On September 25, 2024, global credit rating agency Moody’s expressed a positive outlook on Sri Lanka’s reform trajectory under newly elected President Anura Kumara Dissanayake. While Dissanayake’s election marks a significant shift in Sri Lanka’s political landscape, Moody’s believes the country’s commitment to economic reforms will remain largely intact. However, the agency also highlighted some ongoing fiscal challenges that could pose risks to the nation’s financial stability.
Political Change but Economic Stability
Moody’s assessment comes shortly after Anura Kumara Dissanayake took office as Sri Lanka’s new president, following a historic election. Despite the political shift, Moody’s remains optimistic that Sri Lanka’s reform agenda, particularly its collaboration with the International Monetary Fund (IMF), will not face significant disruptions. According to Moody’s, “Dissanayake’s election constitutes a major shift in Sri Lanka’s political landscape, but we believe the broad appetite for reforms will remain intact.”
The agency underscored that while some policies might be reprioritized under the new administration, the core economic strategies, including ongoing debt restructuring and structural adjustments, are expected to continue. This continuity is crucial for maintaining investor confidence and for the country’s ongoing recovery from its recent economic crisis.
Challenges in Fiscal Consolidation
One of the main challenges highlighted by Moody’s is Sri Lanka’s fiscal consolidation efforts. While the country has made significant strides in restoring fiscal sustainability since defaulting on its debt in 2022, there is still much work to be done. Key reforms, such as increasing the value-added tax (VAT) and corporate income tax rates, have helped raise government revenue from 8.3% of GDP in 2021 to just over 11% in 2023.
These tax reforms also contributed to reducing Sri Lanka’s fiscal deficit, which dropped to 8.3% of GDP in 2023 from 11.7% in 2021. However, Moody’s pointed out that despite these improvements, the country’s debt affordability remains weak. Interest payments are expected to average between 40% and 50% of revenue over the next two to three years, still one of the highest ratios among sovereign nations rated by Moody’s.
Moody’s acknowledged that while these fiscal reforms are necessary, they alone won’t be enough to fully stabilize Sri Lanka’s economy. The country will need to continue focusing on debt restructuring and working closely with international creditors and financial institutions like the IMF to maintain its reform momentum.
The Economic Transformation Act
A key factor that will help ensure continuity in Sri Lanka’s reform efforts is the Economic Transformation Act, which was passed by Parliament in May 2024 under former President Ranil Wickremesinghe. This act obliges future governments, including Dissanayake’s administration, to adhere to the current set of economic and fiscal reforms.
The act also mandates that every year by March 31, the government must present a report to Parliament outlining the steps being taken to achieve specific fiscal and debt targets. This requirement will help maintain accountability and ensure that the reform process continues, regardless of political changes.
Moody’s noted that this legislative framework is critical in ensuring that Sri Lanka remains on track with its IMF program and broader economic goals. The act effectively binds future governments to follow through on the reforms that have been set in motion, which should help mitigate any potential disruptions caused by political changes.
President Dissanayake’s Policy Priorities
Since taking office, President Anura Kumara Dissanayake has outlined several key policy priorities. One of his main focuses is tackling corruption and addressing the needs of the poor, particularly those affected by austerity measures. He has also spoken about the need to reduce the negative impact of fiscal reforms on social welfare programs.
Despite these policy priorities, Dissanayake has made it clear that he supports the ongoing debt restructuring process and Sri Lanka’s collaboration with the IMF. While some changes to specific policies and reform measures may be made, Dissanayake has stated that any adjustments will be made in consultation with the IMF to ensure that they align with the country’s broader economic goals.
However, one area where Dissanayake differs from his predecessor is in his stance on the privatization of state-owned enterprises. He has expressed opposition to the privatization of key sectors, a position that could lead to some delays in certain reform measures. This divergence could potentially cause delays in disbursements or the finalization of Sri Lanka’s external debt restructuring with private-sector creditors.
Potential Political Uncertainty
In addition to the challenges of maintaining fiscal consolidation, there could also be a period of political uncertainty in the coming months. President Dissanayake has indicated that he plans to dissolve Parliament and call for early Parliamentary elections, which could take place as early as November 2024. Moody’s noted that this political uncertainty could lead to delays in implementing certain reforms, as the new Parliament may take time to form and settle.
Despite these potential challenges, Moody’s remains confident that Sri Lanka’s overall reform trajectory will remain intact. The new administration’s commitment to working with the IMF and maintaining the core elements of the economic reform agenda is seen as a positive signal for the country’s long-term stability.
Sri Lanka’s Progress on External Position
Moody’s also highlighted Sri Lanka’s progress in rebuilding its external financial position. The country’s official foreign exchange reserves rose to around $6 billion by the end of August 2024, up from less than $2 billion for most of 2022. This improvement has allowed Sri Lanka to cover around 3.5 to 4 months of imports, providing a much-needed buffer for the country’s economy.
The rebuilding of Sri Lanka’s foreign exchange reserves has contributed to a more stable macroeconomic environment. In recent months, the country has seen a return to real GDP growth, rapid disinflation, and an improved balance of payments. These positive developments have helped stabilize the economy and restore some level of confidence among investors and creditors.
Conclusion: A Path Forward for Sri Lanka
Moody’s overall assessment of Sri Lanka under President Anura Kumara Dissanayake’s leadership is cautiously optimistic. While there are significant challenges ahead, particularly in terms of fiscal consolidation and managing political uncertainty, the country’s commitment to economic reforms remains strong.
The Economic Transformation Act provides a solid framework for ensuring that Sri Lanka stays on track with its reform agenda, while the ongoing collaboration with the IMF will help guide the country through its debt restructuring process. Although some policies may be adjusted or reprioritized, Moody’s believes that the core elements of Sri Lanka’s economic strategy will remain in place.
As Sri Lanka continues to rebuild its economy and strengthen its external financial position, the support of international creditors and institutions like Moody’s and the IMF will be crucial. With careful management and a continued focus on reform, Sri Lanka has the potential to overcome its current challenges and achieve long-term economic stability.
