Can Sri Lanka survive the approaching tariff storm? On Tuesday, 8 July, the United States is set to announce its final tariff verdict on Sri Lanka’s exports, no doubt a decision with far-reaching consequences for the country. At a time when Sri Lanka is desperately trying to meet the conditions of its International Monetary Fund (IMF) bailout programme by imposing further hardships on the people, this decision could prove decisive.

The crunch is this: the IMF at the very outset of its programme insisted that Sri Lanka must maintain a minimum Gross Domestic Product (GDP) growth rate of 5% up to 2032 in order to enable the country to meet its debt service obligations under the revised debt restructuring process. Such was its importance that it was even incorporated in the Constitution as part of the Economic Transformation Act, which outlines Sri Lanka’s national policy for economic development. 

However, the IMF last week projected a 3.5% GDP growth rate for 2025, while unlocking a fresh tranche of $ 350 million under the Extended Fund Facility (EFF). But what it did not factor in, in its latest forecast, was the impact of the impending Trump tariffs, which the IMF subsequently acknowledged could lower that rate by as much as 1.5%. Therefore, in a worst-case scenario, the 2025 GDP rate could potentially plunge to 2%, which, needless to say, is worrisome.

While many, including the IMF, see Sri Lanka’s economic trajectory moving in the right direction, that optimism could dissipate if the US imposes the steep 44% tariff currently being considered on Sri Lankan exports, particularly apparel. It is for this reason that the final decision on 8 July is of significance as the entire economic outlook for 2025 depends on it.

Adding to the growing list of uncertainties is the failure of the National People’s Power (NPP) Government to live up to its core pre-election promise of renegotiating the IMF agreement. This promise, which won it considerable public support, was quietly shelved once installed in office. Instead of fresh negotiations leading to some sort of reprieve, more fuel and electricity price hikes have been imposed on the people, further straining both household budgets and public sentiment.

Interestingly, the IMF’s growth projection does not appear to adequately factor in the knock-on effects of utility price hikes on the manufacturing and agriculture sectors. Higher input costs will likely translate into suppressed production, job losses, and decreased competitiveness, particularly in key export industries already under pressure.

Speaking at the post-Cabinet briefing last week, the Cabinet Spokesperson expressed optimism, claiming Sri Lanka was actively engaging with American counterparts to seek a favourable outcome. According to him, the Government has already held multiple rounds of video discussions with the US Trade Representative (USTR) and submitted a formal written request for exemptions or revisions.

Yet this is not the first time such optimism has been shown. In April, the same Spokesperson claimed that a joint statement with the US offering favourable tariffs was “imminent”. President Anura Kumara Dissanayake made a similar proclamation prior to the local elections in May. Over two months later, no such statement has emerged. Incidentally the President made a similar proclamation in early April, that the masterminds of the 2019 Easter Sunday bombings would be named on 21 April. That, too, never happened.

The lack of transparency and follow-through is creating a credibility crisis for a Government that came into power promising reform, accountability, and a clean break from past political habits. The regime must understand that it cannot afford to play politics with a matter as profound as tariffs, because it could easily trigger an export crisis – one the recovering economy will find hard to withstand.

The US remains Sri Lanka’s single largest export destination, accounting for over $ 3 billion in exports annually. Almost 70% of those exports are from the apparel sector. This sector is vital to the economy because, in addition to critical forex revenue, it also employs thousands, particularly women, and underpins the lifeblood of many rural economies.

According to the IMF, if the 44% tariff is implemented, Sri Lanka’s GDP could decline by 0.5-1.5%. Export revenue could shrink by up to 3% of GDP. The profit margins of apparel exporters are already thin, leaving no room to absorb a steep tariff. The consequence? Factory closures, job losses, and a foreign exchange crunch.

The IMF also warns of a dangerous domino effect: the loss in competitiveness would dampen investor confidence, reduce business expansion, and stall Sri Lanka’s economic recovery. Unemployment could rise, placing enormous pressure on the Government to ramp up social support, which in turn would strain public finances and risk IMF programme underperformance.

Sri Lanka’s current total public debt is estimated to have risen to $ 103.7 billion. The 2025 Budget has allocated nearly Rs. 3 trillion for interest payments – more than double the Rs. 1.3 trillion allocated for essential infrastructure like roads, rail, schools, and hospitals. While interest payments have risen sharply from Rs. 866 billion in 2020 to Rs. 2,950 billion in 2025, the nation’s ability to generate corresponding revenue growth remains a challenge. This is why, despite some improvement in foreign reserves and inflation moderation, the path to debt sustainability remains fraught. 

It appears that rather than re-inventing the export basket as the situation demands, the Government is depending on the low-hanging fruit of tourism to fill its forex coffers. While the Government continues to pin its hopes on a tourism-led recovery, the statistics churned out by the authorities could prove to be deceptive. For instance, even though there has been a 24% rise in arrivals in June compared to 2024, it is still well below the benchmark year of 2018 and, more critically, there is little correlation between higher arrivals and increased revenue.

A growing number of tourists arrive on prepaid packages booked through overseas platforms. While the numbers show up in arrival statistics, much of the revenue remains offshore. These revenue leakages largely go unchecked, even as the Government aggressively taxes the domestic e-commerce sector and small businesses. If tourism is to genuinely support recovery, plugging these holes must become a priority.

Given what is in the pipeline, Sri Lanka cannot afford to squander the opportunities that come its way on the international front to woo foreign investment. The regime has thus far failed to capitalise on key global platforms to promote investment and trade. The recent World Economic Forum meeting, which could have served as a vital launchpad for attracting investors and repositioning the country’s brand, instead became a PR disaster due to the underwhelming performance of its delegation. Likewise, the country’s absence at the BRICS Summit last November meant another lost opportunity to forge new economic partnerships.

In stark contrast, the private sector appears to be taking matters into its own hands. Many in the apparel, construction, hydropower, and services sectors are relocating or expanding to East Africa, South Asia, and the Middle East. Kenya, Bangladesh, India, Israel, Dubai, and Singapore are becoming the new launchpads for Sri Lankan innovation and production, where costs are lower and markets are growing. Firms are engaging in mergers and acquisitions abroad, aiming to establish tariff-safe manufacturing bases to bypass trade barriers. This isn’t just smart business, it is in fact a survival strategy.

The writing is on the wall. The Government needs to shift from reactive posturing to proactive strategy. A successful outcome on 8 July would be ideal, but it cannot be the only plan. Sri Lanka needs to have a Plan B that includes aggressive trade diversification in order to reduce overreliance on the US and EU markets by exploring opportunities in Latin America, Southeast Asia, and Africa. In addition, it must gradually move away from low-margin, volume-based exports and invest in R&D, branding, and innovation.

If Sri Lanka is to make use of the full potential of the tourism sector, then it must move fast to stop revenue leakages. One way to go about this is to regulate prepaid overseas bookings and promote local service integration. It must keep a tab on tourists engaging in business activities – already rampant on the eastern and southern coasts. 

Tuesday’s US tariff decision will be a pivotal moment not just for Sri Lanka’s garment sector but for its entire export architecture as well. A harsh tariff would pose new, critical challenges, while a favourable outcome might buy much-needed breathing space. At the end of the day, Sri Lanka’s recovery must not depend on the goodwill of foreign powers or the whims of global markets. It must be rooted in structural reforms, bold leadership, economic diversification, and an unwavering focus on long-term competitiveness. If inspiration is needed, look no further than the neighbour to the north.