IMF Executive Board Concludes 2021 Article IV Consultation with Sri Lanka

IMF News, March 2, 2022

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Published: March 2, 2022

Background and pandemic impact

Sri Lanka was highly vulnerable to external shocks before COVID-19 due to inadequate external buffers and high risks to public debt sustainability, exacerbated by the Easter Sunday terrorist attacks in 2019 and large tax cuts in late 2019.
Real GDP contracted by 3.6 percent in 2020 because of a loss of tourism receipts and lockdown measures.
Sri Lanka lost access to the international sovereign bond market at the onset of the pandemic.
GDP growth is projected to have recovered to 3.6 percent in 2021, with mobility indicators largely back to pre-pandemic levels and tourist arrivals beginning to recover in late 2021.

Policy response and recovery

Authorities deployed prompt and broad-based relief measures: macroeconomic policy stimulus, increased social safety net spending, and loan repayment moratoria for affected businesses.
A strong vaccination drive complemented these measures.
Limited availability of external financing led to a large amount of central bank direct financing of the budget.
The official exchange rate has been effectively pegged to the U.S. dollar since April 2021.

Fiscal and external positions

Annual fiscal deficits exceeded 10 percent of GDP in 2020 and 2021 due to pre-pandemic tax cuts, weak revenue performance, and pandemic-related expenditures.
Public debt is projected to have risen from 94 percent of GDP in 2019 to 119 percent of GDP in 2021.
Large foreign exchange debt service payments and a wider current account deficit led to a significant FX shortage.
International reserves are inadequate, and despite efforts to secure FX financing from external sources, reserves remain low.

Outlook and risks

The economic outlook is constrained by the debt overhang and persistently large fiscal and balance-of-payments financing needs.
GDP growth is projected to be negatively affected by the FX shortage and macroeconomic imbalances.
Inflation accelerated to 14 percent (y/y) in January 2022 and is projected to remain double-digit in the coming quarters, exceeding the target band of 4–6 percent.
Under current policies and the authorities’ commitment to preserve the tax cuts, the fiscal deficit is projected to remain large over 2022–26, raising public debt further over the medium term.
Risks tilted to the downside include: insufficient financing for fiscal and balance-of-payments needs, contractions in imports and private credit growth, monetary instability if central bank financing continues, COVID-19 resurgence, rising commodity prices, worse-than-expected agricultural production, deterioration in banks’ asset quality, and extreme weather events.
Upside risks include faster-than-expected tourism recovery and stronger-than-projected FDI inflows.

Executive Board assessment and policy recommendations

Directors commended the prompt policy response and successful vaccination drive.
Directors stressed urgency of a credible and coherent strategy to restore macroeconomic stability and debt sustainability, while protecting vulnerable groups and reducing poverty through strengthened, well-targeted social safety nets.
Fiscal policy:
- Need for ambitious fiscal consolidation based on high-quality revenue measures.
- Scope for raising income tax and VAT rates and minimizing exemptions, complemented with revenue administration reform.
- Encourage continued improvements to expenditure rationalization, budget formulation and execution, and the fiscal rule.
- Encourage reform of state-owned enterprises and adoption of cost-recovery energy pricing.
Monetary and exchange rate policy:
- A tighter monetary policy stance is needed to contain rising inflationary pressures.
- Phase out central bank direct financing of budget deficits.
- Gradual return to a market-determined and flexible exchange rate to facilitate external adjustment and rebuild international reserves.
- Gradually unwind capital flow management measures as conditions permit.
Financial sector and structural policies:
- Monitor asset quality closely and identify vulnerabilities through stress testing.
- Continue legislative reforms to strengthen regulatory, supervisory, and resolution frameworks.
- Renewed efforts on growth-enhancing structural reforms: increase female labor force participation, reduce youth unemployment, diversify the economy, phase out import restrictions, and improve the business and investment climate.
- Prudent management of the Colombo Port City project and continued efforts to strengthen governance and fight corruption.
- Increase resilience to climate change.

Key statistics (Selected Economic Indicators, 2018–22)

Real GDP growth (percent): 2018: 3.3; 2019: 2.3; 2020: -3.6; 2021: 3.6; 2022 Proj.: 2.6
Inflation (average, percent) (Colombo CPI): 2018: 4.3; 2019: 4.6; 2020: 6.0; 2021: 10.5; 2022 Proj.: [not listed]
Inflation (end of period, percent) (Colombo CPI): 2018: 2.8; 2019: 4.8; 2020: 4.2; 2021: 12.1; 2022 Proj.: 8.3
Central government revenue and grants (percent GDP): 2018: 13.5; 2019: 12.6; 2020: 9.2; 2021: 8.9; 2022 Proj.: 10.7
Central government expenditure (percent GDP): 2018: 18.8; 2019: 20.6; 2020: 21.9; 2021: 20.3; 2022 Proj.: [not listed]
Primary balance (percent GDP): 2018: 0.6; 2019: -2.0; 2020: -6.2; 2021: -4.9; 2022 Proj.: -2.8
Overall balance (percent GDP): 2018: -5.3; 2019: -8.0; 2020: -12.8; 2021: -11.4; 2022 Proj.: -9.6
Central government debt (percent GDP): 2018: 84.2; 2019: 86.8; 2020: 101.2; 2021: 107.1; 2022 Proj.: 108.6
Public debt (percent GDP) 2/: 2018: 91.0; 2019: 93.6; 2020: 110.0; 2021: 118.9; 2022 Proj.: 119.9
Broad money (percent change): 2018: 13.0; 2019: 7.0; 2020: 23.4; 2021: 15.4; 2022 Proj.: 13.9
Credit to the private sector (percent change): 2018: 15.9; 2019: 6.5; 2020: 13.8; 2021: [not listed]; 2022 Proj.: [not listed]
Current account (percent GDP): 2018: -3.2; 2019: -2.2; 2020: -1.3; 2021: -3.8; 2022 Proj.: [not listed]
FDI (percent GDP): 2018: 1.8; 2019: 0.8; 2020: 0.5; 2021: 0.9; 2022 Proj.: 1.2
Reserves (US$ millions): 2018: 6,919; 2019: 7,642; 2020: 5,664; 2021: 3,138; 2022 Proj.: 2,204
Reserves (months imports): 2018: 3.4; 2019: 5.0; 2020: 3.1; 2021: 1.5; 2022 Proj.: 1.0
External debt (percent GDP) 3/: 2018: 60.2; 2019: 65.1; 2020: 66.4; 2021: 65.6; 2022 Proj.: 64.2

IMF Executive Board Concludes 2021 Article IV Consultation with Sri Lanka, March 2, 2022.

IMF Executive Board Concludes 2021 Article IV Consultation with Sri Lanka

Source details

Other formats

Bibliographic details

Background and pandemic impact

Policy response and recovery

Fiscal and external positions

Outlook and risks

Executive Board assessment and policy recommendations

Key statistics (Selected Economic Indicators, 2018–22)

References