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.
Economic outlook remains sluggish, albeit with a positive recovery momentum. The GDP is projected to contract by roughly 3 percent in 2023 before returning to positive growth in 2024, according to the IMF. Inflation which had risen since October 2021 to reach historic levels in October 2022 has since been declining but remains high. The Central Bank of Sri Lanka’s (CBSL) tight monetary policy including high interest rates adopted mid-last year has likely contributed to further economic contraction. CBSL had pegged the Sri Lankan Rupee’s (LKR) exchange rate with the U.S. dollar early last year; after this practice ended in March 2023, the rupee’s exchange rate has experienced increased volatility.
Key foreign exchange earners for the country include exports (namely apparel and tea), foreign remittances, and tourism. Due to strong export numbers largely led by the apparel sector as well as various import restrictions, the trade deficit remained relatively stable in 2022. 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 current government appears committed to achieving budget sustainability, implementing several key economic reforms via politically unpopular tax hikes and cost-cutting measures. Many of these reforms reflect genuine efforts to qualify for the IMF’s EFF package which is conditioned on budget sustainability and transparency. Successful completion of these reforms and the IMF program is not guaranteed, with the political-economic landscape still very much uncertain in the country. While the government introduced an anti-corruption bill in April 2023 to tackle some of its endemic corruption issues, Sri Lanka’s track record on combatting corruption remains dubious at best, which may undermine the effectiveness of financial reforms to attract foreign investments.
Foreign investments in Sri Lanka, historically below those of other comparable countries, is expected to have declined further in 2022 (the CBSL’s annual FDI report is scheduled for release in late April 2023). Foreign direct investments (FDI) stood at $780 million in 2021 compared to $687 million in 2020. Meanwhile, portfolio investments in the stock exchange and the government securities market also continued to witness net outflows in 2021. FDIs in Sri Lanka have largely been in tourism, real estate, development projects, ports, and telecommunications in recent years. The Sri Lankan government seeks to expand investment potential in franchising, information technology services, agriculture, electronics, and light manufacturing. The Board of Investment (BOI) is the primary government authority responsible for attracting both foreign and domestic investment, aiming to provide “one-stop” services for foreign investors. BOI facilitates FDIs by offering project incentives, arranging utility services, assisting in obtaining resident visas for expatriate personnel, and facilitating import and export clearances.
Sri Lanka’s strategic location off the southern coast of India along the main east-west Indian Ocean shipping lanes gives it a regional logistical advantage, especially as India does not have deep-water ports comparable to what Sri Lanka’s. This geographic advantage remains relatively untapped.
|TI Corruption Perceptions Index||2022||102 of 180||http://www.transparency.org/research/cpi/overview|
|Global Innovation Index||2022||85 of 132||https://www.globalinnovationindex.org/analysis-indicator|
|U.S. FDI in partner country ($M USD, historical stock positions)||2021||USD $148 million||https://apps.bea.gov/international/factsheet/|
|World Bank GNI per capita||2021||USD $4,030||http://data.worldbank.org/indicator/NY.GNP.PCAP.CD|