The turnaround of Sri Lanka from economic collapse to careful recovery is one of the most remarkable stories to emerge in international finance over the past few years. Not only did Sri Lanka become the first Indo-Pacific country to default on its international loans for several decades in 2022, but it has now shown marked stability through its reforms and foreign assistance. Nevertheless, behind its good economics is a complex landscape of difficulties to overcome before it is even certain whether its recovery is to come or go.
IMF’s program provides historic stability for the economy
IMF’s $3 billion Extended Fund Facility program, initiated in March 2023, has surpassed projections in terms of reviving basic economic stability for several indicators. The inflation rate was down substantially from 70 percent at the end of 2022 to negative 1.5 percent at the end of 2024’s fourth quarter, while foreign reserves swelled from zero to 6.1 billion USD.
The GDP started growing at a robust 4.5% in 2024, helped by better investor sentiment and overall stability at the macroeconomic level after several years of shrinkage. The government registered its first primary surplus in more than a decade at 2.2% of GDP, signifying budgetary prudence after several years of profligacy. This shows how overall reforms such as transparent energy prices, a broader tax base, and autonomy of monetary policy have been successful.
Key recovery indicators include:
- Inflation management: 70%+ to negative 1.5%
- Foreign reserves: Rose to $6.1 billion by 2024
- GDP growth: Recovered to 4.5% from negative growth for several years
- Budgetary performance: First primary surplus in more than a decade
- Debt restructuring: $3 billion forgiven and $25 billion in restructuring
Political change ensures reform continuity regardless of political leadership
The electoral success of the National People’s Power Party at the end of 2024 resulted in a drastic shift away from the normal politics of all these past years to bring to power President Anura Kumara Dissanayake, whose promise of “clean politics” and “social protection” had attracted most of the population to his side. At first, “overreach” was feared in market circles to some extent, but this new government quickly alleviated investors’ concerns through its assurances to stick to its IMF program, and also to make “social spending adjustments.”
This political reset cycle has also offered new legitimacy for pursuing reforms while at the same time halting or at least alleviating social concerns emanating from adjustment policies. It is through this combination of reforms being implemented while having new legitimacy in politics that the ground for sustained implementation of reforms is further assured. Yet, the first signs of ‘reform fatigue’ among the population indicate another challenge to pursue sustained social legitimacy between discipline and social protection policies.
Debt restructuring gets major creditor cooperation
A 98% participation level was achieved in Sri Lanka’s bondholders’ deal reached in December 2024, symbolizing investors’ renewed confidence and offering insights for future sovereign restructuring deals. A full restructuring deal cut down Sri Lanka’s repayment of external debts to just half of what was required for the remainder of the decade by decreasing its total external debts by 27 percentage points of its GDP and its total debts by 34 percentage points.
Outstanding external disturbances are threats to Sri Lanka’s stabilization, especially the reimposition of 30% U.S. tariffs on Sri Lankan exports by August 2025 for crucial industries like exports of apparel, tea, and seafood. The United States is responsible for 20-25% import penetration of total Sri Lankan exports and 40% of total apparel exports to Sri Lanka’s total exports, ensuring one million jobs are supported directly or indirectly through exports to this market alone.
A case study of the Sri Lankan economy shows how effective large-scale reforms have been for fast-tracking stability and how progress can become reversible amidst disturbances caused by new environments for economies to carry out their functions. At one level, it appears to be making satisfactory progress in terms of overall stability through reforms started by its policies itself, but being adversely affected by new environments amidst growing concerns for stability associated with new environments for economies to operate within at others.