Sri Lanka

Rebound in tourism and industry drive recovery

After a two-year contraction triggered by the severe balance-of-payments and debt crisis of 2022, the economy began to recover strongly in 2024. Momentum was underpinned mainly by a recovery in construction and services, particularly tourism. Growth also benefited from a rebound in manufacturing, which had been badly hit by the crisis, notably in the food sector, but also in textiles and clothing, as supply shortages eased. In 2025, although growth is likely to slow, reflecting the dissipation of the particularly favourable base effects in 2024, it will nonetheless remain high. On the demand side, falling inflation (deflation expected in 2025) and the resulting rise in real incomes will stimulate private consumption. As will the improvement in employment induced by the continuing boom in tourism and industry. Continued monetary loosening by the central bank will stimulate private investment. Agriculture (8% of GDP, but 30% of employment) will remain vulnerable to the unpredictable nature of the weather, notably the La Niña phenomenon in early 2025, which could affect the rice harvest.

Inflation, which peaked at 67.4% in September 2022, has slowed considerably since 2023, but especially in 2024, due to lower food and energy prices, appreciation of the rupee, improved supply conditions and moderating demand (still moderate, though recovering). In 2025, the trend is set to continue despite increases in consumption taxes. Since June 2023, the central bank has considerably eased monetary policy to stimulate the country's post-crisis recovery. It reduced its benchmark interest rate from 15.5% to 8% in November 2024. It is expected to continue moderating its interest rate. However, a slowdown in the Fed's interest-rate cutting cycle could lead to rupee depreciation and consequently prompt imported inflation and a policy reversal.

Improved public finances bolstered by debt restructuring

The public deficit will continue to narrow in 2025. The new government is committed to meeting the commitments of the IMF's Extended Credit Facility rescue program (approved in March 2023 for a total of USD 2.9 billion over 4 years). Among the administration’s priorities is the implementation of structural reforms aimed at strengthening governance, stepping up the fight against corruption and improving the fiscal situation. Revenues, which rose from 7% to 10% of GDP between 2022 and 2024, should continue to grow on back of increases in VAT and excise duties. New measures agreed as part of the second review of the IMF program, such as the introduction of a rental tax and the limitation of tax exemptions, are also planned. At the same time, the new left-wing government will pursue measures to rationalise public spending, while avoiding excessive cuts in capital expenditure, which is essential to sustain long-term economic growth. Priority will be given to increasing wages and social assistance (Social Safety Nets Program) to protect the most vulnerable populations. The sweeping budgetary adjustment carried out in 2024 will slow the pace of these increases in 2025. Last, the restructuring of public debt (44% external) will significantly reduce the burden of servicing it, as well as liquidity risk, but the public debt-to-GDP ratio will remain high in 2025, although it will decrease thanks to continued fiscal consolidation.

After defaulting in May 2022 on the bilateral and commercial portion (USD 28 billion) of its foreign debt (USD 46 billion), the country proceeded to restructure its debt as part of the IMF rescue program. At the end of 2024, it signed an agreement in principle to exchange its defaulted sovereign international bonds (ISBs) for new debt instruments. While the agreement was initially negotiated with the ad-hoc group (the international holders) and the local consortium (the Sri Lankan holders), who collectively hold 50% of the outstanding ISBs, almost all of the outstanding ISBs will eventually be restructured (USD 14.2 billion). The restructuring initiative introduces macro-linked bonds that adjust repayments in line with economic growth. As a result, an initial USD 3 billion reduction in outstanding debt is planned, which will rise to USD 4.3 billion in the event of an economic slowdown or USD 1.8 billion in the event of economic outperformance. The average coupon rate will be reduced from 6.4% to 4.3%, while the average maturity will be extended to six years. At the same time, the country has concluded arrangements with its bilateral and other commercial creditors, including the Official Committee of Creditors (OCC), led by Japan, India and France (USD 5.8 billion), the Export-Import Bank of China (USD 4.2 billion) and the China Development Bank (USD 3.3 billion). These agreements provide for maturity extensions, interest rate reductions and a capital grace period until 2028. In total, the country will benefit from over USD 17 billion in debt service relief over the next four years (USD 9.5 billion from bondholders, USD 2.9 billion from the OCC, USD 2.4 billion from Eximbank and USD 2.5 billion from the China Development Bank).

In 2025, the current account surplus will slow slightly again. The trade balance is set to widen due to the expected rise in imports, triggered by a gradual recovery in domestic demand and the lifting of import restrictions. However, the negative impact of the trade deficit will be partly offset by the growing surplus on the secondary and services balance, resulting from higher tourism receipts and remittances. In addition, foreign exchange reserves will rise to USD 7.2 billion in 2025, boosted by currency appreciation, lower debt servicing costs over the period, and higher tourism receipts. They will also benefit from the expected disbursement of USD 333 million from the IMF (approved following validation of the third program review) and the recent concessional loans of USD 200 million each from the Asian Development Bank and the World Bank, granted at the end of 2024.

A new government to meet people's expectations after the crisis of 2022

In September 2024, Anura Kumara Dissanayake was elected president with 42.3% of the vote, becoming the first left-wing head of state in the country's history. Leader of the National Coalition for People's Power (NPP), Dissanayake is a Marxist who has largely converted to a market economy and renounced armed struggle. During his campaign, he denounced the corruption of the political elites and promised to reduce taxes on food and medicines, which weigh heavily on the population. His victory reflects the deep discontent of the people and their economic concerns, which have been exacerbated by the severe economic and financial crisis that shook the country in 2022. The President appointed Harini Amarasuriya as Prime Minister, making her the country's first female leader in 24 years. Faced with the NPP's poor representation in Parliament – the party holds a mere three seats out of 255 - Dissanayake dissolved the legislature and called a snap election for November 2024. The NPP won the election with an absolute majority (62%, i.e., 159 seats out of 225), giving it free rein to reform the country.

The country's financial dependence on bilateral donors and multilateral institutions forces the government to maintain good relations with all of them. India is one of the main investors and plays a key development role through its grants and concessional loans. In particular, it provided USD 4 billion in aid in 2023 in the form of currency swaps, lines of credit and deferred payments. In 2025, the two countries agreed to strengthen their cooperation for defence. However, the concomitant rapprochement with China, the country's main bilateral creditor (39% of bilateral debt in 2023), could complicate their relations. Beijing was the first to propose an agreement on debt restructuring in October 2023 and is investing again, notably in the development of a USD 4.5 billion refinery by Sinopec (China Petroleum and Chemical Corporation), on which work began in June 2024. The port of Hambantota, delivered by China in 2010, has long been seen as an illustration of the debt trap. Due to the project's low profitability, the Sri Lankan government was forced in 2017 to sign a concession agreement as part of a public-private partnership with China Merchants Port Holdings, whereby the latter obtained a 70% interest for 99 years in exchange for payment of just over USD 1 billion. The port has enjoyed belated success as a transshipment hub. It recorded a growth rate of 22% in 2024, made possible by infrastructure upgrades, including the introduction of gantry cranes and yard cranes in the container yard. On the occasion of the President's first visit to China in January 2025, Beijing reaffirmed its support for Sri Lanka's economic development through the New Silk Road initiative. It also pledged to strengthen social cooperation by supporting education, health and anti-poverty projects.

Last updated: January 2024