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Overview

Country Context

Sri Lanka faces unsustainable debt and significant balance of payments challenges. The economic outlook is highly uncertain due to the fiscal and external imbalances. Urgent policy measures are needed to address the high levels of debt and debt service, reduce the fiscal deficit, restore external stability, and mitigate the adverse impacts on the poor and vulnerable.

Recent developments

Real GDP is estimated to have expanded by 3.5 percent in 2021 thanks to a strong 12.3 percent, year-on-year, rebound from a low base in the second quarter of the year. Significant contributions came from manufacturing, financial services, construction, transport, and real estate activity. Despite still low tourism receipts, exports expanded significantly, led by the textile industry. Higher imports of intermediate and capital goods increased imports. The $3.20 poverty rate is estimated to have slightly declined to 10.9 percent in 2021, still above pre-pandemic levels.  

Year-on-year inflation accelerated to 17.5 percent in February 2022, mostly due to high food inflation at 24.7 percent, amid rising global commodity prices, adjustments to fuel prices, and partial monetization of the fiscal deficit. Moreover, an agrochemical imports ban between May and November reduced agricultural production. The increase in prices affected the ability of households to cover living expenses, leading to a deterioration of welfare and more food insecurity. Since August 2021, the central bank has increased policy rates and the statutory reserve ratio by 200 basis points to mitigate the pressures.  

The trade deficit widened to USD 8.1 billion in 2021 from USD 6 billion in 2020 as a rising import bill offset the increase in export earnings, despite import restrictions on non-essential goods. Declines in remittances (22.7 percent) and tourism receipts (61.7 percent) are estimated to have further widened the current account deficit to USD 3.2 billion (or 3.8 percent of GDP) in 2021.

The government has mobilized external financing from bilateral partners, including a financial assistance package from India worth US$ 1.4 billion in January 2022 to pay for essential imports and boost foreign exchange liquidity. A further US$ 1 billion support from India was signed on March 17, 2022. However, official reserves at US$ 2.3 billion in February 2022 (equivalent to 1.3 months of imports) remain low relative to foreign currency debt service, estimated at USD 5.6 billion from April to December 2022 (including domestic instruments issued in foreign currency). Net foreign assets of the banking system declined to US$ -4.9 billion in December 2021, showing escalating foreign exchange liquidity shortages. After keeping the exchange rate broadly fixed around 201 LKR/US$ for seven months, the CBSL floated the currency on March 07 to stem reserve losses. By end of March, the currency had depreciated by 46 percent.

The fiscal deficit is estimated to have remained at 11.1 percent of GDP in 2021, and public and publicly guaranteed debt to have increased to 117 percent of GDP. The fiscal deficit was mostly financed by domestic resources, including the central bank. Fitch, S&P, and Moody’s downgraded the sovereign rating deeper into the substantial risk investment category.

Last Updated: Apr 07, 2022

LENDING

Sri Lanka: Commitments by Fiscal Year (in millions of dollars)*

*Amounts include IBRD and IDA commitments
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Additional Resources

Country Office Contacts

Colombo
6th Floor, Hilton Colombo
2, Chittampalam A. Gardiner Mawatha
Colombo 2, Sri Lanka
+94-11 5561300
Washington
1818 H Street NW Washington, DC 20433
+1 202-473-8955