In recent years, Sri Lanka has faced one of the biggest economic crises in its history, caused by both structural problems in the national economy and the short-sighted policies of the republic's government. In 2020, the COVID-19 pandemic hit the country's tourism-dependent economy hard and led to a 4.6% decline in real GDP. In 2021, there was a recovery growth of 4.2%, but it was unstable and accompanied by the accumulation of internal imbalances, which triggered a serious deterioration in the economic situation. As a result, Sri Lanka's real GDP declined by 7.3% in 2022, and the government defaulted on its external debt due to a lack of foreign currency to import essential goods.
Subsequently, the Sri Lankan authorities managed (including by monetary policy) to gradually stabilize the situation: real GDP contraction slowed to 2.3% in 2023 and was replaced by 4.5% growth in 2024 amid the success of the reforms. The country increased its gold and foreign exchange reserves and improved its fiscal indicators thanks to a recovery in service sector revenues driven by a revival in tourism, as well as high levels of remittances from abroad and a strengthening of the national currency.
In the medium term, Sri Lanka's real GDP growth is expected to continue to recover at a rate of around 3% annually, with further development of the tourism sector and an increase in remittances from Sri Lankan emigrants in other countries. Nevertheless, the national economy remains extremely vulnerable to external challenges due to declining agricultural production, excessive dependence on the tourism sector, and labor productivity issues. To ensure further growth, Sri Lanka needs to implement structural reforms and diversify its economy.
One of the signs of the economic crisis in Sri Lanka in 2022 was a sharp rise in inflation (to a record high of 45.2%), caused by a bunch of things like the national currency losing value, rising energy prices, lower crop yields due to a temporary ban on chemical fertilizer imports in 2021, and issuance to finance the budget deficit. In 2023, the rate of price growth slowed to 17.4%, but remained high. In response, the Central Bank of Sri Lanka began to tighten its monetary policy, reducing money supply and raising the key interest rate from 5.0% in January 2022 to 15.5% in March 2023.
As the country's macroeconomic situation improved, and as a result of the stabilization of energy prices and the strengthening of the national currency, inflationary pressure in Sri Lanka gradually eased. Moreover, in the second half of 2024, the country experienced deflation, and according to estimates, price growth amounted to only 1.2% at the end of the year. The easing of inflationary pressure allowed the Central Bank of Sri Lanka to begin the process of softening its monetary policy: from June 2023 to March 2025, the key rate was reduced by a total of 750 basis points to 8.0%. In the medium term, inflation is expected to stabilize within the target range set by the regulator at 5±2%. According to forecasts, price growth in the country will amount to 3.8% by the end of 2025 and accelerate to 5.4% in 2026.
