ECONOMYNEXT – Sri Lanka is on track to reach a 95 percent debt to gross domestic product target two years earlier than originally envisaged by the International Monetary Fund, based on the latest projections, Deputy Minister of Economic Development, Anil Jayantha Fernando said.
In a debt sustainability analysis after Sri Lanka’s first external default without war, the IMF expected the island to hike taxes on the people and bring debt to GDP down to 95 percent by 2032.
But their latest projection indicates that the target would be reached by 2030, two years ahead of schedule, Minister Fernando said.
Sri Lanka’s new administration has been careful not to rock the boat and maintained fiscal measures envisaged in the IMF program.
“Whether outside parties tell us or not, whether it is set in a law or not, it is our responsibility to maintain a correct fiscal discipline,” Minister Fernando told parliament.
“We will be accountable for taxes collected from the people even if there was no law.”
Sri Lanka’s debt to GDP ratio is expected to reach 94.5 percent by 2030, according to the latest IMF projections, a Fiscal Strategy Statement said.
“There is therefore a modest buffer between the target and projections, which is prudent given the significant uncertainty around economic and fiscal developments over the coming years,” the Strategy Statement said.
“These projections will be updated regularly, and fiscal settings can be recalibrated as needed to ensure the achievement of this goal.”
Under a fiscal law Sri Lanka has set a ceiling on 13 percent of GDP for primary spending (expenses other than interest).
The law can contain the ‘heedless spending’ policies that are allowed under revenue based fiscal consolidation, an unusual IMF promoted strategy that rejects spending-based consolidation, on the basis that other countries spend more.
The fiscal strategy statement said it is the intention of the government to keep spending around 12.9 percent for the next two years at least as a prudential measure.
As a result of inflationary rate cuts made to boost growth or reach a potential output target, which triggered currency crises, monetary stability was denied to the people and businesses and frightened away foreign investors and triggered capital flight, critics have said.
The ensuing stabilization crises in 2013/14, 2016/17 and 2019 reduced peacetime growth to levels below levels seen during the war and led to an even more rapid accumulation of foreign commercial debt.
Under ‘revenue based fiscal consolidation’ spending to GDP was raised from 17 percent to over 20 percent, but growth fell and debt expanded and eventually defaulted in 2022 under the most aggressive monetary and fiscal policy ever seen from 2020 to reach potential output.
Now the ‘growth’ mindset is re-emerging, but there can be no growth without monetary stability, analysts say.
Sri Lanka’s rapid stabilization has been helped by the central bank which has kept the exchange rate stable and undershot a high 5 percent inflation target. Printing money to reach the target had led to four currency crises in rapid succession since the end of a civil war.
With the central bank undershooting its inflation target (domestic anchor) and providing monetary stability, growth has been higher than the ‘potential’ 3.1 percent indicated in the IMF’s debt sustainability analysis. In the first quarter growth was 4.8 percent.
Analysts have warned that sufficiently activist ‘growth policies’ including rate cuts, sterilized interventions, stimulus (fiscal policy is tight therefore monetary policy should be loose) as in the recent past will lead to a second rapid unravelling of the country.
Argentina, which is exposed to commercial debt and bullet repayment bonds, brings debt to GDP ratio steeply down before its central bank suppresses rates through sterilized interventions trying to enforce non-market interest rates and ‘market determining’ money and triggers repeated defaults.
Using swaps, a policy error pioneered by the Federal Reserve in the process of busting the Bretton Woods, money can be printed to offset interventions beyond available outright reserves triggering even more domestic credit and imports.
Related : Sri Lanka Treasury should buy its own dollars to settle debt and avoid second default
In addition to exchange rate stability Sri Lanka’s economy expanded faster than the DSA projection in part due to avoiding broad-based restructuring of domestic debt (DSA driven forced default) which restored confidence in government securities triggering 1,000 basis point fall in rates in a day without printing money.
Forced defaults also worsen a banking crisis which is usually associated with a currency crises brought about by rate cuts where private credit is driven to unsustainable levels with liquidity injections, during the period of sterilized forex sales (lost forex reserves replaced with rupee reserves injected to banks).
But many loans go bad as people’s spending power collapses with the ‘market determined’ currency, killing off leveraged SMEs in particular. Tax hikes may further kill spending power. (Colombo/July01/2025)
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