CAL.

Dissanayake's comments during Monday's inauguration offered few clues as to how hardline his economic approach will be.

"Our politics needs to be cleaner, and the people have called for a different political culture," the 55-year-old said. "I am ready to commit to that change."

(Reporting by Uditha Jayasinghe and Sudipto Ganguly in Colombo, Libby George in London; Additional reporting by Karin Strohecker in London; Graphic by Marc Jones; Editing by Clarence Fernandez)