IMF Survey: Post-conflict, Brighter Economic Prospects for Sri Lanka

IMF News, February 4, 2011

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Sri Lanka is experiencing strong economic growth of 7.5 percent after emerging from a decades-long civil conflict.
The country "stands at a crossroads" and needs to build on current reforms to take full advantage of a favorable economic environment.

Since 2009, the IMF has assisted Sri Lanka with a $2.6 billion loan program to help recover from a balance of payment crisis triggered by the global financial crisis and return to long-term, sustainable growth.
Three decades of war had distorted the economy, hindering development and reducing potential growth; economic fundamentals have improved markedly since the end of the conflict.

Sri Lanka’s public debt grew to unsustainable levels over past decades due to increased military spending, higher debt service costs, and falling budget revenues.
The country’s fiscal position is still weak—Sri Lanka has one of the highest public debt-to-GDP ratios among emerging market countries—but this is expected to fall steadily over the coming years.
Inflation and monetary conditions have eased as the economy rebounds.

The government launched a comprehensive public investment program to address infrastructure gaps and reconstruction in the north and east.
With the help of foreign donors, Colombo plans to spend around $1½-2 billion a year on road and rail development, power production, port facilities, and water and sanitation.
The government recognizes the need for increased investment in human capital as well as physical infrastructure.

The IMF supported a fundamental reform of the tax system to generate revenue for increased spending and keep deficits under control.
In the 2011 budget, authorities proposed measures to simplify the tax system, broaden the tax base, reduce rates, and spread the tax burden more equitably—measures expected to boost tax collection.
Reforms aim to reverse distortions introduced during the conflict when sweeping tax concessions eroded the tax base and made the tax system increasingly ad hoc.
Quote: “The government’s tax reform is critical to create the fiscal space for much-needed reconstruction and infrastructure investment, as well as increases in social spending, while ensuring the fiscal deficit is put on a downward path” (Brian Aitken, IMF mission chief).

Public funds alone cannot meet overall investment needs; private sector investment must play a critical role.
Authorities need to preserve macroeconomic stability, ensure external competitiveness, facilitate capital market development, and undertake wholesale reform of the investment regime.
The government has committed to improving the business environment and building on its global competitiveness ranking.
The IMF loan program included measures to help financial sector reform, including improvements to the regulatory framework and development of domestic financial markets to finance higher private sector investment.

Future growth depends on graduating from traditional drivers (garments, tea, and other agricultural products) and exploiting strategic location and comparative advantage in services.
Priority areas for export and service expansion include transshipment and cargo, IT, business processing, and outsourcing.
Quote: “Greater regional integration, capitalizing on Asia's growth will promote higher growth. This should be coupled with growth in the export of services such as transshipment and cargo, IT, business processing, and outsourcing,” (Brian Aitken).

Economic growth: 7.5 percent
IMF loan program size: $2.6 billion
Planned donor-supported infrastructure and reconstruction spending: around $1½-2 billion a year
Conflict ended: 2009
Budget / tax reform measures referenced in: 2011

IMF Survey: Post-conflict, Brighter Economic Prospects for Sri Lanka (IMF Country Focus, February 4, 2011).