• SL to unlock $ 347 m in financing after Executive Board approval 
• IMF review mission praises SL’s ‘commendable outcomes’
• Fund credits strong fiscal performance to higher tax receipts 
• Calls for faster progress on Govt.’s anti-corruption action plan

Sri Lanka’s path out of crisis appears steadier than it has been in years. Inflation has settled near target, reserves are rebuilding, and the economy, once shrinking at record pace, has returned to growth. 

Yet, as the International Monetary Fund (IMF) concluded its Fifth Review mission in Colombo last week, the takeaway was that the recovery is real, but its durability depends on how fast the country can finish what it started.

The IMF mission, led by Evan Papageorgiou, reached a staff-level agreement with the Government on policies under the ongoing four-year Extended Fund Facility (EFF) programme. Once approved by the IMF Executive Board, Sri Lanka will unlock another $ 347 million in financing, bringing total disbursements to about $ 2.04 billion since the programme began in March 2023.

But the next tranche won’t be automatic. Approval hinges on two key conditions: Parliament must pass the 2026 Appropriation Bill in line with agreed fiscal parameters and Sri Lanka must demonstrate sufficient progress in finalising debt restructuring deals with remaining official and commercial creditors.

The review mission’s statement praised Sri Lanka’s “commendable outcomes” under the programme. Growth in the first half of 2025 reached 4.8%, inflation turned positive at 1.5% year-on-year in September, and gross official reserves climbed to $ 6.1 billion by the end of that month. 

Fiscal performance was described as strong, supported largely by revenue from motor vehicle imports, though the IMF cautioned that sustaining these gains would require broader, structural reforms.

Fiscal discipline still at the core

The fund underscored the importance of “sustained efforts to improve tax compliance, broaden the tax base, and tackle revenue leakages,” all familiar phrases in Sri Lanka’s post-crisis vocabulary, but ones that remain challenging to achieve in practice.

First Capital Chief Research and Strategy Officer Dimantha Mathew believes that the linkage between the Appropriation Bill and debt restructuring is central to maintaining confidence in Sri Lanka’s fiscal consolidation plan.

“Maintaining a primary balance and controlling the budget deficit is a critical aspect of debt sustainability,” he said. “Both conditions, the 2026 Appropriation Bill and progress in debt restructuring, are broadly linked to ensuring long-term debt sustainability.”

According to Mathew, around 85–90% of Sri Lanka’s debt restructuring has already been completed, with only a few agreements pending with specific creditor countries. “It’s mostly done,” he noted. “The remaining steps are more about formalising than negotiating.”

The IMF has also stressed the need to operationalise the Public Debt Management Office (PDMO), which is expected to take over debt management responsibilities from the Central Bank of Sri Lanka (CBSL). The idea is to separate monetary policy from debt operations, a practice aligned with international norms.

“We’ve already set it up,” Mathew said. “But there’s a gradual transition happening from the Central Bank to the new office. By 2026, we should see a full shift, which is important because debt management should be handled by the Government while the Central Bank focuses on maintaining macroeconomic stability.”

The revenue question

The IMF’s latest review credited strong fiscal performance in the first half of 2025 to higher tax receipts, particularly from vehicle imports. But economists warn that this boost may not last.

Mathew cautioned that much of the recent revenue growth was cyclical rather than structural. “The pent-up demand for vehicle registrations after the import ban was lifted gave a temporary bump,” he said. “But that’s likely to fall by about 50% next year. Once that happens, the Government will have to find new revenue sources to fill the gap.”

To sustain fiscal momentum, Sri Lanka will need to strengthen tax administration and compliance rather than rely on one-off surges. The IMF has repeatedly called for rationalising exemptions and improving enforcement, politically unpopular measures that have long stalled.

Mathew pointed out that stronger nominal Gross Domestic Product (GDP) growth could help offset the loss in import-related revenue, provided growth could be sustained. 

“If capital expenditure improves and the Central Bank lowers interest rates as inflation stabilises, that could help stimulate real growth,” he said. “But the Government also needs to execute its budget better. So far, only around Rs. 400 billion has been spent on capital expenditure this year, which is low.”

Balancing growth and welfare

The IMF’s Fifth Review also revived a long-running policy debate: how to balance fiscal discipline with the need to protect vulnerable households amid rising living costs. The fund has called for “strengthening the design of the welfare benefit payment scheme” to improve targeting and coverage, a diplomatic way of saying that the current system remains inefficient and leaky.

Advocata Institute Director Riyad Riffai agreed that better targeting was important. “Social spending is necessary; you can’t cut it because social issues would worsen,” he said. “But the problem is not whether we spend; it’s whether we spend on the right people.”

According to Riffai, Sri Lanka’s welfare system suffers from what he calls “social injustice through taxation”. In theory, taxes should redistribute wealth from richer to poorer households, but in practice, benefits often flow to the wrong recipients. “A lot of people who don’t deserve it are getting welfare,” he said. “And the ones who really need help are sometimes left out.”

The core issue, he noted, was targeting. “The Government needs to figure out a reliable way to identify who genuinely qualifies,” Riffai said. “Electricity consumption data could be one approach. Sri Lanka’s electrification rate is over 95%, so if a household uses high levels of electricity, it’s a strong sign it is not in poverty. It’s a practical way to check eligibility.”

The IMF’s statement echoes this logic, urging improved data-driven targeting, especially as fiscal space remains tight. However, as Riffai pointed out, any reform to social welfare systems in Sri Lanka inevitably risked political manipulation. 

“These programmes are highly politicised,” he said. “Every government uses welfare payments as a tool for votes. The challenge is to de-politicise welfare delivery and make it purely needs-based.”

That is easier said than done. Implementing a data-backed system requires digital integration across ministries, Local Government coordination, and constant auditing, all while resisting political interference. 

Governance and the long road ahead

Beyond macroeconomic metrics, the IMF’s Fifth Review leaned heavily on governance reforms. The statement called for faster progress on the Government’s anti-corruption action plan, including electronic asset declarations, improved procurement processes, and stronger independence for the Commission to Investigate Allegations of Bribery or Corruption (CIABOC).

“Corruption won’t disappear overnight,” Riffai said. “But transparency mechanisms like the Right to Information (RTI) Act are already in place. The issue is enforcement. People file RTI requests, but some institutions just don’t respond. You can go to court and force disclosure, but that process takes time.”

In his view, the priority should be to make governance systems work rather than reinvent them. “The laws exist,” he said. “The challenge is ensuring compliance and making sure information is public by default. The Government should keep everything transparent, from procurement to welfare lists. That’s the only way to restore public trust.”

Maintaining reform momentum

The fund warned against complacency, noting that “the reform momentum should be sustained to safeguard macroeconomic stability and enhance resilience to shocks”.

The Government’s next challenge will be to craft a 2026 Budget that aligns with programme parameters, maintaining fiscal discipline while advancing pro-growth measures. That includes tackling long-standing inefficiencies in State-Owned Enterprises (SOEs), which continue to drain public finances.

The IMF stated that maintaining cost-recovery pricing in the energy sector and resolving legacy debts of SOEs would be essential to minimise fiscal risks. It also pointed to upcoming bills on public-private partnerships, procurement, and asset management as opportunities to align domestic legislation with international best practices.

For the Government, that means politically difficult decisions ahead. Utility pricing, public sector reforms, and spending restraint are all sensitive issues that test the balance between short-term political survival and long-term fiscal prudence.

Meanwhile, monetary policy remains one of the few steady anchors. The IMF commended the CBSL for maintaining a data-driven stance and avoiding monetary financing of the budget, a key factor in stabilising inflation and exchange rate expectations. But it also warned against premature loosening, urging continued focus on rebuilding reserves and allowing exchange rate flexibility.

Debt deal in sight, but not done

Sri Lanka’s debt restructuring, though nearing completion, remains the final piece of the puzzle. The IMF’s statement noted “adequate progress,” but stressed that finalising bilateral agreements with remaining creditors was key to restoring debt sustainability and investor confidence.

Once completed, the restructuring, together with fiscal and governance reforms, should help the country re-enter international capital markets on better terms. But until that happens, access to concessional financing and multilateral support remains essential to cover the external financing gap.

Mathew believes that with the bulk of restructuring completed, 2026 could mark a transition year. “If growth holds up and the debt office is fully operational, we could see Sri Lanka gradually shifting from stabilisation to recovery,” he said. “But everything depends on maintaining discipline, both fiscal and political.”

The road from recovery to resilience

Three-and-a-half years after defaulting on its debt, Sri Lanka has come a long way. The economy is growing, inflation is under control, and reserves are rising, milestones few expected this soon. Yet, beneath the headline numbers, the foundations of stability are still fragile.

The IMF’s Fifth Review shows that the programme is working, but also that Sri Lanka’s turnaround remains conditional. Fiscal consolidation, targeted welfare, anti-corruption reforms, and debt management are not boxes to be ticked but systems to be built. 

In the months ahead, much will depend on whether the Government can pass a credible 2026 Budget, finalise the remaining debt deals, and keep reform momentum alive in an increasingly uncertain global environment.

Attempts by The Sunday Morning to contact the Ministry of Finance proved futile.