Sri Lanka receives “no policy errors” warning from IMF as it approves 3rd review

• Highlights economy still vulnerable
• Asserts it is critical to sustain the reform momentum to ensure macroeconomic stability and debt sustainability, and promote long-term inclusive growth
• Points out boosting tax compliance and refraining from tax exemptions are key to maintaining support for economic reforms

On late Friday evening, Sri Lanka celebrated another positive development as the International Monetary Fund (IMF) approved the third review under the Extended Fund Facility (EFF) arrangement, allowing authorities to access US$ 334 million.

While commending the island nation for its efforts in recovering from the 2022 crisis, the IMF’s statement carried an underlying message of caution; Sri Lanka cannot afford any missteps and that tax hikes, subsidy cuts, fiscal discipline, and governance reforms must continue, regardless of the political cost.

Following the IMF Executive Board discussion, Deputy Managing Director Kanji Okamura issuing a statement acknowledged that Sri Lanka’s economy is recovering but remains fragile.

Given that the island nation is not yet fully out of vulnerability, Okamura emphasised that there is no room for mistakes, stressing that Sri Lanka must not deviate from the agreed reform path.

“The recovery is expected to continue in 2025. As the economy is still vulnerable, it is critical to sustain the reform momentum to ensure macroeconomic stability and debt sustainability, and promote long-term inclusive growth. There is no room for policy errors,” he said.

The Manila-based lender, as it has repeatedly done in recent months, acknowledged that reforms in Sri Lanka are bearing fruit and the economic recovery has been remarkable. Inflation remains low, revenue collection is improving, and reserves continue to accumulate. Economic growth has averaged 4.3 percent since growth resumed in the third quarter of 2023. By the end of 2024, Sri Lanka’s real GDP is estimated to have recovered 40 percent of the losses incurred between 2018 and 2023.

Programme performance has been strong, with all quantitative targets met, except for the indicative target on social spending. Most structural benchmarks due by end-January 2025 were either met or implemented with delays.

The IMF also pointed out that sustained revenue mobilisation is crucial to restoring fiscal sustainability and ensuring that the government can continue to provide essential services.

“Boosting tax compliance and refraining from tax exemptions are key to maintaining support for economic reforms. To ease economic hardship and ensure that the poor and vulnerable can participate in Sri Lanka’s recovery, it is important to meet social spending targets and continue with reforms of the social safety net,” it said.

The Fund emphasised that going forward, social support needs to be well-targeted toward the most disadvantaged to promote inclusive growth, given the limited fiscal space. Restoring cost-recovery electricity pricing without delay is necessary to contain fiscal risks from state-owned enterprises. A smoother execution of capital spending within the fiscal envelope would foster medium-term growth.

While acknowledging progress in advancing debt restructuring to restore Sri Lanka’s debt sustainability, the IMF emphasised that timely finalisation of bilateral agreements with creditors in the Official Creditor Committee and with remaining creditors is now a priority. Regarding monetary policy, the IMF stated that Sri Lanka should prioritise maintaining price stability, supported by a sustained commitment to prohibit monetary financing and safeguard Central Bank independence. It also noted that continued exchange rate flexibility and the gradual phasing out of balance of payments measures remain critical to rebuilding external buffers and facilitating rebalancing.

Resolving non-performing loans, strengthening governance and oversight of state-owned banks, and improving insolvency and resolution frameworks are important priorities to revive credit growth and support economic recovery.

“Prolonged structural challenges need to be addressed to unlock Sri Lanka’s long-term potential, including steadfast implementation of the governance reforms,” Okamura said. The total IMF financial support disbursed so far to Sri Lanka under the current programme is approximately US$1.34 billion.