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Sri Lanka - Economy

Sri Lanka, a lower middle-income country with a population of approximately 22 million, continues to face the challenge of navigating its way out of an unprecedented economic crisis. Precipitated by unsustainable external debt load and budget deficits resulting from poor fiscal management, the Sri Lankan economy contracted by an estimated 8.7 percent in 2022. Near depletion of foreign currency reserves to meet even the basic import requirements of the country resulted in shortages of basic goods including food, fuel, and medical supplies throughout 2022, with the government halting the servicing of external public debts pending an orderly restructuring of debt obligations. Mass protests led to the resignation of former President Gotabaya Rajapaksa in July 2022. Meanwhile, Sri Lanka’s deteriorating ability to import agricultural inputs such as fertilizers – exacerbated partly by surging global prices from the Russian invasion of Ukraine – led to mass food insecurity and historic food inflation reaching as high as 94.9 percent in September 2022.

Since assuming office in July 2022, President Ranil Wickremesinghe introduced a variety of sweeping financial reforms including tax hikes and ongoing privatization of money-losing state-owned enterprises (SOEs). After prolonged negotiations, the IMF approved an Extended Fund Facility (EFF) in March 2023 – valued at roughly $3 billion over four years – to support Sri Lanka’s efforts to shore up financing. The disbursement began on March 22 with the first tranche of $330 million.

Out of roughly $13 billion in exports, apparel accounted for $5.6 billion in 2022. Tourism, which recorded a severe blow due to the 2019 Easter attacks and COVID-19, gradually began recovering at the end of 2022; while still below peak arrival numbers in 2018, January-February 2023 saw two consecutive monthly arrivals of over 100,000 for the first time since 2018. Remittances recorded a considerable growth with the rapid increase of Sri Lankans seeking job opportunities overseas since the break of the crisis.

The economic reforms implemented by the Sri Lankan authorities continued to support the recovery, which continued with real GDP posting three consecutive quarters of expansion, and growth accelerating to 5.3 percent year-on-year in the first quarter of 2024. Inflation remained contained below the Central Bank of Sri Lanka’s (CBSL) 5 percent target and domestic borrowing rates have declined. Decisive progress on the reform agenda was necessary to ensure a broad-based and stable economic recovery benefitting all of Sri Lanka’s people. With Sri Lanka’s knife-edged recovery at a critical juncture, sustaining the reform momentum and ensuring timely implementation of all program commitments are critical to cement the hard-won economic progress to date and put the economy on a firm footing. Maintaining macroeconomic stability and restoring debt sustainability require further efforts to raise fiscal revenues. The 2025 Budget needs to be underpinned by appropriate revenue measures and continued spending restraint. Continuing to maintain energy prices at cost-recovery levels was critical to avoid potential fiscal costs. Protecting the poor and the vulnerable through improved targeting and better coverage of cash transfers remained critical.

A few years earlier, the island nation was going through its worst economic crisis since independence in 1948. Forty-per cent inflation, rising costs of petrol, medicines, cooking gas and other essentials put further misery on the people. Sri Lanka defaulted on its debt payments for the first time in its history on 19 May 2022, a day after the cash-strapped country declared it doesn’t even have money to buy fuel even for one-day. Sri Lanka’s central bank governor P Nandalal Weerasinghe said that island nation had fallen into a “pre-emptive default” on its debts. It had to repay about $7bn of international loans this year, out of a total foreign debt pile worth $51bn. The country’s finance ministry said it had $25m in usable foreign reserves.

Crisis-hit Sri Lanka announced 12 April 2022 that it would halt payments on its foreign debt as its dwindling reserves of dollars are needed to purchase food and fuel. “We have come to a situation where the ability to service our debt is very low. That’s why we decided to go for a preemptive default,” the newly appointed central bank governor, Nandalal Weerasinghe, announced. The payments on the South Asian country’s foreign debt would be suspended “on a temporary basis,” pending a bailout from the International Monetary Fund (IMF), he added. The Finance Ministry said Sri Lanka found itself in such a dire situation due to the “effects of the Covid-19 pandemic and the fallout from the hostilities in Ukraine.”

By April 2022 Sri Lanka faced severe shortages of food, fuel and other essentials – along with record inflation and crippling power cuts – in its most painful downturn since independence from Britain in 1948. The country was under a state of emergency imposed after a crowd attempted to storm the president's home in the capital Colombo, and a nationwide curfew in effect.

A critical lack of foreign currency left Sri Lanka struggling to service its ballooning $51-billion foreign debt, with the pandemic torpedoing vital revenue from tourism and remittances. The crisis also left the import-dependent country unable to pay even for essentials. Diesel shortages sparked outrage across Sri Lanka, causing protests at empty pumps, and electricity utilities have imposed 13-hour blackouts to conserve fuel. Many economists also said the crisis had been exacerbated by government mismanagement, years of accumulated borrowing and ill-advised tax cuts.

By late 2021 global food prices had risen sharply as lockdowns to curb the spread of COVID-19 led to a drop in productivity and disrupted supply chains, pushing up transport and freight costs across the world. Sri Lanka, which imports most essential items, including sugar and milk powder, particularly felt the pinch. The depreciation of the Sri Lankan rupee due to inflation further depleted the country’s foreign exchange reserves, which were already shrinking due to a drop in tourists and exports, the two key sources of US dollars. To control food prices and hang on to its diminishing dollars, the Sri Lankan government in September 2021 capped prices of several food items, set limits on purchases at subsidised government shops and restricted imports to essential food items that cannot be produced in Sri Lanka.

The devastating effect of the government’s sudden decision to stop importing chemical fertilisers and pesticides in early 2021, in an attempt to transition to organic farming, was still being felt in tea plantations and paddy fields though the ban had since been lifted. The scarcity of a lot of essential items was probably because of the price controls as some sellers don’t want to sell at the price-controlled amount because they are unable to make a profit. While Colombo rolled back many of those policies, the Central Bank continued to restrict banks from issuing letters of credit to traders seeking to import food and other items, aggravating shortages.

As a result, many of the island’s 22 million residents, more than three-quarters of whom live on less than $10 a day, were eating less. A kilo of fish, one of the main protein sources on the island, now cost 800-1,200 rupees ($4-6), a four-fold rise. The price of chicken doubled since late 2020r, from 400 rupees to 800 rupees ($2-$4), and milk powder and cooking gas remained scarce.

Looming debt service payments presented a significant challenge for the Sri Lankan government, as cited in the decisions of three major credit rating agencies to downgrade the country’s sovereign debt rating in 2020 and Moody’s announcement of a possible further downgrade in 2021. The government’s foreign debt payments amount to $3.7 billion in 2021. Standard & Poor’s credit rating for Sri Lanka stands at CCC+/C with a stable outlook. Moody’s credit rating for Sri Lanka stands at Caa1 with the outlook stable. Fitch’s credit rating for Sri Lanka was last reported at CCC. Despite the country’s challenging debt situation, the government publicly stated it would not seek assistance from the IMF.

Sri Lanka’s debt situation limited the government’s ability to issue sovereign guarantees for major projects. Central Bank of Sri Lanka (CBSL) expected around $1 billion in foreign exchange inflows through currency swaps with Bangladesh and through the IMFs Special Drawing Rights facility in 2021. International economic analysts expect Sri Lanka to avoid a sovereign default until at least 2022. However, in the absence of significant improvements to its economic position in 2022, Sri Lanka faced balance of payments issues given that foreign debt repayments alone amount to over $4.5 billion per year through 2025 – absorbing approximately 40 percent of the annual export receipts of goods. Rising oil prices pose an additional threat to Sri Lanka’s external position given oil imports represented 36.7 percent of the total export receipts of goods from January-May 2021.

Sri Lanka is a lower middle-income country in South Asia off the southern coast of India on the main east-west Indian Ocean shipping lanes. Gross domestic product (GDP) reached $80.7 billion and per capita GDP was $3,682 in 2020. After 30 years of civil war, which ended in 2009, Sri Lanka’s economy was transitioning from a predominantly rural-based economy towards a more urbanized economy oriented around manufacturing and services. The country made significant progress in its socio-economic and human development indicators and ranks among the highest in South Asia. Sri Lanka’s export economy was dominated by apparel and cash-crop exports, mainly tea, rubber, and coconut-based products, but technology services exports are a significant growth sector. Prior to COVID-19 and the subsequent closure of the airport, the tourism industry was expanding rapidly. Severe contractions to that industry have occurred due to the present crisis, with possible follow-on effects in other sectors of the service economy as well as manufacturing.

According to the Central Bank of Sri Lanka (CBSL), the Sri Lankan economy contracted 3.6 percent in 2020 mainly on account of the economic fallout from the COVID-19 pandemic and subsequent island-wide lockdowns imposed by the government. The Sri Lankan economy grew 4.3 percent in the first quarter of 2021, comprehensively exceeding CBSL projections of only 3.5 percent growth in the same period. The Asian Development Bank (ADB) projects 4.1 percent growth in Sri Lanka for 2021 but expects a decline of 3.6 percent in 2022 given high foreign debt obligations. CBSL projected inflation would reach 5 to 6 percent by the end of 2021. Remittances from migrant workers are a significant source of foreign exchange for the country and totaled approximately $7.1 billion in 2020 (a 5.8 percent increase from 2019). However, the inflow of labor remittances stagnated in the first five months of 2021 to $2.8 billion. Tourism was a $4.4 billion industry at its peak of 2.3 million tourist arrivals in 2018. Sri Lanka only recorded 16,908 arrivals during first and second quarter 2021 – earning $22.7 million.

Foreign direct investment (FDI) into Sri Lanka decreased to $548 million in 2020, compared to $793 million in 2019 and $1.6 billion in 2018. Recent FDI was concentrated in real estate, mixed development projects, ports, and telecommunications sectors. The tourism sector, with around two million tourist arrivals per year (before the global COVID-19 pandemic) and a variety of cultural, wildlife, and outdoor offerings, was a priority sector for the government’s post-pandemic economic recovery plan. The business process outsourcing sector was also growing and had strong involvement from U.S. firms. With a growing middle class, investors also see opportunities in franchising, retail, and services, as well as light manufacturing. The uncertainty surrounding the COVID-19 pandemic would likely continue to curtail tourism and foreign direct investment. The government had vaccinated 51 percent of the population as of September 2021.

Sri Lanka is a lower-middle income developing nation with a gross domestic product of about $50 billion (official exchange rate). This translates into a per capita income of $5,100 (purchasing power parity). Sri Lanka's 91% literacy rate in local languages and life expectancy of 75 years rank well above those of India, Bangladesh, and Pakistan. English language ability was relatively high, but declined significantly since the 1970s.

Sri Lanka's income inequality was severe, with striking differences between rural and urban areas. About 15% of the country's population remains impoverished. The effects of 26 years of civil conflict, falling agricultural labor productivity, lack of income-earning opportunities for the rural population, high inflation, and poor infrastructure outside the Western Province were impediments to poverty reduction. There are reports that poverty had been decreasing significantly in the last few years.

The Sirisena government’s initial attempts to introduce economic reforms received mixed reactions. The government’s 2016 budget contained extensive reforms that were commendable but which special interest groups were not prepared to accept. As a result, the government reversed several reforms, creating uncertainty among investors. In March 2016, the government introduced new taxes to meet increasing debt obligations and to cover previously unannounced financial commitments made by the former administration.

The Sri Lankan economy grew 4.8 percent in 2015, a year in which the new government began reversing years of statist economic policies. Gross domestic product (GDP) reached USD82 billion in 2015, and the per capita GDP was USD3,925. Growth was expected to be approximately 5.3 percent in 2016. The new government’s efforts to boost the economy are hampered by a large fiscal deficit and the slowing global economy. The government tax revenue to GDP ratio was one of the lowest in the world. Sri Lanka also suffers from a large foreign debt burden and a persistent current account deficit. Foreign debt was comprised of concessional debt and commercial debt, including debt owed to China for recent infrastructure investment.

In 1978, Sri Lanka shifted away from a socialist orientation and opened its economy to foreign investment. But the pace of reform had been uneven. A period of aggressive economic reform under the UNP-led government that ruled from 2002 to 2004 was followed by a more statist approach under President Mahinda Rajapaksa.

Despite a brutal civil war that began in 1983, economic growth averaged around 5% in the last 10 years. Due to the global recession and escalation of violence during the final stages of the war, GDP growth slowed to 3.5% in 2009 and foreign reserves fell sharply. Business confidence rebounded quickly with the end of the war and an International Monetary Fund (IMF) agreement in July 2009. Consequently, Sri Lanka recorded strong growth in 2010, as GDP grew by 8%. Official foreign reserves, including borrowings, reached $6.6 billion (5.9 months of imports). The post-war economic re-integration of northern and eastern provinces boosted agriculture and fisheries, although a large area of agricultural land was damaged by floods in early 2011.

Reconstruction of the war-damaged areas as well as infrastructure development throughout the country was also fueling growth. Tourism rebounded strongly to record levels. Exports grew by a healthy 17% in 2010. Foreign remittance inflows from Sri Lankans working abroad swelled to $4.1 billion in 2010 from $3.3 billion in 2009. The Colombo Stock Exchange was the second-best performing market for the second year in a row. Inflation, which had reached double digit levels during the war years, was around 7% in 2010. Inflation pressures are building, and inflation reached 8.6% in March 2011. Foreign direct investment (FDI) remained relatively low in 2010 at about $450 million. The FDI target for 2011 was $1 billion, including investments in the tourism sector.

Government fiscal control remains a concern. The budget deficit reached almost 10% of GDP in 2009, but was forecast to fall to around 8% of GDP in 2010.

President Rajapaksa's broad economic strategy outlined in his 2005 and 2010 election manifestos, "Mahinda Chintana" (Mahinda's Thoughts), guides government economic policy. Mahinda Chintana policies focus on poverty alleviation and steering investment to disadvantaged areas; developing the small and medium enterprise (SME) sector; promotion of agriculture; and developing Sri Lanka to become the regional hub of ports, aviation, commerce, knowledge, and energy. The government developed a 10-year development framework to boost growth through a combination of large infrastructure projects. The Rajapaksa government rejects the privatization of state enterprises, including "strategic" enterprises such as state-owned banks, airports, and electrical utilities. Instead, it plans to retain ownership and management of these enterprises and make them profitable.

The Mahinda Chintana plan aims to double Sri Lanka’s per capita income to $4,000 within 6 years. To do so, Sri Lanka requires GDP growth well over 8%, and the investment rate needs to rise from 25% of GDP to 35% of GDP.

Sri Lanka’s economy would continue its post-war resurgence and was expected to grow strongly in the immediate term. Although Sri Lanka should maintain moderate economic growth, Sri Lanka needs to enact important policy reforms to reach its full economic potential. Sri Lanka set the goal of improving its business climate, but must follow through with reforms to decrease bureaucratic red tape; increase transparency, particularly in government procurement; and increase the predictability of government policies. Sri Lanka must also continue to improve its fiscal discipline. The 26-year conflict and high government expenditure have contributed to Sri Lanka's high public debt load (83% of GDP in 2009).

Sri Lanka depended on a strong global economy for investment and for expansion of its export base. It had been advised to diversify export products and destinations to make use of the Indo-Lanka and Pakistan-Sri Lanka Free Trade Agreements and to benefit from rapid economic growth in emerging East Asia. Sri Lanka's exports to the European Union qualified for duty-free entry under the EU Generalized System of Preferences (GSP) Plus market access program, granted in 2005 to help Sri Lanka rebuild after the 2004 tsunami. However, after a lengthy review process, the European Union suspended the GSP Plus market access benefit in August 2010, due to Sri Lanka’s poor human rights record. Nevertheless, Sri Lanka’s exports grew strongly by over 17% in 2010, despite the loss of this benefit. Sri Lanka continues to receive limited tariff preferences under the EU GSP program. Sri Lanka also received preferential access to the U.S. market under the U.S. GSP program. This program was temporarily suspended pending congressional approval.

The service sector was the largest component of GDP at almost 60%. In 2010, service sector growth increased to 8% from about 3% in 2009. Tourism, shipping, aviation, telecom, trading, and financial services were the main contributors to growth. Public administration and defense expenditures increased in recent years due to hostilities, and there had been an expansion of public sector employment. Despite the end of the war, defense expenditures remain at around 3.9% of GDP. There was a growing information technology sector, especially information technology training and software development.

Industry accounts for almost 30% of GDP. Manufacturing was the largest industrial subsector, accounting for 17% of GDP. The construction sector accounts for 7% of GDP. Mining and quarrying account for 2% of GDP. Electricity, gas, and water account for 2% of GDP. Within the manufacturing sector, food, beverage, and tobacco was the largest subsector in terms of value addition. Textiles, apparel, and leather was the second-largest sector. The third-largest sector in value added terms was chemical, petroleum, rubber, and plastic products.

Agriculture lost its relative importance to the Sri Lankan economy in recent decades. It employed 31% of the working population, but accounted for only about 11% of GDP. Rice, the staple cereal, was cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop made significant contributions to export earnings. Domestic agriculture such as rice and other food crops improved significantly with the return of peace to the eastern and northern provinces. However, floods in early 2011 destroyed many crops and livestock, including rice, in the main cultivation period.

Sri Lanka's exports (mainly apparel, tea, rubber, gems and jewelry) were estimated at $8.3 billion and imports (mainly oil, textiles, food, and machinery) were estimated at $13.5 billion for 2010. The resulting large trade deficit was financed primarily by remittances from Sri Lankan expatriate workers, foreign assistance, and commercial borrowing. Sri Lanka must diversify its exports beyond garments and tea. The information technology (IT) and business process outsourcing (BPO) sector was small but growing.

Exports to the United States, Sri Lanka's most important single-country market, were estimated to be around $1.77 billion for 2010, or 21% of total exports. The United States was Sri Lanka's second-biggest market for garments, taking almost 40% of total garment exports. (The EU as a whole was Sri Lanka's biggest export market and largest apparel buyer.) India was Sri Lanka's largest source of imports, accounting for over 20% of imports. United States exports to Sri Lanka were estimated to be around $178 million for 2010, consisting primarily of machinery and mechanical appliances, medical and scientific equipment, electrical apparatus, wheat, plastics, lentils, and paper.

Sri Lanka was a large recipient of foreign assistance, with China, the World Bank, the Asian Development Bank, Japan, and other donors disbursing loans totaling almost $1.0 billion in 2009. China was a major lender for infrastructure projects, such as a new port, a coal power plant, and roads. Iran was also a major lender to Sri Lanka and committed $450 million for the Uma Oya multipurpose irrigation project and $111 for rural electrification. Iran provides an interest-free credit facility for oil imports. Iran also promised assistance for modernization of Sri Lanka's only oil refinery, though no firm commitments are in place. The Government of India was providing loans for the railway sector. Foreign grants amounted to $230 million in 2009. There continue to be problems with projects awarded without tenders.

The unemployment rate declined to 4.5% in fourth-quarter 2010, from 5.7% in fourth-quarter 2009. Unemployment was highest in the 20-29 age group. The rate of unemployment among women and high school and college graduates had been proportionally higher than the rate for less-educated workers. The government embarked on educational reforms it hoped would lead to better preparation of students and better matches between graduates and jobs.

Approximately 20% of the 7.6 million-strong work force was unionized, but union membership was declining. There are more than 1,900 registered trade unions, many of which have 50 or fewer members, and 19 federations. Many unions have political affiliations. The Ceylon Workers Congress (CWC) and Lanka Jathika Estate Workers Union are the two largest unions, representing workers in the plantation sector. The president of the CWC also was Minister of Livestock and Rural Community Development. Other strong and influential trade unions include the Ceylon Mercantile Union, Sri Lanka Nidhahas Sevaka Sangamaya, Jathika Sevaka Sangayama, Ceylon Federation of Trade Unions, Ceylon Bank Employees Union, Union of Post and Telecommunication Officers, Conference of Public Sector Independent Trade Unions, and the JVP-aligned Inter-Company Trade Union.

Public sector trade unions usually resist government moves to restructure state-owned corporations. The Government of Sri Lanka had no plans to privatize any state-owned enterprises, and in some cases the government reversed prior privatizations.

There are 1.7 million Sri Lankan citizens working abroad. A majority are women working as housemaids. Remittances from migrant workers, estimated at around $4.1 billion in 2010, was the most important source of foreign exchange for Sri Lanka, surpassing earnings from apparel exports.