Sri Lanka’s Debt Deal with Japan and IMF support Boosts Economic Recovery

• CNL Reporter
• March 8, 2025
• Weekly Economic Review
• Weekly Economic Review
• 0 Comments

Weekly economic Review

Sri Lanka has made significant progress in its economic recovery by finalizing a $2.5 billion debt restructuring agreement with Japan. This milestone, reached after two years of negotiations, is a crucial step toward financial stability.

The agreement allows the resumption of stalled development projects, including the expansion of the country’s main airport, which had been delayed following Sri Lanka’s 2022 foreign debt default.

The economic crisis leading to this default severely impacted the country, making it difficult to import essential goods like fuel, medicine, and cooking gas.

However, Sri Lanka has recovered faster than expected, aided by a $2.9 billion bailout from the International Monetary Fund (IMF). Finance Ministry Secretary Mahinda Siriwardena emphasized the importance of ongoing economic reforms to avoid future crises.

To maintain IMF support, Sri Lanka continues to negotiate further debt restructuring agreements with major creditors such as China and India.

In December, the country reached a $12.5 billion debt restructuring deal with international bondholders, and discussions with China could lead to additional investments and economic cooperation.

The IMF recently approved the third review of Sri Lanka’s bailout program, resulting in the release of an additional $334 million, bringing the total disbursed amount to $1.3 billion.

The IMF acknowledged Sri Lanka’s strong recovery but stressed the need for fiscal discipline. Key recommendations included avoiding tax exemptions, improving tax compliance, refining social welfare distribution, and ensuring efficient capital expenditure management to sustain economic growth.

The agreement with Japan not only strengthens bilateral relations but also boosts international confidence in Sri Lanka’s economic policies and debt management strategies. This development is expected to attract investors, foster economic growth, and contribute to regional stability.

While Sri Lanka is making steady progress, achieving full economic recovery remains a challenge. The country must adhere to IMF guidelines and implement structural reforms to sustain its economic rebound. A key priority is finalizing agreements with remaining creditors to ensure a stable financial future.

Stock Market Performance and Economic Indicators

Despite positive economic indicators, Sri Lanka’s stock market closed slightly lower, declining by 0.05%. The broader All Share Price Index (ASPI) dropped by 7.63 points, while the S&P SL20 index fell by 9.01 points. Market turnover remained below the monthly average, with some investors engaging in profit-taking.

Meanwhile, Sri Lanka’s tourism sector is rebounding strongly. By early March 2025, the country had welcomed over 530,000 tourists, a 15.1% increase from the previous year. Authorities remain optimistic about achieving their target of 3 million tourist arrivals by the end of the year. India and Russia continue to be the leading sources of visitors, contributing significantly to economic growth.

Worker remittances have also shown positive growth, with inflows reaching $548.1 million in February 2025, reflecting a 15.1% increase from the previous year. Additionally, Sri Lanka’s foreign exchange reserves have risen to an estimated $6.1 billion by the end of February, according to the Central Bank.

Future Outlook and Policy Recommendations

To sustain economic momentum, Sri Lanka must focus on strengthening tax compliance, maintaining exchange rate flexibility, and gradually phasing out balance-of-payments measures. The IMF advises the government to ensure that social spending is well-targeted, prioritizing support for disadvantaged groups while managing fiscal constraints.

Structural reforms in the financial sector are also crucial. Addressing non-performing loans, improving governance in state-owned banks, and enhancing insolvency frameworks will be key to stimulating credit growth and overall economic recovery.

With ongoing reforms and international backing, Sri Lanka is on a promising path toward restoring economic stability. However, continuous efforts are required to secure long-term growth and prevent future financial crises.

The IMF has emphasized the need for effective social spending to alleviate economic hardship, ensuring that vulnerable populations benefit from Sri Lanka’s recovery.

Well-targeted social support is essential for promoting inclusive growth, especially given the country’s limited fiscal space. Additionally, restoring cost-recovery pricing for electricity without delay is crucial to managing fiscal risks associated with state-owned enterprises.

A smoother execution of capital spending within the available fiscal resources would foster medium-term growth, according to the IMF. One proposed revenue measure was an imputed rental income tax, initially introduced by the previous administration as part of a 2025 revenue package. However, the new government has suggested an alternative package aligned with its priorities.

Sri Lanka previously had one of the lowest tax revenue collections among middle-income and low-income countries. However, recent efforts have led to significant progress, with tax revenue as a share of GDP increasing by 5 percentage points—from around 7% to approximately 12.4% last year. Although this is a notable improvement, it is not excessive, and essential government services must be adequately funded.

Conclusion

Sri Lanka has made considerable progress in stabilizing its economy through strategic debt restructuring and IMF-backed reforms. The agreement with Japan marks a significant step in rebuilding the country’s financial stability and reviving crucial infrastructure projects. While economic indicators, such as tourism and worker remittances, show positive trends, challenges remain in achieving full economic recovery.