Sri Lanka’s economy teeters on the brink, with its path to debt sustainability remaining knife-edged despite recent progress. This urgent warning from the IMF accompanies the conclusion of the 2024 Article IV Consultation and the second review under the Extended Fund Facility (EFF). On June 12, 2024, the IMF granted Sri Lanka immediate access to SDR 254 million (approximately USD 336 million) to bolster its economic reforms and policies. While there are glimmers of recovery, the journey ahead is fraught with formidable challenges and risks.
Sri Lanka’s performance under the EFF program has been commendable, meeting all quantitative targets for the end of December 2023 except for a minor shortfall in social spending. Most structural benchmarks due by April 2024 were either met or slightly delayed. The IMF notes that despite these achievements, vulnerabilities persist, making the journey to debt sustainability precarious. Signs of recovery are evident: real GDP grew by 3% year-on-year in the second half of 2023, inflation was contained at 0.9% in May 2024, and gross international reserves rose to USD 5.5 billion by the end of April 2024. Additionally, the primary balance turned positive, with tax revenue increasing to 9.8% of GDP in 2023.
Despite these positive developments, the IMF emphasizes that Sri Lanka’s economy remains vulnerable. The path to debt sustainability is “knife-edged,” with critical risks stemming from ongoing debt restructuring and the need for sustained revenue mobilization. Vulnerabilities within the banking sector and the challenge of accumulating reserves further complicate the economic outlook. The IMF’s recommendations highlight several crucial areas to ensure sustainable recovery.
Continued efforts in revenue mobilization and finalizing debt restructuring according to program targets are essential. Protecting social and capital spending is critical, along with advancing public financial management to enhance fiscal discipline and strengthen the debt management framework. Prioritizing price stability remains essential. The IMF advises against monetary financing and underscores the importance of central bank independence. Continued exchange rate flexibility and phasing out balance of payments measures are necessary to rebuild external buffers and facilitate external rebalancing. Restoring bank capital adequacy and improving governance of state-owned banks are top priorities to support economic recovery. Effective implementation of the Banking Act amendments is vital to enhance supervision. Addressing structural challenges is crucial for unlocking long-term growth potential. The IMF calls for the implementation of governance reforms, trade liberalization, labour market reforms to increase female labour force participation, and state-owned enterprise reforms to improve efficiency and fiscal transparency.
Looking ahead, the IMF projects moderate growth for Sri Lanka in 2024-2025, constrained by limited bank credit and fiscal consolidation. Uncertainties surrounding debt restructuring and policy directions post-election add to the challenges. Despite a positive current account outlook driven by improved tourism and remittances, domestic and external risks remain, including potential reform fatigue and global economic volatility.
Sri Lanka’s economic situation, as assessed by the IMF, presents a cautious optimism interspersed with significant concerns. While the country demonstrates encouraging signs of recovery under the EFF-supported program, the path to sustained economic stability and debt sustainability is narrow and fraught with risks. Strong reform efforts, bolstered by adequate safeguards and contingency planning, are essential for Sri Lanka to navigate this challenging journey successfully.
