By: Staff Writer
November 24, Colombo (LNW): Sri Lanka’s economic recovery remains fragile despite pockets of improvement, with new expert commentary warning that policy missteps especially on interest rates risk prolonging the country’s crisis. Three years after the 2022 sovereign default, the country is still grappling with deep structural vulnerabilities, slow growth, and continuing social distress, even as official indicators point to stabilising external balances.
Sri Lanka continues to face its most severe economic downturn since independence in 1948. The fiscal tightening and austerity measures introduced as part of the IMF programme have helped reduce inflation and rebuild reserves, but they have also pushed large sections of the population into hardship.
Poverty has surged to 24.5% in 2024, more than double the 2019 level of 11.3%, while malnutrition, youth unemployment and rising school dropout rates suggest long-term, intergenerational consequences. Real per capita GDP is not expected to regain its 2018 levels until at least 2026, underscoring the slow pace of recovery.
The central tension within the economy today stems from contradictory conditions: sharply reduced inflation alongside some of the highest real interest rates in the region. According to the Central Bank of Sri Lanka’s August 2025 Monetary Policy Report, headline inflation has stayed below the 5% target for three consecutive quarters, moving only slightly above zero in the third quarter after dipping into negative territory earlier in the year. Yet the benchmark interest rate remains elevated at 7.75%.
This policy stance is now drawing major criticism. Professor Arjun Jayadev, Director at the Center for the Study of the Indian Economy at Azim Premji University, argues that maintaining such high real interest rates—despite low inflation and weak employment is “fiscal self-harm, not prudence.” He notes that Sri Lanka’s employment-to-population ratio has fallen by four percentage points since 2017, a clear sign that the economy is operating far below its potential.
Jayadev further warns that high interest rates threaten the country’s debt sustainability. With debt levels near 100% of GDP, even small increases in interest costs can widen the debt burden. Drawing a comparison to Greece’s post-2010 experience, he highlights how austerity can backfire when economic contraction outpaces debt reduction pushing economies deeper into crisis rather than stabilising them.
He also points out that Sri Lanka’s inflation is driven largely by food prices—which account for 35% of household expenditure—and are influenced more by global markets and supply disruptions than by domestic demand. This weakens the argument for keeping interest rates high to manage inflation.
Importantly, Sri Lanka’s external position has strengthened. The central bank projects a current-account surplus in 2025, official reserves have surpassed USD 6 billion, the rupee has been stable since the 2022 devaluation, and money markets show excess liquidity conditions that typically support monetary easing rather than tight policy.
Jayadev argues that maintaining a 7.75% policy rate benefits external actors at the expense of domestic recovery and warns that if tight monetary policy triggers another downturn, even foreign creditors stand to lose. With the economy returning to 4.9% growth in the second quarter of 2025, he believes the window for policy correction is open.
“Economies escape debt traps through growth, not endless austerity,” he stresses calling on the central bank to cut interest rates and support a more balanced, growth-oriented recovery.