By Seneka Abeyratne
Sri Lankans have received two massive shocks in recent years. The first was the COVID-19 global pandemic of 2020. The second was the economic collapse of 2022, resulting in debt default, a drastic devaluation of the currency, rampant inflation, and a severe shortage of essential goods including food, fuel, cooking gas, and medicines.
Annual GDP growth averaged 3.6% and -2.5% under the 2015-2019 and 2020-2023 regimes, respectively. Largely due to macroeconomic adjustments linked to the IMF’s Extended Fund Facility (EFF) which commenced in March 2023, the economy is showing signs of a slow but steady recovery. (Of the 48-month EFF of $ 2.9 billion, around $ 1 billion in the form of three tranches has been disbursed to date.) The Central Bank forecasts the economy to grow by 3.0 in 2024, compared with the IMF and World Bank forecasts of 2.0% and 2.2%, respectively.
IMF view on economic recovery
As per an IMF Press Release (August 2024): “The economic reform program implemented by the Sri Lankan authorities is yielding commendable outcomes. The recovery continues with real GDP posting three consecutive quarters of expansion, and growth accelerating to 5.3% year-on-year in the first quarter of 2024.
Inflation remains contained below the Central Bank of Sri Lanka’s (CBSL) 5% target and domestic borrowing rates have declined. Gross International reserves increased by US$ 1.2 billion during the first half of 2024 and reached US$ 5.6 billion. Fiscal revenue collections increased during the same period. Going forward, these improvements need to translate into better living conditions for all of Sri Lanka’s people.”
World Bank view on economic recovery
A World Bank Press Release (April 2024) points out that while the Sri Lankan economy is showing signs of stabilization, poverty rates are continuing to rise with an estimated 25.9% of the population living below the poverty line in 2023. Due to multiple pressures from high prices, income losses, and under-employment, households are struggling to make ends meet.
“Sri Lanka’s economy is on the road to recovery, but sustained efforts to mitigate the impact of the economic crisis on the poor and vulnerable are critical, alongside a continuation of the path of robust and credible structural reforms.
This involves a two-pronged strategy: first, to maintain reforms that contribute to macroeconomic stability and second, to accelerate reforms to stimulate private investment and capital inflows, which are crucial for economic growth and poverty reduction.”
External debt restructuring
The government’s external debt (excluding multilateral loans) has been restructured with debt servicing suspended until 2028. A recent online report by ECONOMYNEXT (September 8, 2024) provides a breakdown of official debt (bilateral + multilateral) by source, where the bilateral component is subdivided into 2 groups: Paris Club and Non-Paris Club.
The table shows that the bilateral debt is $10.558 billion, which is the amount excluded from debt-service obligations till 2028. China accounts for the largest share of this debt ($4.66 billion.) According to high-level government sources, Sri Lanka will save $5 billion from the bilateral debt restructuring arrangement vis-à-vis slashed interest rates and longer repayment schedules.” (Voice of America, July 2, 2024.)
The commercial debt is mainly in the form of International Sovereign Bonds (ISBs) amounting to $12.5 billion (excluding arrears). This figure does not include commercial borrowings from the China Development Bank amounting to $2.1 billion, presumably because they are excluded from debt restructuring. The government has not been servicing the commercial debt since announcing sovereign default in April 2022.
The so-called haircut applies to ISBs only. This refers to the proportion of the commercial debt in the form of ISBs to be written off. The government and existing bondholders have tentatively agreed on a ratio acceptable to both parties as per the joint working debt treatment framework.
On July 4, 2024, the Daily Mirror reported the following: “Sri Lanka has reached an agreement to restructure US$ 12.5 billion in bonds, featuring a 28% cut on face value, 11% reduction in past interest, interest payments starting in September 2024, and governance-linked bond features.”
Accrued interest, after the 11% reduction, amounts to $1.66 billion. To quote the Sunday Times of July 7, 2024: “It has been decided to issue new sovereign bonds specifically for this adjusted sum, called a plain vanilla bond, with a maturity period of 4 years and a coupon rate of 4 percent. Payments will be commenced from September 30, 2024. In addition, a payment of $225 million has to be settled as a consideration for expressing consent to the restructuring process.”
Sri Lanka’s external debt-service payments ($2.6 billion) absorbed 14.9% of the earnings from export of goods and services in 2023. Since export growth has been extremely sluggish during the past ten years (see Table 1), this ratio could increase in the near future due to interest payments on vanilla bonds entering the debt-service equation.
When export growth is sluggish, the country’s dollar reserves tend to become depleted due to the widening trade imbalance. The impact of an unhealthy trade balance on dollar reserves (gross official reserves) is shown in Table 1. During the past ten years, these reserves failed to grow and hit rock bottom in 2022, the year the economy crashed. If not for the IMF bailout, the country would be in shambles by now. Though dollar reserves have picked up since 2022, they have not yet reached a level sufficient to cover three months of imports.
A significant increase in net exports and productivity-enhancing Foreign Direct Investment (FDI) is required to accelerate economic growth and boost dollar reserves in the medium term – a tall order, given that a robust ease-of-doing-business environment for stimulating rapid private-sector development needs to be created without delay. Whether the country is capable of meeting this challenge remains to be seen. It is largely due to a tepid business environment that GDP growth has been negative in four of the past five years.
Domestic debt restructuring
The government’s domestic public debt exceeds Rs.15 trillion. Implementation of the domestic debt restructuring (DDR) plan, also known as the Domestic Debt Optimization (DDO) program, commenced soon after it was approved by parliament on July 1, 2023. Commercial banks (the largest holders of treasury bonds) were excluded from the DDR exercise as their tax burden accounts for roughly 50% of their income, and the government did not wish to subject them to further stress.
The DDO program consisted of two main components: (a) conversion of Rs.2.54 trillion worth of treasury bills held by the CBSL into treasury bonds; and (b) replacement of Rs.3.22 trillion worth of existing treasury bonds held by the Employment Provident Fund (EPF) with new treasury bonds.
Both conversions entailed an extension of the maturity period and a lowering of the coupon rate of the relevant debt instrument. This was done with a view to gradually reducing the government’s annual debt-service payments (gross financing needs) to GDP ratio to an acceptable level, as required by the IMF agreement.
Over 90% of EPF assets were invested in the old treasury bonds which have been converted into new bonds. To quote the CBSL Governor: “These bonds will earn 12% interest until 2025 and 9% interest thereafter. Importantly, the amount in the EPF will not decrease as the government guarantees a future benefit of 9% interest. Any deficit will be covered by the treasury.
Those who choose not to participate in the treasury-bond exchange have the option of paying a 30% tax instead of the standard 14% tax. The aim is to complete the bond exchange within a few weeks and finalize the process in July.” (Ceylon Today, Online, July 8, 2023). If one were to ask the architects of the DDO program why they targeted superannuation funds instead of exploring other options, such as a wealth tax, “Easy pickings” is likely to be their cynical response.
High cost of living
The drastic currency devaluation that occurred in April 2022 triggered a huge spike in the inflation rate, which inflicted enormous suffering on the poor. Though the inflation rate is averaging only 2.5% in 2024, due to the price hike in 2022, the Colombo Consumer Price Index (CCPI) for all items increased from 100 in 2021 (base year) to 191.8 in 2023 (see Table 48 of the CBSL Annual Review 2023, Statistical Appendix).
The CCPI is currently in the neighborhood of 196, which means prices of consumer goods have more or less doubled between 2021 and 2024. Since average GDP growth has been negative during the past five years, the majority of consumers have experienced a steep decline in real per capita incomes.
Hence, government policy has a crucial role to play in stimulating the creation of productive income- and employment-generating activities for active job-seekers, using global competitiveness as the yardstick. Tourism, agribusiness, and information communication technology are three key sectors in this regard.
Current status of Sri Lankan economy
The bottom line is that in terms of a wide range of macroeconomic indicators, such as GDP growth, external trade balance, fiscal deficit to GDP ratio, and external current account to GDP ratio, the country’s performance during the past ten years has been exceedingly poor (see Table 1). It is encouraging to note that largely due to policy reforms implemented under the IMF Agreement, these indicators performed far better in 2023 than in 2022. In this regard, it is worth mentioning that last year the country registered an external current account surplus after nearly five decades. The primary balance surplus achieved last year is also a rarity.
“Sri Lanka’s performance under its Fund- Supported program remains strong. All quantitative targets were met, except for the marginal shortfall of indicative target on social spending. Most structural benchmarks were either met or implemented with delay. Reforms and policy adjustment are bearing fruit.
The economy is starting to recover, inflation remains low, revenue collection is improving, and reserves continue to accumulate. Despite these positive developments, the economy is still vulnerable and the path to debt sustainability remains knife-edged.” (Kenji Okamura, Deputy Managing Director, IMF.)
The country does not have much time to get its act together. It will be seen from Table 1 that throughout the 2014 to 2023 period, the external trade balance was negative. If by 2028 (when the loan repayment moratorium ends), the trade imbalance has not been corrected, there is every possibility of another severe balance of payments (BOP) crisis occurring by the end of this decade. Policy and regulatory reform should therefore be accompanied by rapid growth of net exports and FDI inflows in order to ensure long-term economic stability.
Export-led growth
The most effective way to achieve a sustainable BOP surplus is through rapid, export-led growth. What is urgently required at this time is a viable institutional mechanism for formulating and implementing a sound export-led growth strategy, which must be anchored in a stable and consistent macroeconomic policy framework.
This is Sri Lanka’s last chance to get it right. The newly elected President should be aware that if the ongoing, IMF-supported policy reform program is undermined by a populist political agenda and the wrecking ball of debt distress, macroeconomic instability, and economic collapse unleashed again, the multilateral donor community may pull out en masse. This would surely spell doom for the island.
The author is a retired economist and former international consultant to ADB/Manila. He can be contacted at snabeyratne@gmail.com
Factum is an Asia-Pacific-focused think tank on International Relations, Tech Cooperation, and Strategic Communications accessible via www.factum.lk
The views expressed here are the author’s own and do not necessarily reflect the organization’s.
Table 1: Sri Lanka – Selected Macroeconomic Indicators 2014-2023
| Indicator | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
| GDP growth (%) | 5.0 | 4.2 | 5.1 | 6.5 | 2.3 | –0.2 | -4.6 | 4.2 | -7.3 | –2.3 |
| Government expenditure (% of GDP) | 16.7 | 19.8 | 18.2 | 17.9 | 17.5 | 21.0 | 19.4 | 20.0 | 18.6 | 19.4 |
| Government revenue + grants (% of GDP) | 11.2 | 12.6 | 13.2 | 12.8 | 12.6 | 11.9 | 8.8 | 8.3 | 8.4 | 11.1 |
| Domestic current account balance (% of GDP) | -1.2 | -2.3 | -0.6 | -0.7 | -1.2 | -3.6 | -7.9 | -7.3 | -6.4 | -6.0 |
| Primary balance (% of GDP) | -1.5 | -2.9 | -0.2 | 0.0 | 0.6 | -3.6 | -4.6 | -5.7 | -3.7 | 0.6 |
| Fiscal balance (% of GDP) | -5.5 | -7.2 | -5.0 | -5.1 | -5.0 | -9.0 | -10.7 | -11.7 | -10.2 | -8.3 |
| Exports (USD billion) | 11.1 | 10.6 | 10.3 | 11.4 | 11.9 | 11.9 | 10.0 | 12.5 | 13.1 | 11.9 |
| Imports (USD billion) | 19.4 | 18.9 | 19.2 | 21.0 | 22.2 | 19.9 | 16.1 | 20.6 | 18.3 | 16.8 |
| External trade balance (USD billion) | -8.3 | -8.3 | -8.9 | -9.6 | –10.3 | -8.0 | -6.1 | -8.1 | -5.2 | -4.9 |
| Foreign direct investment (USD million) | 894 | 680 | 897 | 1373 | 1614 | 743 | 434 | 592 | 898 | 712 |
| Workers’ remittances (USD billion) | 7.0 | 7.0 | 7.2 | 7.1 | 7.0 | 6.7 | 7.1 | 5.5 | 3.8 | 6.0 |
| External current account balance (% of GDP) | -2.5 | -2.2 | -2.0 | -2.4 | -3.0 | -2.1 | -1.4 | -3.7 | -1.9 | 1.8 |
| Balance of payments (USD billion) | 1.4 | -1.5 | -0.5 | 2.1 | -1.1 | 0.4 | -2.3 | -4.0 | -2.8 | 2.8 |
| Gross official reserves (USD billion) | 8.2 | 7.3 | 6.0 | 8.0 | 6.9 | 7.6 | 5.7 | 3.1 | 1.9 | 4.4 |
| External debt (USD billion) | 42.9 | 44.8 | 46.4 | 51.6 | 52.4 | 54.8 | 49.0 | 51.8 | 49.7 | 54.8 |
| External debt (% of GDP) | 54.1 | 52.7 | 52.8 | 54.7 | 55.3 | 61.6 | 58.1 | 58.4 | 64.6 | 65.0 |
| Inflation rate ( %) | 3.3 | 2.2 | 4.0 | 6.6 | 4.3 | 4.3 | 4.6 | 6.0 | 46.4 | 16.5 |
| Exchange rate (Rs/USD) | 130.56 | 135.94 | 145.60 | 152.46 | 162.54 | 178.78 | 185.52 | 198.88 | 324.55 | 327.53 |
