Nov. 1 (Bloomberg) -- Sri Lanka's widening current-account deficit, a dependence on foreign borrowings and an overvalued currency pose ``serious risk'' to the nation's economic stability, the International Monetary Fund said.

The South Asian economy, facing among the highest inflation in Asia exceeding 20 percent this year, must undertake reforms to ease consumer prices, consolidate public spending and increase financial supervision to reduce the pressure on the local currency, the IMF said.

``Amid increased international risk aversion, raising external finance will become increasingly challenging,'' the Washington-based agency concluded in a report yesterday after a consultation on Oct. 17. ``Sri Lanka's external accounts are vulnerable to a reduction in investor risk appetite.''

The risk of a global recession pushed up the number of worldwide borrowers at risk of credit rating cuts to the highest this month since September 2005, Standard & Poor's said in a report yesterday. The IMF agreed last month to consider emergency loans to Hungary, Ukraine and Iceland to prevent the turmoil in global credit markets from escalating.

Sri Lanka's current-account deficit will widen to $3.33 billion, or 7.9 percent of gross domestic product, in 2008 and 8.2 percent in 2009, the IMF forecasts, versus 4.2 percent last year. Economic growth will slow to 6.1 percent in 2008 and 5.8 percent in 2009, from 6.8 percent in 2007, it said.

Currency Risks

Governor Novard Cabraal and policy makers at the Central Bank of Sri Lanka on Oct. 20 kept its benchmark repurchase rate at six-year high of 10.5 percent, unchanged in 20 straight meetings since February 2007 to cool prices. Inflation accelerated 28.2 percent in June, the highest in Asia, as global crude oil traded near a record.

The government's increased reliance on dollar-denominated short-term commercial debt add to public debt distress, while rising bad loans among local lenders suggest the banking system could face ``sizeable vulnerability'' to higher borrowing costs, the IMF said.

The central bank's foreign-exchange reserves are expected to increase by 7 percent to $3.27 billion, enough to finance 2.2 months of imports and cover 57 percent of short-term foreign debt, the IMF forecasts. The country's external debt will amount to about 46 percent of its gross domestic product this year, down from 52 percent in 2007.

The IMF said risks to external stability are associated directly with a loose fiscal policy and a build-up of short-term and foreign-currency debt and recommended authorities ``monitor closely short-term foreign liabilities and maturity risk.''

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net.

Last Updated: November 1, 2008 04:33 EDT