THE ECONOMY

THE LITMUS TEST OF ECONOMIC RESILIENCE

The clarion call for a reform agenda that encompasses trade, digitisation and FDI 

Shiran Fernando ponders on how to overcome Sri Lanka’s economic fragility 

Foreign reserves improved, workers’ remittances reached record highs and tourism arrivals returned to near 2018 levels.

FRAGILE STATE Despite the outbreak of hostilities in the Middle East in late February, the economy initially displayed resilience, particularly in terms of exchange rate stability. 

However, the sharp depreciation of the Sri Lankan Rupee and volatility witnessed in May have once again highlighted the fragilities that continue to exist beneath the surface of the recovery story.

In this context, the continuation of the IMF programme becomes critically important. Disbursements and the broader reform framework of the programme will provide an important short-term anchor for market confidence. 

The more important factor for Sri Lanka’s outlook over the coming months will be developments in the Middle East. If the US-Iran MOU holds and the conflict gradually de-escalates, it will reduce pressure on global energy markets and help stabilise external sector conditions for countries such as Sri Lanka. 

URGENT REFORMS Even if external conditions improve however, Sri Lanka can’t afford to lose momentum on structural reforms. 

Stability achieved through temporary external relief or financing inflows isn’t sustainable unless they are accompanied by deep reforms that improve productivity, competitiveness and foreign exchange earning capacity.

The next phase of reforms must focus squarely on trade, investment, tourism and energy security.

Trade reforms remain one of the most underappreciated areas on Sri Lanka’s economic agenda. The country continues to operate with outdated systems and processes, which increase transaction costs and reduce competitiveness. 

Reforming the customs ordinance is essential to modernising border procedures and improving trade efficiency. Equally important is ensuring full compliance with commitments under the WTO Trade Facilitation Agreement (TFA). 

Sri Lanka also needs a far more robust and technically capable free trade negotiation framework. Global trade is increasingly shaped through strategic bilateral and regional agreements. 

The country can’t remain passive while competing economies aggressively negotiate market access and supply chain integration opportunities. It requires a dedicated trade negotiation team with the technical expertise and strategic vision that’s necessary to secure agreements that genuinely benefit domestic industries and exporters.

Investment reforms are equally critical. Sri Lanka has struggled to attract large-scale transformational foreign direct investments (FDI). One of the most important priorities should be securing an anchor tenant investor that signals confidence in Sri Lanka and catalyses broader investor interest. 

Countries across Southeast Asia have successfully used such investments to create industrial ecosystems and integrate into global value chains.

Sri Lanka must also operationalise the essence of the Economic Transformation Act through which Board of Investment’s (BOI) regulatory and promotional functions are separated. A dedicated ‘Invest in Sri Lanka’ agency that’s focussed purely on investment promotion and facilitation will help address longstanding investor frustrations around approvals, coordination and bureaucracy.

The government must also continue with selective divestment and restructuring of state-owned enterprises (SOEs). Beyond improving efficiency, such measures can generate non-tax revenue and reduce the fiscal burden on the state. 

Reforming SOEs also signals policy seriousness to investors and development partners.

CENTRAL PILLARS Digitisation must become another key item of the reform agenda. Greater digitisation across government services, taxation systems and public administration can improve efficiency, reduce leakages and widen the tax net. 

Sri Lanka’s tax-to-GDP ratio remains below the level needed to sustainably finance public expenditure. Expanding the tax base through tech driven compliance and better data integration will be far more sustainable than repeatedly increasing tax rates on already compliant taxpayers.

Tourism presents another major untapped opportunity. Although arrivals recovered strongly last year, Sri Lanka still underperforms relative to its potential. The country urgently needs a globally coordinated tourism campaign that’s backed by consistent branding and market targeting. 

India should be the starting point: despite being one of the world’s largest outbound tourism markets and our closest neighbour, Sri Lanka captures only around two percent of India’s outbound tourists. Even a modest increase in market share can substantially boost foreign exchange earnings and regional tourism development.

The recent external pressures once again demonstrated the country’s vulnerability to imported fuel shocks

FUEL SHOCKS Finally, Sri Lanka must accelerate its energy transition.The recent external pressures once again demonstrated the country’s vulnerability to imported fuel shocks. 

Improving energy security through rapid expansion of renewable energy is not only an environmental priority but also a macroeconomic necessity. 

Faster implementation of renewable projects, grid modernisation and investment certainty in the energy sector will reduce long-term external vulnerabilities while improving competitiveness.

Sri Lanka’s recovery story is as real as its vulnerabilities. The country now stands at a critical juncture, where the sustainability of stability will depend on whether it can convert crisis driven reforms into a broader transformation agenda.