The Asian Development Outlook, the premier publication of the Asian Development Bank in its latest issue released in September noted that the Sri Lankan economy has outperformed expectations in the first quarter (Q1) of 2024 as headwinds diminished.
The report said: GDP grew by 5.3% year on year (yoy). Industry expanded at a faster-than-anticipated 11.8% on a low base effect, decelerating inflation, and better supply of raw materials. Services posted modest growth at 2.6%, and agriculture at 1.1%. Growth was driven by 17.6% expansion in investments, while consumption growth remained muted at 0.5% under strong fiscal austerity measures, including hikes to value-added and income taxes. Net exports continued to contribute positively to growth as imports remained constrained, though recovering under easing import controls and better forex liquidity.
Leading indicators signal a strong recovery in the first half (H1) of 2024 and beyond. Forward looking indicators show steady improvement thanks to loosening monetary policy, better public financial management, and negotiations to restructure external debt. Purchasing managers’ indexes for manufacturing, services, and construction remained in expansionary territory through most of H1 2024. The index of industrial production rose by 7.3% in Q1 and 8.4% in April and May, though the index remains below 100, indicating decline from 2015. Based on these trends, growth projections for 2024 and 2025 are revised up from ADO April 2024 (Table 3.3.7). However, following two consecutive years of contraction, the projected real GDP for 2025 remains below its 2019 value.
Inflation remained muted in H1 2024 and is now forecast to be lower this year than projected in April. Following the value-added tax rate hike, the Colombo consumer price index edged up to 6.4% yoy in January before easing to 5.9% in February. Monthly inflation has since remained at about 2.0% yoy, owing to substantially reduced utility prices following better hydropower generation, Sri Lankan rupee appreciation by 6.0% against the US dollar in H1 2024, and weak consumption demand despite cuts to the two policy rates of the Central Bank of Sri Lanka by 75 basis points each during January–July 2024. The inflation forecast for 2025 remains unchanged, however, on the expectation of faster growth.
The current account continues to improve in 2024. Relaxed import restrictions since mid-2023 and rupee appreciation fueled 6.4% growth in imports in H1 2024, outpacing 4.7% growth in export earnings. However, the resulting widening of the trade deficit was offset by expansion in net service exports as tourism earnings grew by 77.9% yoy in H1 2024, led by higher arrivals and spending per tourist, and expansion by 11.4% yoy in remittance inflows. Gross official reserves grew by $1.2 billion to equal 3.9 months of imports, from 3.1 months at the end of 2023, owing to the current account surplus, disbursement by the International Monetary Fund (IMF), a $1.4 billion swap with the Peoples’ Bank of China, and the central bank’s net purchase of dollars.
Sri Lanka reached agreement with the Official Creditor Committee and the Exim Bank of China to restructure its bilateral debt. In addition to these memoranda of understanding, signed on 26 June 2024, a steering committee of major bondholders agreed on core financial terms for restructuring international sovereign bonds, including a 28% principal haircut, under a joint working framework. Next steps are IMF confirmation that restructuring terms meet debt sustainability objectives and confirmation of comparable debt treatment by the Official Creditor Committee. Any delay in ongoing negotiations with other commercial lenders will delay the finalization of the overall debt restructuring exercise. Earlier, the IMF completed its Article IV Consultation and Second Review under a 48-month External Fund Facility, and it has so far released approximately $1 billion. Sri Lanka has met several key benchmarks, notably the submission of the new public financial management bill to Parliament that aims to enhance fiscal discipline with a primary spending limit equal to 13% of GDP. It achieved a primary surplus of 0.6% of GDP in 2023.
Lost reform momentum ahead of elections is a major risk to the outlook. Presidential elections are to be held on 21 September, likely to be followed by parliamentary elections in Q1 2025. The impact of the election cycle is visible in delays to critical reform of state-owned enterprises and the submission of new tax measures to Parliament. Prolonged delays in the reform agenda could stifle growth, delay IMF disbursement, and hit investor sentiment. Other downside risks are delay in finalizing debt-relief agreements, unpredictable weather, and spillover from geopolitical tensions.
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