Sri Lanka has had an excellent year with foreign exchange in 2024, with official reserves gradually reaching 2019 levels and the currency appreciating by over 10% in 11 months, while the Central Bank of Sri Lanka (CBSL) claims that it has made the highest-ever net foreign purchase of $ 2.3 billion from the market.
There are many reasons for this build-up in foreign reserves, which include improvements in tourism and worker remittance numbers while exports are also recovering from global shocks.
Gross official reserves have already reached $ 6.4 billion by the end of October, beating the International Monetary Fund (IMF) reserve target of $ 5.6 billion.
However, Sri Lanka is expected to resume its restructured debt payments in 2025 while the vehicle import ban will be phased out gradually, bringing two new outflows the country did not have to deal with since April 2022.
According to the IMF, interest payments will continue to take up half of the revenues collected in the 2024-2027 period while post-restructuring, debt is expected to decline to 106.2% of gross Domestic Product (GDP) in 2024, 102% by 2027, and gradually decline towards 95% in the outer years in line with the targets set by the Extended Fund Facility (EFF) programme.
Also, Gross Financing Needs (GFN) will remain high in the medium-term (approximately 20.8% of GDP on average between 2024 and 2027), with reductions in the outer years, and is projected to stay below the EFF target (an average of 13% of GDP in 2027-’32).
However, this reduction in the GFN hinges on the Government’s ability to replace maturing Treasury bills (currently 13.2% of GDP) with longer-term Treasury bonds, which are subject to the absorptive capacity of the domestic market.
Fitch Ratings said last week that although Sri Lanka’s gross official reserves had soared by 81% Year-on-Year (YoY) to $ 6.5 billion in October on the back of the IMF programme, the speed of the recovery in reserves was likely to be set back if the Government resumed servicing its external debt and its improved external buffers would only begin to influence the sovereign’s rating once it moved out of ‘RD’.
Need for continuous accumulation of forex
Speaking to The Sunday Morning, Softlogic Stockbrokers Co-Head of Research Raynal Wickremeratne said that tourism was definitely on the rise in Sri Lanka and that while 2024 would likely be a good year, the country would see further improvement next year.
He added that Sri Lanka was gradually recovering to pre-Covid-19 levels in terms of worker remittances, where the average was about $ 550-600 million per month.
As of the end of October, the monthly average of worker remittances received so far in 2024 stood at $ 543.1 million.
However, Wickremeratne said that in order for the Government to have some room to manoeuvre, Sri Lanka would ideally need some other sources of foreign exchange coming in.
“If we can continue with the restructuring plans of some of the State-Owned Enterprises (SOEs) and even find investors to dispose of them, it would give the Government a lot of breathing space,” he said.
Moreover, he said that Sri Lanka also needed to work actively on Foreign Direct Investments (FDIs), with a critical aspect in this regard being the Government budget in February in order to demonstrate to the market and to foreign investors that the Government was not embarking on a major deviation from the current progress.
Further, he said that with the official reserves of the CBSL increasing significantly at the moment, there was room for the bank to accumulate reserves even further, adding that there was a possibility of seeing reserves crossing $ 7 billion by the end of this year.
He pointed out that once debt restructuring was finalised, there was a fee of about $ 700 million that Sri Lanka needed to pay bondholders, which could have an immediate impact on the reserves.
Sri Lanka has to make total payments amounting to $ 724 million by the end of 2024, which includes a consent fee of $ 225 million to be paid upfront upon finalisation of the debt restructuring agreement, a maturity of $ 291 million, and coupon payments of $ 208 million.
Wickremeratne said that past debt repayments had been very inconsistent, which made debt unsustainable for Sri Lanka, while there would be consistent and annual debt repayments after debt restructuring.
“This will help the Government plan the budget and there won’t be massive shocks to the reserves due to debt repayments,” he said. However, he noted that there had to be a constant accumulation of reserves, as reserves would decline when Sri Lanka started making payments.
However, this accumulation of reserves should not be at the same pace as in the last two years, during which the country accumulated $ 3 billion annually; instead Sri Lanka should accumulate at least $ 1 billion annually to keep up with IMF targets and make debt repayments.
The IMF expects gross international reserves to be at $ 13.4 billion by 2027 and $ 15.1 billion by the end of 2028.
In the letter of intent at the second review, Sri Lankan authorities said that they would gradually rebuild gross international reserves including through outright forex purchases in the market, supported by a non-interest current account surplus, new external financing and other non-debt-creating inflows, and sovereign debt relief.
They also said that they were committed to meet the programme targets on net official international reserves, which are predicated on the CBSL’s outright forex purchases on a net basis of $ 2 billion for 2024.
Economic growth remains narrow: WB
The World Bank’s (WB) Sri Lanka Development Update released in October noted that the country’s path towards stability and sustainable economic growth remained narrow. While recent economic performance has been sound, macroeconomic stability remains fragile and is predicated on the continued implementation of prudent fiscal, financial, and monetary policies.
The WB said that reforms were vital for a strong and inclusive recovery and completing the external debt restructuring was critical to bring Sri Lanka’s debt back to a sustainable path.
It said that near-term risks included policy uncertainty and a protracted or insufficiently deep debt restructuring. There will also be pressure to roll over or replace maturing Treasury bills (currently 13.2% of GDP) at a reasonable cost.
The report said that the scarring effects of the crisis would weigh on medium-term growth potential as the economic growth forecast was reduced to 3.5% in 2025 from 4.4% in 2024.
“Concerns persist over the impact of food insecurity and lower spending on health and education on future human capital, and inequality is expected to remain high,” it said, adding that elevated Non-Performing Loans (NPLs) and high exposure to the sovereign meant financial sector risks needed to be carefully monitored.
However, on the upside, the WB stated that a strong and sustained implementation of the structural reform programme could boost confidence and attract fresh, non-debt-creating capital inflows.
“Prudent fiscal, monetary, and financial sector policies are needed to preserve macroeconomic gains and maintain stability. These measures need to be accompanied by the continued implementation of key structural reforms – related to debt management, social assistance, SOEs, trade and investment, and governance and anti-corruption – that will determine the prospects for medium-term growth and poverty reduction,” the report said.
On foreign exchange earnings, it said that the potential for successful diversification and expansion of exports in manufacturing, services, and agriculture was high if structural reforms were implemented.
“This requires liberalised trade and a better investment climate to increase the competitiveness and export orientation of the economy,” it said.
Moreover, the report added that Sri Lanka had the largest port in a dynamic economic region, substantial existing capacity in export markets, and a middle-skilled workforce. The latter is particularly valuable given the rise in skill intensity of Global Value Chains (GVCs).
In addition, it said that there was potential for increased quality and higher value addition in critical sectors, including agribusiness and sustainable high-value tourism.
Achieving IMF targets will depend on ’25 Budget
Speaking to The Sunday Morning, Frontier Research Senior Macroeconomist Thilina Panduwawala said that given initial remarks from the IMF and the Government, it appeared that an IMF Board approval of the third review was likely in early 2025.
He said that the indication appeared to be that the fund would assess how potential fiscal changes of the new Government would affect the meeting of IMF fiscal targets in 2025 and beyond.
“However, it will also have to take into account the fiscal overperformance in 2024 so far, as well the primary surplus being significantly larger than the IMF target for 2024,” he added.
Panduwawala noted that following the debt restructuring, the Government would have immediate access to bilateral project loans. However, he pointed out that it would take time to access commercial markets. Although the IMF expects Sri Lanka to access the market in 2027, he noted that it would depend on the credit rating, global interest rates, and domestic conditions at that time.
The IMF expects project loans to be at $ 1.6 billion in 2027 from $ 1 billion in 2024.
Panduwawala observed that there were two perspectives in declaring that the country had recovered from the economic crisis. Firstly, from a financial markets perspective, recovery means that the country emerges from its default status and has credit rating upgrades.
“Meanwhile, from a macroeconomic perspective, it would mean economic growth and performance in other economic indicators,” he said, adding that completing the IMF programme did not mean that the country had recovered but that it had achieved stability.
Need to continue with current account surplus
Panduwawala said that the Government should focus on earning foreign exchange in addition to raising revenues, which implies that the country should have a current account surplus as well as a primary surplus in the coming years.
He noted that although gross official reserves had grown over the past two years, the IMF would be more concerned about the net international reserves.
According to the IMF, net international reserves should be at $ 9 billion by 2027 from $ 716 million in 2024, while net foreign assets of the CBSL are expected to increase from Rs. 299 billion in 2024 to Rs. 3,225 billion in 2027.
Net international reserves grew significantly but remained negative at $ 2.2 billion at the end of 2023.
Addressing the impact of vehicle imports on foreign reserves, Panduwawala said that the pent-up demand could cause an initial spike in imports, especially in the higher-end categories. However, the medium term impact of reopening vehicle imports on foreign exchange will depend on whether there is sustained demand for low- to-mid-category vehicles, essentially the Wagon R and Alto buyers from the previous vehicle import peaks in 2017/’18.
Govt. to bank on tourism, IT to secure forex
Speaking to the media on Monday (11), President Anura Kumara Dissanayake said that the Government planned to make 2025 the year with the highest number of tourist arrivals to Sri Lanka, surpassing the 2018 numbers of 2.3 million, and thereby gain the highest annual tourism revenue.
He said that discussions were ongoing with the tourism industry regarding necessary action should the numbers exceed capacity.
According to the Sri Lanka Tourism Development Authority (SLTDA), as of June, there were 4,390 registered tourism establishments in the country with 53,378 rooms, with only about 150 rooms added to the industry since the end of 2023.
The President also said that the Government’s long-term plan was to eradicate poverty in Sri Lanka by digitising the country and the economy and raising it to a new level within three years.
Speaking at an election-related event regarding the Government’s plan for the IT sector, National People’s Power (NPP) National List Candidate Eranga Weeraratne said that one of the reasons IT export earnings were stuck at $ 1.2-1.3 billion annually was because most head offices of Sri Lankan businesses were located outside the country, while money was only brought into the country to cover costs, even as a significant portion of the profits remained overseas.
He said that the Government intended to promote the IT sector so that businesses could maintain their head offices within the country and get them to declare their profits.
Weeraratne further observed that IT businesses did not maintain their offices within Sri Lanka due to the political and economic instability in the country. He added that following the General Elections, the Government hoped to ensure policy stability and minimise the frequency with which policies were changed.
Moreover, he said that another reason for IT as well as overall export earnings to remain overseas was due to obstacles in taking foreign exchange out of the country, which the Government planned to minimise in future.
Further, Weeraratne said that Sri Lanka’s IT sector had an outsourcing culture, where foreign companies outsourced to Sri Lankan companies, which was also a reason for low export revenue.
“We are trying to change to an Intellectual Property (IP) creation mode [from outsourcing]. Sri Lankan IT companies should change to this, since this is how we can ensure value creation for the domestic IT sector,” he said.
He noted that the Government would look to increase the foreign exchange garnered through IP creation as a means of achieving the $ 5 billion target by 2030.
Further, he added that the Government would look to bring venture capitalists to Sri Lanka and make them invest in domestic IT businesses, since many Sri Lankan businesses had established their offices in Singapore and Dubai in search of venture capitalists.
Weeraratne also said that the current workforce of IT engineers, which stood at about 85,000, should increase to 200,000 in order to achieve the $ 5 billion target.
Exporters require support
Oberlin College, Ohio Associate Professor of Financial Economics and Verité Research Global Academic Fellow Udara Peiris said that instead of focusing on how to earn foreign currency or which specific goods to export, Sri Lanka should consider how it could support entrepreneurs and exporters.
He said that the Government could not create exports but that it could foster an environment where businesses thrived.
For this, two key areas need attention. One is simplifying customs and import/export processes as most exports require imported materials. Making it faster and easier to import these items into the country by eliminating red tape and hidden fees will greatly assist exporters.
The second is providing trade finance, as exporters often face delays in payment from overseas buyers, which can strain their cash flow.
Prof. Peiris added that Sri Lankan banks should offer trade credit to exporters, especially new and small businesses.
Attracting forex via FDI, equity, G-sec crucial
Prof. Peiris further said that Sri Lanka’s official reserves were increasing at the moment, primarily due to foreign debt repayments being deferred and the restrictions and taxes on imports.
“Once debt repayments resume (although there are several more years for this) and imports become easier, foreign currency outflows will rise significantly,” he said.
He noted that attracting capital inflows would be crucial for Sri Lanka in order to navigate the next few years, whether through FDI, investments in equity or bond markets, or Government loans and grants.
“These inflows depend on political stability and, more importantly, consistent economic policies,” he said, adding that the key challenge for the new Government was to quickly develop policies and regulations that were guaranteed to remain stable in the future, ideally by enshrining them in law.