ECONOMYNEXT – A shock to Sri Lanka’s gross domestic product in 2026 from Cyclone Ditwah is likely to be at least partly offset by the effect of reconstruction, as well as a fast-normalizing economic activities, officials said.

There are expectations that the loss of output would be limited to the first quarter, IMF Mission Chief Mission Chief Evan Papageorgiou said, though more time and data was needed to get a firm idea.

Hopeful of Temporary Shock

“This is something that we have to very carefully think and examine, particularly with how the response also plays out,” he said.

“Of course, there is a very large degree of uncertainty, and I hope you can understand this.

“Now, our preliminary estimate, and that I have to caution the word preliminary, is that growth will likely take a hit in the short term.

“Short term could mean perhaps one quarter, could perhaps even be even less, but we cannot really equate the growth rate with the economic loss, because economic losses clearly are going to be very, very important, and they’re going to be sizable.”

The IMF will be watching high frequency data such as tourism arrivals and electricity output to gauge how activity is bouncing back.

Cyclone Ditwah destroyed about 108,000 hectares of paddy, which is anyway in low lying land, but most of it can be replanted. What is lost is not late season mature paddy, but small small plants a few weeks or days old with large tracks yet to be planted.

The cyclone brought vast swathes of the nation to a standstill and people stopped buying goods and stocks in shops in inundated towns were destroyed in several towns and sales and purchases halted.

Deputy Minister of Economic Development Nishantha Jayaweera said it was too early to say anything about value added tax collections but excise revenues appear to have softened.

Some distilleries have gone under water and about two million people were displaced.

A IMF country report issued with the RFI release said the preliminary assessment indicated a growth could slow to 2.9 percent (down 0.2-pct compared to the standard pessimistic 3.1-pct).

However Sri Lanka had generally grown above the 3.1 percent since default. Sri Lanka generally grows above 4 percent unless there is a stabilization crisis after a currency collapse from rate cuts.

Time to Normalize

Deputy Minister of Finance and Planning Anil Jayantha Fernando says there are no reliable measures of the actual output loss as yet.

“The economic loss will depend on how quickly the economy comes back,” Minister Fernando said last week.

“If things come to a standstill the economic loss will be greater. If economic activity resumes quickly the loss will be less.”

The government has announced a series of compensation measures to get production of agriculture, animal husbandry, small and medium industry back on track.

A damage assessment from the World Bank is due soon, he said which will have more reliable data.

Sri Lanka domestic tourism came to a standstill and foreign tourism reduced somewhat, but industry officials say the South Coast hotels are full.

Most roads have been made passable.  The government is to spend 500 billion rupees extra. Some foreign funds are also coming.

The government has collected a lot of data on actual losses to infrastructure, businesses and people.

Broken Window Fallacy

When GDP is calculated loss of capital stock is not counted. But reconstruction adds to GDP.

“Reconstruction will also add to growth, like the broken window fallacy,” Minister Jayantha explained.

The Broken Window Fallacy, is a parable related by French classical economist Jean-Baptiste Say involving a glazier who replaces a broken window and gets some money, which will have knock on spending across suppliers and workers.

All this adds to output (GDP), but what also happens is that only some lost capital stock has been replaced.

Minister Fernando said it was the intention of the government to rebuild what is replaced with better infrastructure.

The government has already said that roads will be augmented with slope strengthening and people will be shifted out of landslide prone areas. The compensation hopefully would result in better houses for the least well off.

“As you can understand, construction is likely to support growth during the rebuilding phase, and because of the size of the economic damage, this is likely to add to GDP considerably,” Papageorgiou said.

“But that doesn’t mean, of course, that the country hasn’t had a severe economic shock.”

One of the problems with government or private disaster spending is that money spent on reconstruction comes from funds that could have been used elsewhere, for real expansion of the capital stock, as pointed out by Say himself.

Prices

Sri Lanka could face higher prices from supply shocks, Papageorgiou said.

“In addition to that, we project higher inflation, at least for the short term, again, due to shortages in selected food items and some supply chain disruptions from damaged infrastructure and import control and import ability.

“Now, equally important is the external balance. Reconstruction spending is already kicking in.

“We think that the current account deficit is likely to widen at least for the next six to 12 months due to the increased food and construction import rates, the lower agricultural exports, and potentially some reduced tourism earnings.”

Sri Lanka started having balance of payments troubles in February 1952, after the newly set up central bank abandoned its initial deflationary policy in the first 18 or so months after its creation.

Sri Lanka has generally grown higher than the IMF’s conservative 3.1 percent rate after default with the central bank providing exceptional monetary stability with  broadly deflationary policy, unlike the economic currency and collapses triggered by stimulus and high inflation targets since the end of a civil war.Say’s Law</b.

Sri Lanka’s economic growth has recovered to above 5 percent in the third quarter amid measures that inflationists usually call ‘austerity’, involving tax hikes, and deflationary policy, which analysts say is showing the effect of another economic principle outlined by Jean Baptiste Say : Say’s Law,

Abandoning stimulus leads to a recovery not because people love taxes, but because deflationary policy reduces uncertainty from inflation and currency instability.

Stimulus or inflationary rate cuts in general works because some economic agents, like wage earners, fail to anticipate the inflation generated by the central bank, which translates as profits for producers, who may invest more in capacity, until consumers run out of purchasing power and revolt.

Radical stabilization measures (debt deflation or credit contractions) are needed to avoid hyperinflation or default though it may be too late for either.

“Inflation thus can never be more than a temporary fillip, and even this beneficial effect can only last as long as somebody continues to be cheated and expectations of some unnecessarily disappointed,” classical economist Friedrich Hayek pointed out as ‘full employment’ policies became popular in Anglophone countries after World War II.

“Once it has continued for some time, even the prevention of further acceleration of inflation will create a situation in which it will be very difficult to avoid a spontaneous deflation.”

Sri Lanka’s central bank in 2025 has not resumed inflationary policy by monetizing bank domestic assets (inflationary open market operations) but concerns have risen over recent depreciation amid current account surpluses, especially after the last rate cut.

Concerns have also been raised about monetizing bank foreign assets through inflationary buys-sell swaps.

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Sri Lanka is planning to finance 500 billion rupees of additional spending in 2026, mostly with a cash buffer made up of extra borrowings, which have been deposited not in the monetary authority (as colonial administrations did before 1950 which led to a rise in foreign reserves) but in state commercial banks.

Commercial banks appear to have deposited some money in the central bank, at least at first, loaned some in in the interbank market for other banks to give credit, and may have also bought government securities with the money.

Analysts are watching as to what the effects will be seen in the banking system as money from the large ‘single depositor’ is withdrawn from state banks and spent on goods and services.

Sri Lanka is planning to raise around 500 million dollars in external finance as well, President Disssanayake said. The IMF has already provided 200 million dollars.
(Colombo/Dec21/2025)