ECONOMYNEXT – Sri Lanka would grow 3.9 percent in 2025, after a better than expected 5.0 percent in 2024, Asian Development Bank said in its economic outlook report, though the island was vulnerable to the effect of a Trump tariff.
Sri Lanka was hit with a 44 percent tariff.
“Implementation of tariffs may differ from what was announced so far. Tariffs could be postponed,” ADB Senior Country Economist, Lilia Aleksanyan (Senior Country Economist, Sri Lanka Resident Mission said prophetically, hours before they were deferred by US President Donald Trump.
“There could be exemptions. Rates could be negotiated down. So all those can lead to smaller impacts. On the flip side, stronger retaliation and further escalation could result in bigger impacts than what is presented on this chart.”
Sri Lanka is now to face a 10 percent tariff along with other nations.
Sri Lanka’s fiscal and monetary management has been good with foreign debt reduced and inflation kept low, the ADB officials said.
“Despite these achievements, the recovery remains fragile,” ADB country Director Takafumi Kadono said.
“Continued fiscal discipline and further strengthening of external and fiscal buffers are essential as the country navigates both domestic and global uncertainties.
“Since macroeconomic stability is now being restored to a greater extent, the commitment to sustained efforts for much-needed structural reforms is crucial for long-term growth.
“Further enhancing regional cooperation is essential to address shared vulnerabilities, including fragility of supply chains and global trade shocks.”
From around 2028, Sri Lanka foreign debt repayments will start going up with the intial relief from debt restructuring leveling off.
“So what Sri Lanka needs to do from now and 2028 is to ensure that there are sufficient buffers available,” Lakshini Fernando (Senior Economics Officer, Sri Lanka Resident Mission said.
“Ensure that cash flow management is done adequately in order to meet this higher debt repayments that will come once the restructured ISBs capital payments start taking place.”
Sri Lanka’s domestic debt had risen amid a reduction in foreign debt due to lack of access to capital markets, she said.
In order to repay foreign debt Sri Lanka has to sell rupee debt reducing the ability of domestic agents to make imports (crowding out private credit), use the money to buy dollars from current inflows and repay foreign debt, analysts have pointed out.
In Sri Lanka this requires the central bank to run deflationary policy (sell down its domestic assets stock and trigger a balance of payments surplus) at the correct interest rate to allow domestic debt to be sold and forex shortages not to emerge.
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However, when rates are cut claiming past – or current – inflation is low, injecting reserve money, Sri Lanka cannot convert dollar debt into rupees, leading to foreign borrowings being made to repay maturing installments or reserves being run down.
In post-1920s international economics this phenomenon is known as the ‘transfer problem’ which is a loss of ability to squeeze domestic credit and the current account to make payments through the financial account.
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Reserve sales are then sterilized with new money to maintain the lowered policy rate triggering further BoP deficits as happens in Argentina Latin American nations repeatedly which try to run credit cycles beyond the US, despite having de facto external anchors, analysts have said.
Sri Lanka’s policy rate is now at 8 percent, and the central bank has promised inflation would return to 5 percent. Under the central banks 5-7 percent inflation target, the policy rate is now only 1 percent, above the forward looking inflation. (Colombo/Apr10/2025)