DRIVERS OF GROWTH

Shiran Fernando analyses the likely trajectory of the economy in year 2025

Sri Lanka’s economy enjoyed a remarkable turnaround last year; it achieved five percent growth, which is the highest since 2017, having endured two consecutive years of economic contraction.

It beat the projections of most forecasters who expected growth to be under four percent at the beginning of 2024.

Nevertheless, according to the IMF, Sri Lanka has only recovered 40 percent of its GDP losses between 2018 and 2023. We have now seen six consecutive quarters of growth; and it would help if we understand what drove growth last year and whether it can be sustained in 2025 – and identify the key risks there are.

FOURTH QUARTER GROWTH The economy grew by 5.4 percent in the fourth quarter of 2024, driven by robust performances of 13.1 percent and 2.5 percent in the industry and services sectors respectively.

However, the agriculture sector contracted by 2.2 percent; it experienced a sequential contraction after four quarters of expansion. Declines in the cultivation of rice, fruits and spices, and dimini­shed fishing activities, highlighted vulnerabilities that need to be addressed in 2025 and beyond.

GDP GROWTH IMPETUS The industry sector emerged as a strong driver of the recovery with construction and manufacturing leading the way.

High frequency indicators – such as the Purchasing Managers’ Index (PMI) for manufacturing and industrial production metrics – signalled a consistent upward trajectory throughout 2024.

The services sector also contributed substantially, bolstered by a thriving tourism industry, which welcomed approximately 570,000 arrivals and generated US$ 820 million in revenue in the fourth quarter of 2024 alone.

As for the main contributors to growth, manufacturing, construction and accommodation stand out as the top three. This highlights the turnaround of these industries, in particular tourism. Services also saw growth in transportation, wholesale and retail trade, and real estate.

THE OUTLOOK FOR 2025 Looking ahead, projections for 2025 suggest moderate growth with expectations aligning closer to Sri Lanka’s estimated potential growth of three percent.

The IMF, which has been conservative with its forecast, is expecting three percent growth for 2025 and 2026. This anticipated deceleration stems from the normalisation of key economic drivers such as exports, tourism and remittances, which had pre­viously provided substantial boosts.

In its report following the disbursement of the third tranche of the Extended Fund Facility (EFF), the International Monetary Fund noted that “there is no room for policy errors.”

Sri Lanka has done well so far to recover from the economic crisis but there’s much to do to sustain the reform process.

The successful completion of debt restructuring and adherence to the IMF’s guidelines have been pivotal in stabilising the economy. To sustain and build upon the gains of 2024, it is imperative that Sri Lanka maintains its commitment to the International Monetary Fund’s programme and broader reform agenda.

Budget 2025 aims to address structural challenges by focussing on sectors with high growth potential including exports, tourism and logistics. However, the allocation of resources for their upliftment appears modest in comparison to welfare spending, and it will potentially limit the impact of the initiatives.

There is a high allocation for public investments of Rs. 1.3 trillion (or 4% of GDP), which is higher than the 817 billion rupees expended in 2024. Last year’s budget saw a higher allocation for public investments but the actual was much lower. This was done to balance the budget; and it has been a common practice of government.

And 26 percent of the allocation for public investments is towards roads, in particular the first stage of the Central Expressway. Disbursements of this allocation will support construction industry growth.

The government also has to double down on its commitment for customs reform, and the implementation of a National Single Window (NSW), digitisation efforts and the implementation of measures to improve the ease of doing business.

NAVIGATING RISKS While the local growth story is improving, Sri Lanka will have to navigate a number of key risks.

In particular, the impact of the massive tariff hike announced by the Trump administration and potential slowdown in global growth – the challenges to world trade following the trade policies adopted by the US are obvious.

Sri Lanka maintains a trade surplus of around US$ 2.5 billion with significant exposure to apparel and rubber exports. The country mainly imports items such as feed for the dairy industry and pharmaceutical products.

Therefore, the government will have to be proactive in managing this key risk and ensure that export growth is safeguarded.

Local risks mainly stem from potential delays in implementing key structural reforms. With local government elections set for 6 May, it’s possible that the government will wait until the elections are over before implementing any reforms.