Sri Lanka has had a long association with the International Monetary Fund (IMF) since her independence in 1948 — in fact, the latest loan (in 2023) is its 17th IMF support package. In this post, Tharindu Udayanga Kamburawala analyses the trends and reasons behind Sri Lanka’s recurring reliance on the IMF, and suggests ways forward towards a sustainable economic future. 

In March 2023, the International Monetary Fund (IMF) approved a US$3 billion loan under the Extended Fund Facility (EFF) for Sri Lanka, sought by the country as it faced its most severe economic crisis since independence in 1948. Per the terms and conditions, all current government policies are aligned with the EFF 2023 framework. This marks the 17th IMF program initiated by Sri Lanka, indicating a pattern of recurring reliance on IMF support. This post explores the underlying reasons for Sri Lanka’s repeated recourse to IMF assistance.

Discontinuation of IMF Programs and Policy Reversals

Despite initiating numerous IMF programs, many have in fact been only partially disbursed; of the previous 16 programs, seven can be classified as ‘partially disbursed’. Table 1 details fully and partially disbursed IMF programs.

Table 1

Source: Compiled by the author based on IMF Policy Documents

The discontinuation of IMF programs before their scheduled completion is a primary factor in Sri Lanka’s ongoing macroeconomic instability and its repeated need for IMF assistance. The inability to complete necessary policy adjustments resulting from these program discontinuations and subsequent policy reversals has hindered the achievement of long-term stability.

Standby Arrangements (SBAs)

There are several types of programs relevant to IMF financial assistance, each with its own characteristics. The Stand-By Arrangement (SBA) is the most popular,  providing short-term financial support to countries facing balance of payments problems. Unlike Extended Fund Facility (EFF) programs, SBAs do not include specific policies targeted at structural reforms. Of the 16 previous IMF programs in Sri Lanka, 10 are classified as SBAs; of the nine fully disbursed programs, seven are SBAs. This shows that most of Sri Lanka’s IMF programs have targeted short-term balance of payments difficulties rather than the structural reforms needed to address medium-term balance of payments problems. Sri Lanka has successfully completed only one EFF in 1979, and no EFF has been successfully completed since 2000.

Debt Distress and Non-Tradable Bias

For developing and emerging economies, a debt-to-GDP ratio of 40 per cent is the suggested threshold that should not be breached on a long-term basis. Some studies suggest that a 77 per cent debt-to-GDP ratio is optimal; exceeding this threshold makes an economy vulnerable to debt defaults and a deterioration of sovereign debt.

Sri Lanka’s total government debt significantly exceeds this recommended threshold for developing countries. Figure 1 illustrates the percentage of GDP represented by Sri Lanka’s government debt. Since 1976, this debt has consistently exceeded 60 per cent of its GDP. In 2022, amidst the economic crisis following the Covid–19 pandemic, Sri Lanka’s total government debt reached 114.2 per cent of its GDP leading to severe debt distress. In April 2022, Sri Lanka defaulted on its foreign debt for the first time, triggering the worst economic crisis in its history.

Figure 1: Central Government Debt (as % of GDP)

Source: Compiled from data from Central Bank of Sri Lanka.

In the five years following the end of the civil war in May 2009, Sri Lanka’s economy grew at an average annual rate of 7 per cent, marking the fastest average growth rate for any sub-period in the country’s history since independence. However, this period of rapid growth is identified as debt-driven, primarily facilitated by large-scale infrastructure projects funded through external debt. Sri Lanka was unable to generate sufficient foreign exchange earnings to meet interest payments on this external debt, as the growth was largely fuelled by non-tradable sectors. Unlike tradable sectors, non-tradable sectors do not expose the economy to international competition, thus failing to enhance productivity.

Sri Lanka’s inability to expand tradable production sectors is evidenced by the declining export revenue relative to GDP over the years. Figure 2 illustrates the performance of Sri Lanka’s exports as a percentage of GDP, highlighting the decline in export revenue relative to GDP and the concurrent increase in total external debt relative to exports. This debt-driven growth and the economy’s non-tradable bias have contributed to ongoing macroeconomic instability, necessitating frequent recourse to IMF assistance.

Figure 2: Exports as %age of GDP and Total External Debt as %age of Exports

Source: Compiled from data from Central Bank of Sri Lanka.

Large Budget Deficits and Current Account Deficits

The Sri Lankan economy has consistently faced challenges on both fiscal and external fronts. In 2022, Sri Lanka’s tax-to-GDP ratio was among the lowest in the world, characterised by low rates, a narrow base and complexity. According to the World Bank, tax revenue collection as a share of GDP ranges from 15 to 20 per cent in lower and middle-income countries, and exceeds 30 per cent in upper-income countries. However, as a lower middle-income country, Sri Lanka has been unable to maintain its tax-to-GDP ratio even at the lower threshold of 15 per cent. Figure 3 illustrates the changes in Sri Lanka’s government tax revenue as a percentage of GDP over the years. The significant decline in government tax revenue, combined with irrational government expenditure, has resulted in large budget deficits. To finance these fiscal deficits, the Sri Lankan government has relied on both domestic and foreign debt, exacerbating the debt burden.

Figure 3: Tax Revenue and Overall Fiscal Balance (as % of GDP)

 Source: Compiled from data from Central Bank of Sri Lanka.

On the external front, the Sri Lankan economy has experienced continuous current account deficits, reflecting a weakened export sector. As shown in Figure 2 (above), Sri Lanka’s export revenue relative to GDP has declined continuously since 2000. One of the main reasons for this persistent underperformance is the low level of industrialisation. To address this, Sri Lanka needs to diversify its industrial exports by shifting from labour-intensive products to more skilled and technology-driven products. The country is gradually losing its low-cost labour advantage and faces disadvantages related to energy costs. Additionally, Sri Lanka’s inability to implement structural reforms in the economy is a significant factor behind the underperformance of its current account.

Out of the five recent IMF programs, four (excluding the SBA in 2009) have targeted the restructuring of State-Owned Enterprises (SOEs). SOE restructuring is also a policy priority in the 17th program, underscoring the country’s long-standing failure to address issues within SOEs — particularly the Ceylon Electricity Board and Ceylon Petroleum Corporation. The persistent large budget and current account deficits have categorised Sri Lanka as a classic twin deficit country, contributing to its macroeconomic instability. Figures 3 (above) and 4 illustrate the evolution of Sri Lanka’s fiscal and current account deficit over the years.

Figure 4: Current Account Balance (as % of GDP)

Source: Compiled from data from Central Bank of Sri Lanka.

Way Forward

To prevent future economic crises and ensure macroeconomic stability, Sri Lanka must adhere to the objectives of the 17th IMF program and implement all required policy adjustments and reforms. Discontinuing the ongoing IMF program or reversing policies will have significant negative repercussions for the economy.

Key actions for Sri Lanka include:

• Complete External Debt Restructuring: Proactive measures are needed to successfully restructure external debt.
• Maintain a Surplus in the Primary Budget Account: It is crucial to rationalise government expenditure and strengthen government revenue.
• Implement Structural Reforms: Addressing the bias against tradable sectors is essential for economic revival. Diversifying industrial exports and fostering growth in skilled and technology-driven sectors can improve productivity and competitiveness.

By following these steps, Sri Lanka can hope to stabilise its economy and lay the foundation for sustainable growth.

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Banner image © Micheile Henderson, 2020, Unsplash.

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