Sri Lanka has finally got approval for the delayed fourth review of the International Monetary Fund’s (IMF) US$3 billion bailout package. Sri Lanka had to raise the electricity tariffs for the approval and the IMF Executive Board last week completed the Fourth Review, unlocking a new tranche of SDR 254 million (approximately US$350 million), bringing the total disbursement to US$1.74 billion.
According to the IMF, Sri Lanka’s performance under the program has been “generally strong,” despite some implementation risks and data reporting lapses.
Notably, Sri Lanka fulfilled prior actions including restoring cost-recovery electricity pricing and operationalising automatic tariff adjustments. These reforms aim to reduce fiscal risks associated with energy subsidies.
Quantitative targets set for end-March 2025 were broadly met, except for the stock of expenditure arrears. Structural benchmarks due by end-May 2025 were achieved, albeit some with delay.
Debt restructuring nears completion
A key pillar of the EFF is debt sustainability. Sri Lanka has made significant headway in this regard, having finalised deals with most of its official creditors, including the Paris Club, India, and China.
Commercial debt restructuring is ongoing but nearing finalisation. The IMF has praised the Government’s commitment to completing bilateral and private creditor negotiations in a timely manner.
Debt restructuring is essential not just for immediate liquidity relief but also to ensure medium- to long-term fiscal stability. However, delays in negotiations with bondholders and domestic stakeholders could affect future disbursements and investor confidence.
Independent analysts see stabilisation as the first step of the country’s recovery from the unprecedented default, but far less than the much needed economic growth. Sri Lanka’s economic stabilisation under the IMF deal has shown promising signs, with notable improvements in inflation control, fiscal discipline, and foreign reserves.
According to the IMF’s latest review in July 2025, the country has largely met its fiscal and structural reform targets, including restoring cost-reflective energy pricing and improving public financial management.
Inflation has dropped sharply, aided by lower energy prices, and tax revenues are improving due to tighter enforcement and reduction in exemptions. These achievements have bolstered investor confidence and offered some breathing space for policymakers to focus on deeper economic restructuring.
However, despite these internal gains, Sri Lanka’s medium-term economic growth remains under pressure due to rising global uncertainties.
The resurgence of Donald Trump’s reciprocal tariff policies threatens to disrupt global trade flows, which could negatively impact Sri Lanka’s export-dependent industries such as apparel and tea. Similarly, the growing instability in the Middle East—an important destination for Sri Lankan migrant workers and a key source of remittances—poses a dual threat to foreign income and employment.
If tensions escalate further, reduced remittance inflows and higher oil prices could reverse recent improvements in the current account. These global headwinds highlight the fragility of Sri Lanka’s recovery.
While IMF-backed reforms have laid the groundwork for stabilisation, sustainable growth will depend heavily on the country’s ability to shield itself from external shocks. This means accelerating export diversification, reducing reliance on Middle Eastern remittances, and strengthening domestic industries to cushion global volatility.
As the IMF said, a “human rights economy” approach—focused on inclusive development and equitable social protection—may also be critical to maintain social cohesion amid painful reforms.
Ultimately, the success of Sri Lanka’s recovery hinges not only on following the IMF roadmap, but also on adapting it to a rapidly shifting global economic and geopolitical landscape.
Fiscal policy and revenue mobilisation
One of the most contentious aspects of the IMF program has been the push for fiscal consolidation. The Government has committed to increasing tax revenues from a historically low base. Since 2023, it has reintroduced direct taxation measures, reduced tax exemptions, and expanded the tax net.
The IMF has lauded the efforts to strengthen tax administration, including reforms to the Inland Revenue Department and improved digital compliance mechanisms. However, the Government missed the target on clearing expenditure arrears, which has raised concerns about fiscal transparency and budget discipline.
The under-reporting of arrears triggered a breach of IMF rules under Article VIII, Section 5. Nonetheless, the IMF accepted the Government’s explanation of an administrative oversight and granted a waiver, given their commitment to improved public financial management. Raising taxes to meet the IMF’s fiscal targets, however, carries significant economic and social risks for Sri Lanka, particularly given the fragile state of its post-crisis recovery.
While revenue mobilisation is essential for restoring fiscal sustainability, excessive tax hikes—especially in a short timeframe—can stifle consumption, discourage investment, and slow down private sector growth. The burden often falls disproportionately on middle- and lower-income groups, deepening inequality and risking public backlash.
This is particularly concerning in a country still grappling with the aftershocks of the 2022 economic collapse, including high food prices, job losses, and cuts in social welfare. Moreover, over-reliance on tax increases without corresponding reforms in expenditure efficiency can create long-term structural imbalances.
Sri Lanka’s tax-to-GDP ratio remains low by regional standards, but simply raising rates won’t resolve the underlying inefficiencies in tax collection or address widespread evasion. Without well-targeted social protections, further tax increases risk undermining the very macroeconomic stability the IMF program seeks to achieve.
To ease fiscal pressure without excessive tax hikes, Sri Lanka has several alternatives.
One key area is improving tax administration and compliance through digitisation, broadening the tax base, and plugging leakages. The Government has already focused on this while reducing wasteful Government spending, particularly on loss-making State-owned enterprises (SOEs). This move could free significant fiscal space.
Asset monetisation, such as leasing underutilised State assets or land to generate non-debt revenues, is another potential strategy. Prioritising growth-enhancing reforms—such as facilitating trade, boosting tourism, and easing the business climate—could expand the tax base organically by growing the formal economy.
While taxation will remain part of the equation, a more balanced approach combining revenue, expenditure, and structural reforms is vital for sustainable fiscal consolidation.
Monetary policy and inflation control
The Central Bank of Sri Lanka (CBSL) has played a crucial role in macroeconomic stabilisation. Under the IMF’s guidance, CBSL adopted a tighter monetary stance to control inflation, and interest rates were maintained to discourage excessive borrowing.
As of Q2 2025, inflation has fallen below expectations, signaling that price stability is within reach.
The CBSL has also committed to ending monetary financing of the fiscal deficit, a long-standing problem that fueled hyperinflation during the crisis. Central Bank independence has been reinforced through legislative changes, though critics said that political interference still lingers.
As inflation subsided and the IMF program progressed, the Central Bank has gradually began easing rates in 2024 and 2025 to support economic recovery. While this shift was justified by falling inflation and improving reserves, it comes with risks.
Premature or overly aggressive rate cuts could reignite inflationary pressures, especially if fiscal discipline weakens or external shocks—such as rising global oil prices or renewed currency depreciation—materialise. Lower rates might spur credit expansion without adequate safeguards, potentially inflating asset bubbles or increasing non-performing loans in a still-recovering banking sector.
Another significant risk lies in the evolving global monetary environment. If major economies such as the United States or the European Union tighten monetary policy to combat inflation or recessionary threats, capital could flow out of emerging markets like Sri Lanka, putting downward pressure on the rupee and external reserves.
This would strain Sri Lanka’s external position and could force the CBSL to reverse course abruptly, tightening policy again and risking a stop-start growth cycle. To mitigate these risks, the CBSL must maintain policy flexibility, enhance its forward guidance, and strengthen macro-prudential tools to ensure that monetary easing does not compromise the hard-earned stability achieved since the crisis.
Exchange rate flexibility and external resilience
Another major reform has been the shift towards a flexible exchange rate regime. After years of defending an overvalued rupee, the Government allowed the market to determine the currency’s value. This has helped Sri Lanka rebuild foreign reserves and improve trade competitiveness.
However, the IMF warned that global trade uncertainties could pose new risks to Sri Lanka’s external sector. Maintaining a buffer through continued reserve accumulation and phasing out administrative measures remains essential.
Reviving private sector credit also remains a key challenge. The IMF has urged reforms to address non-performing loans (NPLs), particularly in State-owned banks, and improve the insolvency framework.
Weak banking sector governance and insufficient risk management still threaten financial stability. Efforts to improve oversight and governance of state-owned financial institutions are ongoing.
The implementation of a modernised banking law, expected in late 2025, could further stabilise the financial sector and restore investor confidence.
Governance, transparency and anti-corruption measures
One of the core structural reform areas under the EFF is governance. The IMF has repeatedly stressed the need for transparency and accountability in public finance. The adoption of a new Public Finance Management (PFM) law is a step forward.
Still, implementation remains uneven. The IMF has urged faster action on prosecuting high-profile corruption cases and improving access to public procurement data.
Civil society continues to criticise the Government for a lack of progress on anti-corruption institutions, such as the Commission to Investigate Allegations of Bribery or Corruption.
While macroeconomic indicators have improved, the IMF program has exacted a heavy toll on the population.
Increases in electricity tariffs, tax burdens, and reductions in subsidies have disproportionately affected low- and middle-income households. Social safety nets have been expanded, but many say they are insufficient.
The IMF acknowledges the need to better target and broaden support for vulnerable populations. Failure to do so risks triggering renewed social unrest.
Political implications
and reform fatigue
The IMF program’s success also depends on political will. Sri Lanka’s current Government, led by President Anura Kumara Dissanayake, has signalled support for the reforms, though public pressure and electoral considerations may affect the pace and depth of future changes.
The fragmentation of the political landscape poses a challenge to long-term policy continuity.
Opposition voices are gaining ground by promising to review or renegotiate the IMF deal because the current Government promised to do so during its election campaign.
Despite commendable progress, Sri Lanka faces multiple risks: Escalating geopolitical tensions and trade disruptions could threaten export earnings and FDI. Political instability could stall structural reforms though the ruling party has more than a two-third majority in the Parliament. Delays in finalising commercial debt restructuring could undermine financial stability.
On the positive side, Sri Lanka has an opportunity to emerge as a success story if it sustains the reform momentum. The shift towards a human-rights-based economic framework, as promoted by both the IMF and the UN, may also offer a new lens for inclusive development.
However, a sustainable economic growth model has to be decided locally by Sri Lankans without external pressure including from the IMF. If not, there is a greater possibility of facing the second sovereign default in 2028 and then repeated cycles thereafter.
