Sri Lanka at a Crossroads: Path to Sustainable Growth amidst Economic Recovery

Weekly Economic Review

Navigating Opportunities and Challenges in a Post-Crisis Economy

Sri Lanka’s experience serves as an important case study for middle-income nations dealing with post-pandemic debt distress. As of mid-January 2025, the country’s economy is showing signs of stability, driven by economic growth, low inflation, a thriving tourism sector, and a strong stock market. However, significant challenges remain on the horizon.

Sri Lanka stands at a pivotal moment, balancing between economic opportunity and lingering risks. The newly elected National People’s Power (NPP) government must navigate this delicate balance by implementing a transformative growth strategy that ensures long-term debt sustainability, prevents future crises, and fosters equitable economic progress.

To support this effort, ODI Global has launched a study group comprising prominent Sri Lankan economists. This initiative builds upon insights from the co-edited essay series Sri Lanka: From Debt Default to Transformative Growth, which outlines 27 actionable policy recommendations developed by both local and international experts.

Lessons from the Crisis and the Path Forward

The urgency of economic reform stems from the severe crisis Sri Lanka endured between 2022 and 2023, following a historic default on external debt in April 2022. This default marked a significant setback for a nation once recognized for its progress in meeting basic needs, despite being a low-income country in the 1970s.

The root causes of the crisis remain widely debated. Key contributors include persistent fiscal and current account deficits, economic mismanagement from 2019 to 2022, and extensive commercial borrowing from China’s policy banks for underperforming infrastructure projects such as the Hambantota Port and Mattala Airport. Additionally, external shocks like the 2019 Easter Bombings, the COVID-19 pandemic, and the Russia-Ukraine conflict further exacerbated economic instability. President Anura Kumara Dissanayake and the NPP government campaigned on a promise of transparent governance and economic reform to address these issues.

Economic Stabilization and Persistent Risks

Sri Lanka’s economy has witnessed a remarkable stabilization in recent months. The Central Bank’s prudent financial policies, combined with a $3 billion IMF program and $4 billion in financial aid from India, have contributed to a more stable macroeconomic environment. Additionally, a $17.5 billion debt restructuring agreement with private bondholders and China has alleviated immediate fiscal pressure. A resurgence in tourism has further strengthened foreign exchange reserves.

President Dissanayake has reaffirmed his commitment to the IMF program and debt restructuring while emphasizing increased social spending to combat poverty, a stance also taken by his predecessor. The World Bank projects economic growth at 4.4% in 2024, with a slight decline to 3.5% in 2025. However, maintaining this trajectory will require a well-defined growth plan to address potential economic vulnerabilities.

Public debt remains a significant concern, with projections indicating that it will exceed 100% of GDP by 2028. Despite the restructuring agreement, high debt servicing obligations pose long-term risks. Additionally, demands for wage increases from public sector unions could add further fiscal strain.

Currency Volatility and Inflation Trends

The Sri Lankan rupee has experienced fluctuations, leading to reports labeling it the world’s worst-performing currency in early 2025. However, Central Bank Governor Nandalal Weerasinghe has explained that short-term volatility is expected under a flexible exchange rate regime. Although the rupee depreciated by 2% in January, it had appreciated by over 10% in both 2023 and 2024 after a sharp decline in 2022 due to the country’s financial crisis.

Weerasinghe emphasized that currency depreciation does not necessarily indicate economic weakness, citing similar trends in major economies like India and China, which have substantial foreign exchange reserves. He argued that a currency should experience both appreciation and depreciation within a flexible exchange rate framework.

On the inflation front, Sri Lanka’s consumer prices fell by 4% in December 2024, with the Colombo Consumer Price Index (CCPI) increasing by only 0.5%. The Central Bank’s deflationary policies since 2022, including stabilizing the exchange rate and reducing inflationary pressures, have contributed to this trend. As a result, inflation has only increased by 1.7% since September 2022, reaching levels comparable to developed economies. However, some concerns remain about wage stagnation and the impact of inflation on household incomes.

Stock Market and Investment Climate

Despite ongoing economic challenges, Sri Lanka’s stock market remains resilient. The All Share Price Index (ASPI) showed marginal gains, closing 0.04% higher on the last Friday of January. Investors displayed mixed sentiments, with month-end selling pressure offset by renewed buying interest. Sectors such as banking, finance, and capital goods attracted significant investor attention, especially following the easing of the vehicle import ban.

Financial institutions like LOLC Finance, Commercial Bank, and DFCC Bank recorded modest gains, signaling renewed investor confidence. The market, though stagnant, continues to witness gradual intervals of selling and buying pressure, indicating cautious optimism among investors.

Agriculture and Commodity Markets

Agricultural production and commodity markets remain essential to Sri Lanka’s economic stability. The country’s rice industry is recovering, with new paddy harvests arriving from key districts after delays caused by heavy rains. The Marandhagahamulla Rice Producers Association has assured the public that staple rice varieties will be available at controlled prices.

Similarly, Sri Lanka’s coconut industry has faced fluctuations in auction prices. In January 2025, auction prices for 1,000 coconuts were capped at 140,000 rupees following a previous peak of 145,687 rupees. However, lower auction volumes suggest that farmers are opting to sell their produce on the open market rather than at controlled prices. The coconut industry has also experienced production shortfalls, potentially affecting exports and necessitating the import of raw materials to remain competitive in global markets.

The Road Ahead: Ensuring Sustainable Growth

While Sri Lanka has made significant strides in economic recovery, sustaining growth requires a comprehensive strategy. The NPP government must focus on long-term policy measures, including:

Debt Management: Ensuring fiscal discipline while negotiating favorable terms for ongoing debt restructuring.

Exchange Rate Stability: Implementing monetary policies that balance inflation control with economic growth.

Public Sector Reform: Addressing wage demands while improving productivity and efficiency.

Investment in Key Sectors: Strengthening industries such as tourism, agriculture, and finance to drive economic expansion.

Social Welfare Initiatives: Expanding social safety nets to protect vulnerable populations and reduce poverty.

The coming years will be crucial for Sri Lanka as it seeks to cement its economic stability and transition towards sustainable, inclusive growth. The government’s ability to implement sound economic policies while balancing fiscal constraints with social needs will determine the nation’s long-term prosperity.

 

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