Monetary Sector
Interest Rates remained low in 2023 and 2024
In 2024, with inflation staying low, the Central Bank continued to ease monetary policy. It had already cut interest rates significantly, totaling 650 basis points in the latter half of 2023. In March 2024, it reduced rates further by 50 basis points, responding to low demand, stable inflation expectations, and no major external financial pressures. This was intended to encourage lower lending rates across the market. After a brief pause, the Central Bank lowered rates again in July 2024 by 25 basis points, reinforcing its commitment to keeping monetary policy loose. This approach aims to support economic recovery, as inflation remains under control.
This easing of monetary policy has gradually lowered interest rates, leading to a notable drop in market deposit rates and improving liquidity conditions. Prime lending rates returned to pre-crisis levels by June 2024, but SME and retail loan rates remain relatively high. The spread between loan and deposit rates is still elevated, indicating potential for further lending rate cuts, especially for small borrowers who have yet to fully benefit from relaxed monetary conditions.
Yields on G-Sec
Yields on government securities have generally declined, supported by improved market sentiment, clarity on debt restructuring, and lower auction sizes. However, a temporary yield increase occurred in late June 2024 due to larger auction volumes. Overall, Treasury bill yields dropped between 2.86 and 4.96 percentage points by mid-July 2024. While nominal market interest rates have decreased, real interest rates remain high and positive due to low inflation.
Growth in credit to private sector
6.9%
NPL ratio remained elevated, especially in the Non-Bank Financial Institutions (NBFI) sector
~13%
Liquidity conditions in the domestic money market improved in 2024. Average Weighted Call Money Rate (AWCMR) in July was at
~8.76%
NFA (Net Foreign Assets) of the banking system improved notably during H1-2024, turning positive for the first time since April 2020.
Economic Growth
The Sri Lankan economy continued its positive growth momentum for the third consecutive quarter in Q1-2024.
Leading indicators point to the economy continuing its positive growth momentum during Q2-2024, with growth expected to be largely driven by Industry and Services activities.
World Bank Revises Sri Lanka's 2024 Growth Forecast to 4.4%, Doubling April Projection of 2.2%
The World Bank projects Sri Lanka’s GDP to grow by 4.4% in 2024, up from an earlier 2.2% forecast, driven by recent macroeconomic stabilization.
However, sustained structural reforms are essential to unlock long-term growth, as poverty remains high and is projected to stay above 20% until 2026.
Inflation
In July 2024, the Central Bank’s projections showed that inflation is expected to slow down in the near term, mainly due to recent cuts in electricity tariffs and a favorable comparison to last year’s higher inflation. By late 2024 and early 2025, inflation might even fall below the target rate of 5%, creating a temporary undershoot of the Central Bank’s target. However, by the second half of 2025, inflation is expected to rise temporarily, influenced by a low base from the previous year, possible rises in global food prices, a weaker Sri Lankan rupee, and recovering demand. This rise is seen as short-lived, with inflation stabilizing around 5% in the medium term as global oil and food prices settle.
The Colombo Consumer Price Index (CCPI) entered negative territory in September 2024, registering deflation of 0.5%. This marks the first instance of deflation since September 2015, when a deflation rate of 0.3% was recorded.
Under the new Central Bank Act, the Central Bank must maintain headline inflation at 5% ±2%. With inflation in Q2 and Q3 at 1.37% and 0.80%—below the 3% lower bound—the Monetary Policy Board is required to report to Parliament, explaining the deviation, proposing corrective actions, and estimating when inflation will return to target.
| Month | Monthly Inflation | Quarterly Inflation |
|---|---|---|
| April | 1.5% | |
| May | 0.9% | 1.37% |
| June | 1.7% | |
| July | 2.4% | |
| August | 0.5% | 0.8% |
| September | -0.5% | |
| October | -0.8% |
Energy and transport prices are expected to stay low in the near term, but may gradually rise as global oil prices and the rupee’s value shift, potentially leading to increases in domestic energy costs.
Food inflation may stay high temporarily but is expected to ease, helping to stabilize overall inflation.
According to the Central Bank’s June 2024 survey, businesses expect inflation to rise modestly in the short term due to lower interest rates, higher government spending, and rupee depreciation. Longer-term expectations remain around the 5% target, indicating that inflation expectations are well-anchored.
Fiscal Sector
Fiscal performance improved in the five months ending May 2024, driven by strong revenue-focused consolidation measures by the government, resulting in a significant primary balance surplus and a reduced budget deficit.
Increased revenue from VAT, excise duties, and income taxes, supported by recent tax reforms, a broader tax base, and better tax administration, led to significant revenue growth compared to 2023.
Import duty collection also rose following eased restrictions. Non-tax revenue grew due to higher receipts from interest, profits, dividends, and charges, while total expenditure declined slightly due to reduced interest costs and restrained capital spending.
With limited access to international markets, the government relied on domestic sources for budget financing, although total debt fell in rupee terms due to currency appreciation.
External Sector
Positive external sector momentum in early 2024 with a current account surplus in Q1 improving domestic forex market liquidity.
Balance of Payment (BOP)
Q1-2024 current account surplus of $706 million was driven by strong services exports and remittances, despite a widening trade deficit. Export and import values rose, with export growth led by petroleum and key goods, while import increases were mainly in machinery, textiles, and chemicals. Tourism and other service sectors grew, along with remittances, which may help offset future trade deficit expansion. However, the financial account remained weak, with limited FDI and minor net inflows to the Colombo Stock Exchange.
Reserve Assets
Sri Lanka’s Gross Official Reserves (GOR) rose to $5.7 billion by June 2024, up from $4.4 billion at end-2023, aided by Central Bank forex purchases and an IMF inflow. GOR now covers 3.9 months of imports, though it includes a conditional swap with the People’s Bank of China.
Exchange Rate
The Sri Lankan Rupee appreciated by 6.6% against the USD by July 23, 2024, supported by improved forex inflows and positive market sentiment. Despite some depreciation pressure in May and June due to higher import payments and outflows, the Central Bank intervened to stabilize the market. The Rupee also strengthened against other major currencies.
Government Debt
Remaining USD 17.4 Bn of debt in ISBs and CDB was finalized in mid-September
When this is completed, Sri Lanka will have to pay consent fee of USD 225 million and commit to paying the Past Due Interest for the bonds between 2022-2024 in instalments during the period leading up to 2028. Sri Lanka will receive an overall haircut of 27% on the baseline scenario for nominal GDP.
USD 10.3 Bn Bilateral Debt restructured through the official creditor committee
The OCC and the IMF has provided their go ahead in terms of the agreement being in line with the debt sustainability analysis and providing for inter-creditor equity. The new Government has committed to go ahead with the restructuring and as such the next steps will be to conduct the exchange offer for the issuance of the new bonds.
Sri Lanka and IMF
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.
- 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 rationalize government expenditure and strengthen government revenue. The 2025 Budget needs to be underpinned by appropriate revenue measures and continued spending restraint so as to reach the medium-term primary balance objective of 2.3 percent of GDP—a key requirement for restoring Sri Lanka’s debt sustainability.
- Implement Structural Reforms: the Public Financial Management Act and the Public Debt Management Act is a milestone that will improve fiscal discipline and prudent debt management, bolstering transparency and accountability. Policy slippages could jeopardize the recovery.
It is important to swiftly resolve the remaining steps to achieve debt sustainability and regain investor confidence.
- IMF Debt sustainability analysis
- Domestic debt restructuring
- OCC Memorandum of Understanding and Agreement with China Exim Bank
- External commercial debt restructuring (ISBs and China Development Bank)
- Sri Lanka’s credit ratings to be re-rated
Political Risks to Sri Lanka’s stability
Budget deficits in Sri Lanka has been very high in the recent past due to the tax reductions that took place in 2019, which brought government revenue down to a record low of 8.3% of GDP in 2021.
Budget deficits were at 10.7% in 2020, 11.7% in 2021, 10.2% in 2022 and this upward trend was reversed in 2023 at 8.3% of the GDP.
Fiscal responsibility is best measured by the primary balance.
The primary balance excludes interest cost from the budget deficit.
Therefore, the primary balance is a better measure of a government’s fiscal performance.which is why this is included as a target in the proposed Economic Transformation Bill as well.
Post-independence, the country has run Primary Balances in only 6 years
1954 – Sir John Kotelawala
1955 – Sir John Kotelawala
1992 – Ranasinghe Premadasa
2017 – Ranil Wickremesinghe
2018 – Ranil Wickremesinghe
2023 – Ranil Wickremesinghe
Deficit financing is a challenge at a time the country is at a default, as required domestic borrowings will have to be made entirely from the domestic market leading to spike in interest rates and crowding out effect.
This is why the debt restructuring process must continue uninterrupted.
Economic stability will depend on the below political factors:
- The government’s capacity to push through policy changes.
- Maintain the Revenue/GDP ratio at a healthy level despite the political promises made in the presidential campaign to reduce taxes.
- Reduce government expenditure to maintain the IMF stipulated levels of Primary Balance Surplus, despite the promises made in discontinuing SOE reforms.