STAYING ON TRACK SRI LANKA | APRIL 2025 SRI L A N K A DE V E L O P M E N T UP DA T E 1 © [2025] The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved This work is a product of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. The boundaries, colors, denominations, links/footnotes and other information shown in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The citation of works authored by others does not mean the World Bank endorses the views expressed by those authors or the content of their works. Nothing herein shall constitute or be construed or considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. 2 Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Attribution—Please cite the work as follows: “World Bank. [2025]. [STAYING ON TRACK]. © World Bank.” Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. 3 Preface The Sri Lanka Development Update (SLDU) has two main aims. The team thanks Mathew Verghis (Regional Director, Prosperity, First, it reports on key developments over the past 12 months in South Asia Region), David Sislen (Country Director for Maldives, Sri Lanka’s economy, places these in longer term and global Nepal and Sri Lanka), Gevorg Sargsyan (Country Manager, contexts, and updates the outlook for Sri Lanka’s economy. Maldives and Sri Lanka), Shabih Ali Mohib (Practice Manager, Second, the SLDU provides a more in-depth examination of EP), Ximena del Carpio (Practice Manager, Poverty), and Arvind selected economic and policy issues. It is intended for a wide Nair (Acting Program Leader and Lead Country Economist, audience, including policymakers, business leaders, financial Prosperity) for their guidance and comments on the report. market participants, think tanks, non-governmental organizations Tracey Ann Plunkett and Yasindu Amarasinghe provided and the community of analysts and professionals interested in administration support. Ruwani Rajapakse was responsible for Sri Lanka’s evolving economy. the layout, design, typesetting, and printing. Buddhi Feelixge and Samitha Senadheera led external outreach efforts. For questions, The SLDU was prepared by a team consisting of Shruti Lakhtakia please contact: infosrilanka@worldbank.org. (Economist, Economic Policy Department (EP)) and Udahiruni Atapattu (Research Analyst, EP), with inputs from Richard Walker The report is based on published data available on or before (Senior Economist, EP), Anthony Obeyesekere (Senior Economist, March 18, 2025. EP), Karina Baba (Senior Financial Sector Specialist, Finance, Competitiveness and Innovation (FCI)), Tasneem Dhudhia Photo Credits: (Young Professional, FCI), Marta Schoch (Economist, Poverty), Cover, Context, Recent Developments, and Outlook: Nazly Nandini Krishnan (Lead Economist, Poverty), and Tiloka de Silva Ahmed/Sri Lanka (Consultant, Poverty). 4 This report, additional material and previous reports can be found at: ↗ . www.worldbank.org/sldu Previous editions: ↗ . October 2024: Opening Up to the Future ↗ . April 2024: Bridge to Recovery ↗ .October 2023: Mobilizing Tax Revenue for a Brighter Future ↗ . March 2023: Time to Reset ↗ . October 2022: Protecting the Poor and Vulnerable in Time of a Crisis ↗ . April 2021: The Economic and Poverty Impact of COVID-19 ↗ . February 2019: Demographic Change in Sri Lanka ↗ .June 2018: More and better jobs for an upper middle-income country ↗ . November 2017: Creating opportunities and managing risks for sustained growth ↗ . June 2017: Unleashing Sri Lanka’s trade potential ↗ .October 2016: Structural challenges identified in the SCD 5 Connect with us www.worldbank.org/en/country/srilanka WorldBank,@WorldBankSAsia,#SLDU2025 worldbanksrilanka @worldbank the-world-bank 6 Key messages 1 The economy continues to recover, with growth, fiscal balances, and external buffers exceeding expectations in 2024. But household incomes, employment, and non-monetary welfare remain well below pre-crisis levels. 2 Despite the recovery, medium-term growth is expected to remain modest, reflecting scarring effects of the crisis, structural impediments to growth, and significant global economic uncertainties. 3 Medium-term growth and poverty reduction prospects hinge on continued macroeconomic stability (exchange rate flexibility, continuation of fiscal-financial reforms) and successful implementation of structural reforms (on trade, investment, SOEs, competition, female labor force participation, etc.). 7 Context The Sri Lankan economy is emerging from its worst post-independence economic crisis, which resulted in a sharp economic contraction, unprecedentedly high inflation and currency depreciation, and a rapid fall in international reserves. 8 Context Amid the crisis in 2022-23, and in the context of an IMF program, the government implemented a series of reforms to restore macroeconomic stability, including cost-reflective utility pricing, new revenue measures, and a return to prudent monetary policy. Additionally, legislation was enacted to support debt and fiscal management, central bank independence, electricity sector reforms, the investment climate, and anti-corruption measures. 9 Context Following these reforms, the economy began to stabilize from mid-2023, as: ↗ .Quarterly GDP growth turned positive after six quarters of contraction ↗ .Headline inflation eased (4 percent in Dec 2023 from 69.8 percent in Sep 2022) ↗ .Usable reserves grew (US$4.7 billion in Dec 2024 from US$500 million in Dec 2022) ↗ .Public debt-to-GDP fell (111.7 percent at end-2023 from 119.2 percent at end-2022) ↗ .Domestic debt restructuring was completed, and external debt restructuring progressed 10 Recent Developments 11 Growth in 2024 has surpassed expectations… Figure 1: The economy grew by 5 percent in 2024 The economy expanded by 5 percent (y-o-y) in 2024, Net taxes Construction which is higher than the 4.4 percent projected in the Other services F&B and tobacco manufacturing Transportation & warehousing Agriculture October SLDU. Accommodation, food & beverage services GDP growth (y-o-y) Other industry Growth was driven by industry and services. 6 . ↗ Industry rebounded (11 percent, y-o-y), led by a Percent (y-o-y) and percentage point contribution 4 faster-than-expected resumption in construction. 2 . strong performance in tourism-related services ↗ A 0 (accommodation, F&B, transport services) -2 boosted service sector growth (2.4 percent, y-o-y). -4 . ↗ Agricultural growth remained stagnant at 1.2 -6 percent (y-o-y). -8 -10 2018 2019 2020 2021 2022 2023 2024 Source: Department of Census and Statistics, World Bank calculations Note: The main contributors to "Other industry" are textiles, chemical and metal products, and mining. The largest contributors to "Other services" are wholesale and retail trade, IT, real estate, and financial services. 12 … with a pick-up in high-frequency indicators such as PMI Figure 2: Activity in industry and services expanded The economic recovery is also reflected in certain high- 80 frequency indicators: 70 . for manufacturing, services, and construction ↗ PMI broadly remained in expansionary territory 60 Services throughout 2024. Purchasing Managers’ Index Manufacturing Construction 50 . ↗ Cement consumption picked up by 22.2 percent 40 (y-o-y) in 2024, with the resumption of construction projects. 30 . ↗ Index of Industrial Production expanded, driven by 20 the textile, beverage, and pharmaceutical sectors. 10 0 Apr-24 Feb-24 Sep-24 Feb-25 Aug-24 Nov-24 Dec-24 Jan-24 May-24 Jan-25 Mar-24 Jun-24 Oct-24 Jul-24 Source: Central Bank of Sri Lanka 13 Inflation dropped significantly in 2024… Figure 3: Deflation recorded since September 2024 After staying in the low single-digits for most of 2024, Other Transport inflation turned negative (deflation) in September 2024. Education Headline inflation (y-o-y) Food & non-alcoholic beverages Housing, water, electricity, gas & other fuel Headline inflation, measured by the Colombo Consumer Price Index, reached -4.2 percent (y-o-y) in February Percent (y-o-y) and percentage point contribution 8 2025, driven by downward adjustments in energy prices, 6 currency appreciation, and subdued household demand. 4 The National Consumer Price Index showed a similar 2 trend. 0 -2 -4 -6 Sep-24 May-24 Feb-24 Feb-25 Aug-24 Apr-24 Jan-24 Jan-25 Nov-24 Dec-24 Mar-24 Oct-24 Jun-24 Jul-24 Source: Department of Census and Statistics, World Bank calculations 14 … allowing the central bank to cut policy rates Figure 4: Lending and deposit rates have trended downwards With inflation well below target, monetary policy was Standing deposit facility rate Average weighted new lending rate further eased. The CBSL cut policy rates by 150 basis Standing lending facility rate Overnight policy rate Average weighted new deposit rate points in 2024 (beyond the 650 basis points cut in 2023) and has maintained rates so far in 2025. 30 Combined with higher levels of overnight liquidity, this 25 has supported a steady decline in commercial lending (and deposit) rates. Furthermore, improved investor 20 sentiment contributed to a decline in 91-day T-bill rates. Percent 15 With deflation and falling nominal interest rates, real interest rates are now higher than nominal rates. 10 5 0 Nov-23 Nov-24 Jan-23 May-23 Sep-23 Jan-24 May-24 Sep-24 Jan-25 Mar-23 Mar-24 Jul-23 Jul-24 Source: Central Bank of Sri Lanka 15 The financial sector continued to stabilize as rates fell and economic conditions improved… Figure 5: Lending by commercial banks to the private sector has picked up Declining interest rates boosted credit demand, while 25 strong real lending rates and economic recovery have driven credit supply. This led to a pickup in private 20 credit growth throughout 2024, reaching 10.7 percent 15 Credit to (y-o-y) in December. private sector 10 Lending to SOEs has decreased substantially driven by government efforts to restructure legacy SOE debts Percent (y-o-y) 5 and upcoming regulatory requirements on large 0 exposures. Furthermore, the recapitalization of state- owned banks was completed in December 2024. -5 However, overall exposure of the financial sector to -10 the sovereign remains high (roughly 36 percent of -15 commercial banks’ assets in Q3 2024, compared to 36.8 percent in Q3 2023). Aug-21 Apr-19 Aug-19 Apr-20 Aug-20 Apr-21 Apr-22 Aug-22 Apr-23 Aug-23 Apr-24 Aug-24 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24 Source: Central Bank of Sri Lanka, World Bank calculations 16 … and financial sector resilience improved Figure 6: Profitability and capital adequacy of the banking sector continues This is underpinned by increases in capital adequacy to improve and profitability in 2024. Higher profits and Tier 2 25 Capital adequacy ratio NPLs to gross loans Return on equity issuances boosted capital adequacy to 18.5 percent in Q3 2024 (from 16.4 percent in Q3 2023). Stronger net 20 interest margins and lower credit costs increased profitability, with return on equity and return on assets 15 reaching 12.5 and 1.2 percent, respectively (compared to 11.1 and 1 percent in Q3 2023). Ratio 10 NPLs have gradually declined to 12.6 percent of gross loans in Q3 2024 from 13.4 percent in Q3 2023. However, credit risks continue to be high in key sectors 5 such as tourism and construction (despite their improved growth performance). 0 2022 Q3 2024 Q1 2022 Q1 2022 Q2 2022 Q3 2022 Q4 2023 Q1 2023 Q2 2023 Q3 2023 Q4 2024 Q1 2024 Q2 2024 Q3 2022 Q1 2022 Q2 2022 Q4 2023 Q1 2023 Q2 2023 Q3 2023 Q4 2024 Q1 2024 Q2 2024 Q3 2022 Q1 2022 Q2 2022 Q3 2022 Q4 2023 Q1 2023 Q2 2023 Q3 2023 Q4 2024 Q2 2024 Q3 Source: Central Bank of Sri Lanka, World Bank calculations 17 Although the merchandise trade deficit widened… Figure 7: The import recovery was broad-based The merchandise trade deficit widened by 23.9 percent Investment goods and others Fuel in 2024, as imports grew faster than exports. Other intermediate goods Motor Vehicles Textiles Merchandise import growth (y-o-y) Other consumer goods Imports grew by 12.1 percent (y-o-y) to US$18.8 billion, 40 as demand recovered, credit conditions eased, and FX liquidity improved further. Stronger economic activity Percent (y-o-y) and percentage point contribution 30 boosted all main categories of imports – including intermediate (mainly textiles and chemical products) 20 and investment goods (mainly machinery and equipment) 10 – except the fuel bill, which fell due to lower imported quantities. 0 Exports grew 7.2 percent to reach US$12.8 billion. -10 This was driven by industrial exports, as petroleum -20 exports nearly doubled due to higher volumes of marine bunkering (driven by disruptions in the Red Sea), and as -30 textile and garment exports recovered marginally. 2018 2019 2020 2021 2022 2023 2024 Source: Central Bank of Sri Lanka, World Bank calculations 18 … the current account balance remained positive… Figure 8: Travel drove service export growth The current account balance stayed positive at 1.2 Other services Transport percent of GDP, albeit deteriorating compared to 2023. Other business services Construction Telecommunication, ICT/BPO services Service export growth (y-o-y) This was supported by strengthened trade balance on Travel services (US$3.4 billion) strengthened, driven by 100 tourism-related service exports, such as travel (which Percent (y-o-y) and percentage point contribution 80 grew 53.2 percent y-o-y to reach US$3.2 billion) and transport, as well as telecom and other business 60 services. 40 20 Remittances also continued to pick up, increasing 10.1 percent (y-o-y) to US$6.6 billion. 0 -20 -40 -60 -80 2018 2019 2020 2021 2022 2023 2024 Source: Central Bank of Sri Lanka, World Bank calculations 19 … contributing to the accumulation of reserves Figure 9: Usable reserves continue to be rebuilt Reserves picked up to US$4.7 billion (3 months of 6,000 imports) by end-2024, compared to US$3 billion at end-2023, supported by the current account surplus, 5,000 FX purchases by the central bank, suspended debt Gross usable reserves service payments, and inflows from development 4,000 partners. US$ Million The currency appreciated in 2024 (9.7 percent, y-o-y), 3,000 reflecting favorable external sector developments, and has remained stable in 2025, while net foreign assets 2,000 in the banking sector have continued to strengthen. 1,000 0 Jan-22 May-22 Sep-22 Jan-23 May-23 Sep-23 Jan-24 May-24 Sep-24 Jan-25 Nov-22 Nov-23 Nov-24 Mar-22 Mar-23 Mar-24 Jul-22 Jul-23 Jul-24 Source: Central Bank of Sri Lanka, World Bank calculations 20 Fiscal performance surpassed expectations… Figure 10: Key fiscal balances continued to strengthen The primary balance is estimated to have recorded a 25 surplus of 2.2 percent of GDP, which surpassed expectations in the second review of the IMF’s EFF (1 Total expenditure 20 percent of GDP) and government’s budget (0.8 percent of GDP). 15 Total revenue and grants 10 Percent of GDP 5 Primary balance 0 Overall balance -5 (including interest payments) -10 -15 2018 2019 2020 2021 2022 2023 2024e Source: Central Bank of Sri Lanka, Budget Speech 2025, World Bank calculations Note: 2024 figures are estimates and referred to as 2024e. 21 …due to a remarkable revenue turnaround and prudent expenditure management… Figure 11: The tax-to-GDP ratio increased sharply in 2024e Tax revenues increased from 9.9 to 12.4 percent of Others Income taxes GDP between 2023 and 2024e. VAT collections were Trade taxes Tax revenue Excise taxes the main driver of the increase, supported by rate, VAT threshold and exemptions changes implemented in 14 January 2024. Growth in import demand, excise duty revisions, and lower Social Security Contribution Levy 12 thresholds further contributed. 10 Primary expenditure increased from 10.6 to 11.5 Percent of GDP 8 percent of GDP between 2023 and 2024e. Spending on salaries and pensions (due to arrears on gratuity being 6 cleared) and welfare payments increased. While capital 4 spending increased marginally, the increase in total spending was limited by under-execution of the capital 2 budget. 0 2020 2021 2022 2023 2024e Source: Central Bank of Sri Lanka, Budget Speech 2025, World Bank calculations Note: 2024 figures are estimates. 22 …although the interest bill remained substantial Figure 12: The interest bill continued to rise The reduction in the fiscal deficit was limited by the high Domestic interest interest bill. Interest payments were the single largest Foreign interest Interest as a percentage of GDP (RHS) expense, amounting to 9 percent of GDP in 2024e. 3,000 10 The interest bill was higher than expected due to the 9 state-owned bank recapitalization, which was provided as 2,500 8 an interest subsidy, rather than a capital expenditure as 7 originally budgeted.1 2,000 Percent of GDP 6 As a result, the fiscal deficit is estimated to have fallen LKR Billion 1,500 5 by only by 1.5 percentage points to 6.8 percent of GDP. 4 With limited access to foreign financing, this was 1,000 3 primarily funded by domestic sources. 2 500 1This cash injection was provided to People’s Bank and Bank of Ceylon to compensate 1 for their losses resulting from the restructuring of loans provided to CPC. - 0 2018 2019 2020 2021 2022 2023 2024e Source: World Bank calculations Note: 2024 figures are estimates and are referred to as 2024e. 23 Debt indicators improved… Figure 13: The debt-to-GDP ratio declined in 2024e The stock of PPG debt is estimated to have fallen from Residual Real interest rate 111.7 percent of GDP at end-2023 to 102.4 percent at Primary deficit Change in public sector debt Real GDP growth end-2024. The main drivers were an improved primary Exchange rate depreciation balance, alongside growth and currency appreciation, 50 which helped reduce the debt-to-GDP ratio. Gross financing needs are estimated to have fallen to 24.5 40 percent of GDP (from a peak of 30 percent in 2023), 30 due to the primary balance surplus and lower 20 amortization payments. Percent of GDP 10 0 -10 -20 -30 -40 2018 2019 2020 2021 2022 2023 2024e Source: Central Bank of Sri Lanka, Budget Speech 2025, World Bank calculations Note: 2024 figures are estimates and are referred to as 2024e. 24 …and restructuring made progress Figure 13: The debt-to-GDP ratio declined in 2024e Debt restructuring has made significant progress: Residual Real interest rate Primary deficit Change in public sector debt . ↗ Bilateral agreements are being finalized to Real GDP growth Exchange rate depreciation restructure US$10 billion of official and Exim Bank of China debt. 50 40 . first of these was signed on March 7, 2025, ↗ The 30 with the Japan International Cooperation Agency. 20 . December 2024, the debt exchange with ↗ In Percent of GDP 10 bondholders was concluded, wherein about 98 0 percent of the US$12.5 billion ISBs were exchanged, except for US$268 million (with -10 Hamilton Reserve Bank Ltd. being the significant -20 holdout). -30 -40 2018 2019 2020 2021 2022 2023 2024e Source: Central Bank of Sri Lanka, Budget Speech 2025, World Bank calculations Note: 2024 figures are estimates and are referred to as 2024e. 25 Poverty and vulnerability remain elevated… Figure 14: Poverty is estimated to remain above 20 percent in the medium- The poverty rate was 24.5 percent (at US$3.65 per term person per day, PPP) in 2024. Although poverty declined 30 marginally during the year, it remains nearly double what it was in 2019 (11.3 percent). Household incomes are 25 well below pre-crisis levels, resulting in elevated poverty Poverty Rate $3.65 per person per day and food insecurity. Vulnerability has also increased, with 20 a third of Sri Lankans living in poverty or one shock away from falling back into it. 15 Malnutrition increased in 2024 posing concerns over 10 potential long-term impacts on human capital formation and intergenerational poverty transmission. Food prices 5 more than doubled between 2021 and 2024. Households changed their diets, reducing the consumption of 0 nutritious food, contributing to an increase in malnutrition 2019 2020 2021 2022 2023 2024 2025p 2026p 2027p from 12.2 to 17 percent (underweight among children under 5) and from 7.4 to 10.5 percent (stunting among Source: World Bank calculations children under 5) between 2021 and 2024. 26 …and the labor market has been adversely affected Figure 15: Emigration remains higher than pre-crisis levels Employment and real wages remain below pre-crisis levels, encouraging emigration: Registrations with the Sri Lanka Bureau of Foreign Employment 300,000 . ↗ Labor force participation continued to decline from 250,000 48.6 percent in Q2 2023 to 47.8 percent in Q2 2024 (compared to 52.3 percent in 2019). 200,000 . wages are between 14 (private sector) and 24 ↗ Real (public sector) percent below their pre-crisis levels. 150,000 . ↗ Limited economic opportunities, partly due to the 100,000 post-crisis public sector hiring freeze, resulted in Sri Lankans leaving the country. Applications with the 50,000 Sri Lanka Bureau of Foreign Employment for the first nine months increased y-o-y in 2024. - . ↗ Increasing emigration has potential adverse 2018 2019 2020 2021 2022 2023 2024 January - September consequences for the quality of public service delivery. Source: Central Bank of Sri Lanka, Sri Lanka Bureau of Foreign Employment 27 Outlook 28 Recent history and projections 2022 2023 2024e 2025f 2026f 2027f Real GDP growth, at constant market prices1 -7.3 -2.3 5.0 3.5 3.1 3.1 Private consumption -0.5 -1.6 3.2 3.3 3.4 3.4 Government consumption 1.4 -5.4 -0.8 1.6 1.1 1.0 Gross fixed capital investment -24.5 -8.4 18.8 7.0 4.0 4.7 Exports, goods and services 10.2 12.0 5.6 -6.3 2.1 2.4 Imports, goods and services -19.9 6.5 11.1 -4.1 3.2 4.3 Real GDP growth, at constant factor prices -7.0 -2.6 4.6 3.5 3.1 3.1 Agriculture -4.1 1.6 1.2 1.5 1.8 1.9 Industry -16.0 -9.2 11.0 5.9 4.1 3.3 Services -2.6 -0.2 2.4 2.6 2.8 3.1 Employment rate (% of working-age population, 15 years+) 47.5 46.3 45.2 45.2 45.2 45.2 Inflation (consumer price index) 46.4 17.4 1.2 2.5 3.2 4.5 Net foreign direct investment flow (% of GDP) 1.2 0.8 0.9 0.5 0.6 0.7 International poverty rate ($2.15 in 2017 PPP)2 4.1 5.4 4.6 3.9 3.7 3.5 Lower middle-income poverty rate ($3.65 in 2017 PPP)2 22.7 27.1 24.5 22.7 21.9 21.2 Upper middle-income poverty rate ($6.85 in 2017 PPP)2 64.4 68.0 65.9 65.0 64.1 63.2 GHE emissions growth (mtCO2e) -6.7 -3.6 5.2 5.4 5.1 4.8 Source: World Bank, Poverty and Economic Policy Global Departments, Emissions data sourced from CAIT and OECD. Notes: e= estimate, f=forecast. Data in annual percent changes unless indicated otherwise. 1Components of GDP by expenditure for 2022-2024 are estimates, as the data published on March 18th 2025, by authorities only included GDP by production 2Calculations based on SAR-POV harmonization, using 2019-HIES. Actual Data: 2019. Nowcast: 2020-2024. Forecasts are from 2025 to 2027 29 The growth outlook is modest − Despite the recovery in 2024, medium-term growth is expected to be modest at around 3.1 percent, reflecting the scarring effects of the crisis, structural impediments to growth, and significant global economic uncertainties. − The current account is expected to revert to a modest deficit in 2025, as trade-related uncertainties reduce exports (relatively more than imports), outweighing any positive impacts from reduced global oil prices. − Inflation is projected to turn positive by mid-2025, due to revived domestic demand, but remain below the central bank’s medium-term target of 5 percent. − Despite continued fiscal consolidation, fiscal financing pressures will persist due to large T-bill refinancing needs. − The resumption of parate rights, in conjunction with planned insolvency reforms and efforts to implement a workout framework, are expected to give banks a wider range of tools to address NPLs and maximize debt recovery in a sustainable manner, contributing to financial sector resilience. 30 A more pro-poor recovery is needed to improve welfare − Following continued macroeconomic stabilization, poverty is expected to decline to 22.7 percent in 2025 and remain around 20 percent in the medium term. Under current projections, the economic crisis is expected to have reversed a decade of poverty reduction in Sri Lanka. − The increase in public sector wages will support households and help revive consumption. However, potential trade-related job losses could severely impact households. − A more pro-poor economic recovery, in which economic growth translates into higher rates of growth in household income among less well-off households, could help bring poverty rates back to their pre-crisis levels before 2030, through: . ↗ expanding employment opportunities in industry and services for poorer and vulnerable segments of the population ↗ . increasing labor incomes ↗ . restoring growth in micro and small enterprises, and agricultural incomes. 1 Parate execution grants a bank the power to sell a mortgaged property that had been secured to the bank as collateral, without going through formal court proceedings. 31 Downside risks are significant amid global headwinds − Global growth is expected to slow in 2025 and 2026, driven by unprecedented trade policy uncertainty and high global interest rates. These factors could limit capital inflows, discourage investment, and dampen export demand. − Given limited (and narrowing) fiscal and external buffers, downside risks from inequitable fiscal consolidation, limited investment and external financing support, as well as global trade and monetary policy uncertainty remain high. − Policy uncertainty (including the direction and pace of reforms) and any further scarring effects (limited job opportunities and increased outmigration) from the crisis could slow the recovery. − Beyond an economic slowdown, the ongoing reliance on regressive indirect taxes could worsen the poverty outlook. The increased prevalence of stunting and malnutrition raises concerns about long-term human capital development and intergenerational poverty transmission. − Conversely, there are upside risks from the successful implementation of structural reforms – particularly in . trade and investment – which would boost growth and attract non-debt-creating flows 32 Policy watch − Since being elected to power in October 2024, the new government has undertaken several reforms, including: ↗ . Establishing the new Public Debt Management Office ↗ . Recapitalizing State-Owned Banks ↗ . Commencing the recertification of Aswesuma beneficiaries ↗ . Publication of a Governance Action Plan for 2025 − Furthermore, the third review of the IMF EFF was completed in February 2025. − This has helped continue the reform momentum. − Implementation of reforms, including published plans, remains key 33 Policy watch − The 2025 Budget focuses on promoting export-led growth, by creating an enabling environment through digitalization, strengthening governance and legal frameworks, and boosting competitiveness. − Prospects for growth and poverty reduction depend on continued macro stability, and the sustained and successful implementation of structural reforms. It is critical to expedite reforms that: (i) strengthen macro- fiscal-financial stability; (ii) boost competitiveness; and (iii) reduce the economy’s inward orientation. In this regard, the 2025 Budget proposes the following reforms: I. Strengthening macro-fiscal-financial stability through the enactment of a: • Public Procurement Act – to improve competition and quality of goods and services procured • Law to address the Exchange of Information between State Institutions – to ensure better citizen-state engagement • Rescue, Rehabilitation and Insolvency Act – to reduce cost of credit and increase access to finance • Revised Micro Finance and Credit Regulatory Authority Act – to enhance supervision and better protect customers Additional reforms required: Progressive and equitable tax policy, along with a modernized digital tax administration system, are essential for achieving revenue targets in a sustainable manner and ensuring continued macro-fiscal stability. 34 Policy watch II. Strengthening macro-fiscal-financial Boosting competitiveness through the enactment of a: • Revised Economic Transformation Act (ETA), or/and Investment Protection Act (IPA) – to ensure a modern overarching legal, institutional and regulatory framework for investors • Public Private Partnership (PPP) Investment Management Act – to provide a clear and stable legal framework for PPPs • State Business Enterprises Management Act – to improve governance, transparency and accountability of SOEs Additional reforms required: Labor market (e.g., ensuring a more inclusive and flexible labor market) and land reforms (e.g., facilitating better state land asset management) are also critical for boosting competitiveness and attracting investment. III. Reducing the inward-orientation of the economy by trade liberalization and market access expansion through: • Preparation of a National Export Development Plan (2025–2029) – to boost exports of goods and services • Implementation of the National Tariff Policy – to create a simple, transparent and predictable tariff framework • Enactment of a new Customs Law – to modernize and streamline Customs (e.g., close long rooms, improve cargo flow) and enhance revenue collection • Establishment of a Trade National Single Window – to simplify, digitize and automate cross-border trade procedures 35 List of abbreviations CBSL Central Bank of Sri Lanka CPC Ceylon Petroleum Corporation EFF Extended Fund Facility F&B Food and Beverage FX Foreign Exchange GDP Gross Domestic Product IMF International Monetary Fund ISBs International Sovereign Bonds NPLs Non-Performing Loans PMI Purchasing Managers’ Index PPG Public and Publicly Guaranteed PPP Purchasing Power Parity SOEs State-Owned Enterprises . T-bills Treasury Bills VAT Value-Added Tax y-o-y Year-on-Year 36 37