WHAT IS THE HARDEST CONDITION FOR SRI LANKA TO MEET?

Maintaining a 7 percent budget deficit in 2009. Latest Ministry of Finance data showed the deficit has already hit 4 percent in the first four months of this year and economists expected the full-year figure to reach at least 9 percent.

They say the government will be forced to revise its populist policies to more economically rational ones if it wants to receive the entire $2.6 billion loan.

The 5 percent fiscal deficit target in 2011 will also be a difficult task for President Mahinda Rajapaksa, who faces a parliamentary and presidential election before then.

Analysts say the Rajapaksa administration, which has already promised to cut military expenditure after the war, could introduce new indirect taxes to increase revenue.

But that might be unpopular with the electorate. So Rajapaksa could take advantage of his current high popularity and call for elections early and, assuming he wins, implement the less popular policies afterwards.

WHAT WILL IMF DO IF SRI LANKA FAILS TO MEET THE CONDITIONS?

Initially, the IMF is likely to be flexible, taking into consideration Sri Lanka's post-war situation. However, continued failures to meet conditions will compel the lender to stop disbursement of the loans, which would be negative for domestic markets. The IMF discontinued a previous loan programme due to Sri Lanka's failure in adhering to its conditions in 2001.

WHAT IMPACTS WILL THE CONDITIONS HAVE ON THE ECONOMY?

Inflation is expected to pick up. The government has agreed with the IMF to halt subsidies to loss-making state enterprises Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC). That is likely to lead to higher inflation via increased energy prices, raising pressure for policy rates to rise.

WILL THE EXCHANGE RATE POLICY BE AN ISSUE?

No. One of the conditions state that the central bank must allow flexibility in the foreign exchange rate and limit intervention to smooth volatility in the market. But the IMF has also said the flexibility should help maintain exporters' competitiveness, suggesting it is in line with the current central bank policy of intervening only when the rupee is depreciating.

Central bank Governor Ajith Nivard Cabraal told Reuters on Monday that the rupee is trading at a reasonable rate and it will continue to maintain a stable exchange rate.

Traders also expect the rupee remain steady.

In another Reuters report, By Lesley Wroughton, IMF has defended the Sri Lanka loan "amid human rights worries:''

The International Monetary Fund defended a $2.6 billion loan to Sri Lanka on Monday saying it is aware of human rights concerns by donors but the funding is needed to prevent a devastating balance of payments crisis.

The loan was approved by the IMF board on Friday with opposition from several countries including the United States, Britain, Germany, France and Argentina, which expressed concern at human rights abuses in Sri Lanka.

"In Sri Lanka's case they have been hit by the global crisis and the IMF's mandate is to address and ward off balance of payments crises," IMF mission chief to Sri Lanka, Brian Aitken told reporters on a conference call.

"The balance of payments crisis sounds rather dry but it really would have a devastating impact on the economy and on the people, particularly the most vulnerable," he added.

Aitken said the IMF was in regular contact with humanitarian groups and diplomats over human rights worries.

Months after the end of the civil war with the Liberation Tigers of Tamil Eelam, the Sri Lankan government continues to hold thousands of Tamils displaced by the fighting in detention camps, according to Human Rights Watch.

Aitken said none of the IMF funding would be directed through the government budget. Instead, the entire loan is going toward rebuilding the central banks currency reserves, which have been drained by the collapse in global trade that has affected the country's mainstay garment industry.

"The hope is that the loan provides a framework in which multilateral and bilateral donors can support the reconstruction effort directly," he added.

He also said it was important that Sri Lanka's foreign exchange policy remained flexible to meet targets for rebuilding international reserves to at least 3.5 months of imports by the end of the 20-month program.

"The program is targeted to increase reserves and the exchange rate under those circumstances needs to be flexible to respond to changes in foreign exchange flowing into the country," Aitken said.

Aitken said as the global crisis dissipates, Sri Lanka's growth should rebound quickly on the back of post-war rebuilding. He said the IMF agreed with the central banks' forecast for economic growth of 3 percent for 2009.