ECONOMYNEXT – Sri Lanka’s state revenues grew 18 percent 760.7 billion rupees in the two months to February 2025, but current spending followed closely behind, growing 15 percent to 791.3 billion rupees, official data show.
Tax revenue grew 18 percent to 760.7 billion rupees.
Sri Lanka opened vehicle imports in February 2025, which is expected to boost revenues, but state worker salaries were also raised from April which will push up spending.
Car imports were seen picking up in March and April with more letters of credit being opened.
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Cascading Policy Errors
When macro-economists print money though open market operations to cut rates and trigger forex shortages and currency depreciation and/or reserve losses, Sri Lanka usually halts non-essential imports including cars, slashing tax revenues.
The lost revenues then push up domestic borrowing pressure, making more money to be printed to maintain a policy rate, in what critics call a ‘cascading policy error’.
In Sri Lanka there is a strong belief that currency troubles are caused by imports or the current account deficit rather than liquidity injections of the central bank.
The policy rate may be suppressed either for flexible inflation targeting to push up prices by 5 percent a year, disregarding domestic credit developments, or to target potential output, a type of macroeconomic get-rich-quick scheme which inevitably ended in tears.
Higher Current Spending in 2025
In 2025 Sri Lanka is also raising salaries of state workers, whose real salaries were hit in 2022 when macroeconomists depreciated the currency after printing money.
But Sri Lanka is also hiring 30,000 unemployed graduates in 2025 adding to an already bloated state.
In 2004, Sri Lanka started to handout taxes to able-bodied unemployed graduates, further bloating an already bloated state making salaries the biggest cashflow expense in the run up to the sovereign default.
The account deficit of the budget improved slightly to 30.7 billion rupees up to February to 30.7 billion rupees from 44 billion rupees last year.
Capital spending fell 34 percent to 56.2 billion rupees, from 85.6 billion rupees. Sri Lanka’s capital spending is expected to pick up later in the year as halted foreign funded projects resume.
Helped by slightly higher revenue growth compared to current spending, and the fall in capex, the overall budget deficit fell to 86.6 billion rupees up to February 2025, down from 129.5 billion rupees last year.
As a result, domestic borrowing fell to 86.6 billion rupees from 129.3 billion rupees.
Foreign Debt Repayment
Foreign financing was a net payment of 10.2 billion rupees, down from 15.5 billion rupees.
It is rare for Sri Lanka to repay debt on a net basis, but it can be done as long as macroeconomists do not print money to suppress rates and trigger forex shortages, allowing rupee borrowings to be converted to dollars.
The action (outflows through the financial account) made possible by appropriate domestic market interest rates, narrows the current account deficit or triggers a surplus if other financial account inflows (such as foreign project financing) also dry up.
Sri Lanka’s external current account is in surplus in the first quarter with negative foreign financing of the budget.
When money was printed to target high inflation and potential output based on IMF backed statistical formulae, especially after then Finance Minister Mangala Samaraweera cut the deficit and hiked fuel prices, analysts had warned that the country risked default.
Similar warnings were raised when an IMF-backed single policy rate was introduced.
When forex shortages are created by statistical monetary doctrines rejecting classical economics, maturing debt has to be repaid by new foreign borrowings, leading to a rapid racheting up of outstanding foreign debt, ahead of with actual foreign financing of the budget.
Monetary reserves may also be run down to repay debt.
In Sri Lanka, the Treasury does not have a foreign exchange trading desk, as a result it is totally dependent on the central bank running deflationary policy to generate dollars to repay debt, analysts have pointed out.
Potential output, is also in an IMF backed monetary law. At the moment under exceptional monetary policy by the central bank which had brought inflation to just above zero for three years, the economic is believed to be growing above ‘potential output’.
At the moment however the ‘single policy rate’ itself has kept interbank rates slightly above the true floor rate, by so-called ‘signalling’ allowing some foreign reserves to be collected.
However in the last quarter, rates were pushed down by brute force of excess liquidity (technically called ‘heavy lifting’) to bring rates to the mid-corridor leading to reserve losses in the last quarter.
Related Sri Lanka ‘single’ policy rate signals interbank rates to stay up
It is not clear whether it is sufficient to repay debt going forward as private credit picks up. A functioning interbank market, with a wide policy corridor allows the banking system to respond to credit demand.
(Colombo/May05/2025)
