Business
Sri Lanka’s macroeconomic policy setting: Cohesion or confusion?
By Dushni Weerakoon
The hike in policy interest rates by the Central Bank of Sri Lanka (CBSL) in August 2021 marks a shift from stimulus to exit strategies in the pandemic era. Such recalibrations globally are focused on how to tackle the historically large debt-to-GDP ratios that the COVID-19 pandemic leaves in its wake. At end 2020, advanced economies (AEs) on average had amassed debt to the tune of 120% of their GDP with emerging markets economies (EMEs) trailing some distance at 65% of GDP. As the spotlight moves, the full impacts of the macroeconomic policy measures, hitherto obscured by the urgency to deal with the health crisis, are now coming under greater scrutiny.
Sri Lanka’s debt metrics make an orderly exit more difficult
Many countries, especially AEs, exercised their ‘monetary sovereignty’ to create and print their own money to support stimulus efforts. They have done so through coordinated monetary/fiscal policies – i.e. using monetary policy to keeping borrowing costs low while fiscal authorities provide back-stop assurance. Some are better positioned to manage the inherent risks and conflicts of interest that are involved in this exercise. AEs have an advantage as issuers of reserve currencies with global demand and historically low interest rates; EMEs with limited exposure to foreign currency-denominated debt and holding comfortable stockpiles of reserves are less exposed to disruptive tail events.
Such countries can bring down their debt ratios if they are able to maintain nominal GDP growth persistently above the average interest rates that they pay on their debt – i.e. the growth-corrected interest rate (r-g) whereby countries can run modest primary deficits and still have a stable or falling debt-to-GDP ratio.
Sri Lanka is not similarly positioned. Its debt metrics point to high vulnerabilities – a high debt-to-GDP ratio of 101% of GDP, large exposure to foreign currency-denominated debt, and a hefty foreign debt repayment schedule. Under these conditions, the threat from exercising monetary sovereignty was always self-evident. A depreciating currency, notwithstanding distortionary controls on imports and capital flows, worsens the debt vulnerabilities.
Domestic and foreign debts are hardly similar. Given Sri Lanka’s debt metrics and the fundamental economic imbalances that have generated them, simple accounting identities do not always offer very plausible solutions. If the exchange rate depreciates, it adds to the real value of outstanding debt, relative to the size of the economy, even if interest rates remain modest. Further, shocks like COVID-19 raise risk premia, and marginal borrowing costs can rise suddenly and sharply, cutting countries abruptly out of financial markets.
Crucial to instill and retain macroeconomic policy credibility
Short of distortionary measures such as inflating debt away or maintaining an overvalued currency, a primary surplus is needed to stop the public debt-to-GDP ratio from rising and an even larger surplus is needed to reduce it. Improving the primary budget balance calls for tax increases or public spending cuts that are unpopular and have upfront costs. Given the government’s unwillingness to go down this path, households and firms will be required instead to bear the cost through higher interest rates that will affect their consumption and investments.
Higher interest rates in this instance will also not ‘pull in’ foreign capital to firm up the exchange rate given the risk premia on the currency front as depreciating pressure deepens. With reserves in hand to cover barely two months of imports, the forex market will continue to face volatility and instability until a steady stream of capital inflows, beyond short-term swaps, emerge. Until such time, a depreciating domestic currency will increase the interest burden as calculated in that currency. If debt servicing interest rate costs are pushed persistently above the economic growth rate, Sri Lanka’s debt burden will grow steadily even in the absence of new borrowing – a context sometimes called a ‘debt spiral’.
Without a clearly spelt-out debt sustainability path, Sri Lanka seems to be placing all its bets on foreign direct investment (FDI) to ease external pressures and revive economic growth. For a successful outcome – i.e. productivity gains to drive long-term growth – the type of FDI matters. The more desirable is efficiency-seeking FDI, but this is also harder to attract. For now, a policy environment of import curbs and capital controls is more likely to see strategic-seeking infrastructure-led FDI. The latter runs the risk of switching resources to non-tradable sectors – reducing the availability of external financing over the longer term – and the prospect of a short-lived growth burst as before in the post-war years. Crucially too, the sole reliance on FDI leaves Sri Lanka at the mercy of developments beyond its control.
Rather, efforts to attract FDI should be coupled with building effective policy strategies that instill and maintain credibility. Indeed, this is all the more important as Sri Lanka appears to be firmly against an International Monetary Fund (IMF) bailout. IMF loan amounts are small and it no longer has much sway on debt relief with much of EME foreign debt held by private institutional investors and China. An IMF programme is mostly useful in firming up sovereign credit ratings and reviving the sentiments of investors. But investor sentiments can also improve if governments put forward and implement credible policy strategies. By contrast, the CBSL’s policy rate adjustment to anchor expectations, for instance, will not stick if direct financing of fiscal spending is to continue under yield control measures. Instead, market convictions on the credibility of the policy mix will drive economic fundamentals. As Sri Lanka readies to transition out of pandemic-related emergency support, some notion of fiscal and debt sustainability to anchor confidence should be the priority in Budget 2022 preparations.
* This blog is based on the comprehensive chapter on “Economic Performance and Outlook: Managing the Crisis and Promoting Recovery” in IPS’ forthcoming annual flagship publication ‘Sri Lanka: The State of Economy 2021’
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Link to blog: https://www.ips.lk/talkingeconomics/2021/08/30/sri-lankas-macroeconomic-policy-setting-cohesion-or-confusion/
Dushni Weerakoon is the Executive Director of the Institute of Policy Studies of Sri Lanka (IPS) and Head of its Macroeconomic Policy research. She joined IPS in 1994 after obtaining her PhD, and has written and published widely on macroeconomic policy, regional trade integration and international economics. She has extensive experience working in policy development committees and official delegations of the Government of Sri Lanka. Dushni Weerakoon holds a BSc in Economics with First Class Honours from the Queen’s University of Belfast, U.K., and an MA and PhD in Economics from the University of Manchester, U.K.
‘Sri Lanka recorded a growth of five percent or more but due to the Middle East crisis this growth rate could be expected to drop. However, this decline could be managed effectively through the adoption of prudent policy adjustments, Central Bank Governor Dr. Nandalal Weerasinghe said at the monthly CBSL monetary policy review meeting. The meet was held at the CBSL head office in Colombo yesterday.
The Governor said that the CBSL had decided to increase the Overnight Policy Rate (OPR) by 100 basis points, bringing it to 8.75 percent.
Following this adjustment, the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), which are linked to the OPR, have been increased to 8.25 percent and 9.25 percent, respectively. The decision comes after a careful evaluation of evolving domestic and global macroeconomic conditions, Dr Weerasinghe explained.
Dr. Weerasinghe added: ‘The tightening of the monetary policy stance is primarily driven by mounting inflationary pressures. Heightened geopolitical tensions in the Middle East have kept global commodity prices, especially petroleum, elevated.
‘This has led to sharp upward adjustments in domestic energy prices, pushing Sri Lanka’s year-on-year headline inflation to 5.4 percent in April 2026.
‘While the recent spike is largely supply-driven, strengthening domestic demand, evidenced by continued credit expansion, credit-driven imports and robust economic activity—has further accelerated short-term inflation expectations.
‘The external sector has also faced amplified headwinds in recent weeks. A widening merchandise trade deficit, driven by increased fuel import costs and a slowdown in tourism earnings, resulted in a modest external current account surplus for the first quarter of 2026.
‘Additionally, speculative activities led to notable depreciation pressures on the Sri Lankan rupee, though conditions have since stabilized. Despite these pressures and ongoing foreign debt servicing, Sri Lanka’s Gross Official Reserves stood at a resilient USD 6.8 billion by the end of April 2026, a figure that includes a swap facility from the People’s Bank of China.
‘Looking ahead, headline inflation is projected to remain above the Central Bank’s target of 5 percent in the near term before stabilizing.
‘To counter potential second-round effects on inflation from energy price hikes and unchecked private sector credit growth, the Board deemed a restrictive policy stance necessary to maintain long-term domestic price stability. Upcoming multilateral inflows and government stabilization measures are expected to support the external sector and we will continue to monitor incoming data ahead of the next scheduled monetary policy review on July 22, 2026.’
By Hiran H Senewiratne
A new tilapia culture-based production and semi-processing centre launched in Iranamadu, Kilinochchi, is expected to boost climate-resilient aquaculture, strengthen rural livelihoods and create sustainable employment opportunities for women in Sri Lanka’s Northern Province.
The facility, launched by the International Labour Organization in partnership with Cargills (Ceylon) PLC and supported by the Government of Norway, is being hailed as a significant milestone in inclusive economic development and inland fisheries advancement.
Located in the Iranamadu freshwater fisheries hub, the centre has been established under the ILO’s Promoting Advancement of Vulnerable Persons and Enterprises (PAVE) Project, aimed at promoting climate-resilient livelihoods among vulnerable communities, particularly women and persons with disabilities.
Speaking at the launch, ILO Country Director for Sri Lanka and the Maldives, Joni Simpson, said the initiative demonstrated the power of partnerships in advancing social justice and decent employment.
“This processing centre represents what can be achieved when communities, government, development partners and the private sector work together. It contributes not only to strengthening aquaculture value chains but also to expanding access to decent and productive employment, especially for women and marginalized groups,” she said.
The centre is expected to generate new jobs in fish handling, processing and quality assurance while providing training in food safety standards, value addition and enterprise development. Officials said this would significantly increase women’s participation in the aquaculture value chain in the Northern Province.
Representing the Norwegian Government, Tormod Nuland said Norway’s continued support for livelihood projects in the North reflected its commitment to gender equality, inclusivity and climate resilience.
“Illustrating the success of long-standing cooperation with the ILO, the new tilapia processing unit is a key initiative that will help strengthen socio-economic conditions for communities in the Northern Province,” he said.
Cargills officials noted that the project marked the company’s first major venture into inland fisheries development after years of engagement with agricultural and dairy farming communities in the North.
Group Manager Agribusiness at Cargills, Haridas Fernando, said the company saw immense potential in developing the tilapia industry as an affordable and nutritious protein source for Sri Lankan consumers.
“We are pleased to partner with the ILO on this important initiative to support the inland fisheries sector while strengthening livelihoods for small-scale fishing communities,” he said.
The initiative also strengthens market access for the Iranamadu Freshwater Fishermen’s Cooperative Society by linking smallholder fisher communities with private sector markets and national retail networks.
Officials said the project would continue under the ILO’s Generating Resilient Opportunities for Work (GROW) programme, funded by the Governments of Australia and Norway, with the aim of expanding climate-resilient and market-oriented livelihood systems across the Northern Province.
The GROW project builds on more than a decade of interventions under the ILO’s Jobs for Peace and Resilience Programme and focuses on sustainable employment creation, private sector partnerships and social empowerment for vulnerable communities.
By Ifham Nizam
As West Asian tensions continued to simmer, the All Share Price Index moved down by 189.63 points, while the more liquid S&P SL20 went down by 36.97 points.
Turnover stood at Rs 4.93 billion with four crossings. Those crossings were: Softlogic Life Insurance 33.8 million shares crossed to the tune of Rs 3 billion at a per share value of Rs 92, HNB 316,889 shares crossed for Rs 125.2 million; its shares traded at Rs 395, HNB (Non-Voting) 318,199 shares crossed to the tune of Rs 105 million; its shares sold at Rs 330 and Lanka IOC 200,000 shares crossed for Rs 27.7 million; its shares traded at Rs 138.50.
In the retail market companies that mainly contributed to the turnover were; LOLC Holdings Rs 116.5 million (207 900 shares traded), Softlogic Life Insurance Rs 112.3 million (1.2 million shares traded), Commercial Bank 78.2 million (380,000 shares traded), Overseas Reality Rs 64 million (1.3 million shares traded), Sampath Bank Rs 48.9 million (340,000 shares traded), CIC Holdings (Non-Voting) Rs 46.5 million (1.7 million shares traded) and JKH Rs 46 million (2.3 million shares traded). During the day 94.3 million share volumes changed hands in 22097 transactions.
It is said that 75 percent of the turnover came from Softlogic Life Insurance which amounted to more than Rs 3 billion. Therefore, the Insurance sector led the market while the banking sector, especially Commercial Bank and HNB, performed well.
Main contributors to the ASPI were DFCC Bank (up 0.75 percent at Rs 135.00 ), Lanka Ashok Leyland (up 7.38 percent at Rs 3,050.00 ), and Tokyo Cement Company (Lanka) (up 2.00 percent at Rs 92.00 ).
Hayleys (down 1.78 percent at 234.00 rupees), Melstacorp (down 0.53 percent at Rs 186.25 ), Sunshine Holdings (down 3.49 percent at Rs 30.40), LB Finance (down 3.44 percent at Rs 161.25 ), and Dialog Axiata (down 1.25 percent at Rs 39.40 ) were top negative contributors.
Lanka Ashok Leyland announced a first and final proposed dividend of Rs 30 per share for the financial year ended March 31, 2026.
The Lighthouse Hotel has also declared a final dividend of Rs 3 per share for the financial year ended March 31, 2026, subject to shareholder approval at its Annual General Meeting on June 30, 2026.
Yesterday the rupee was quoted at Rs322.00/323.50 to the US dollar in the spot market , stronger from Rs 325.50/327.00 the previous day, dealers said, while bond yields were quoted higher following the rate hike.
The telegraphic transfer rate for Sri Lanka’s rupee against the US dollar was 321.50 buying, 330.50 selling.
By Hiran H Senewiratne
Banking sector claims its integrity intact despite ‘isolated incidents of fraud’
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MAC Holdings donates Rs. 5 million to ‘Rebuilding Sri Lanka’ Fund
Move to postpone PC polls: Cabinet spokesman contradicts JVP Gen. Sec.
Over 300 busted for possession of narcotics during Sri Pada season
Mendis handed white-ball reins
‘Dates have the highest sugar content to fight Coronavirus’
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