Five-Day Bank Holiday to Cleaning Up Debt: How Sri Lanka Is Steadying Its Economy After IMF Bailout

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(Bloomberg) — As Pakistan finally secured a long-sought interim deal with the International Monetary Fund, neighboring Sri Lanka is seen to be on its way to steadier ground after a $3 billion IMF bailout in March.

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Tough fiscal and monetary policies have steered Sri Lanka past its worst post-independence crisis that saw the economy come to virtual standstill as the nation defaulted on its debts last year. It made a breakthrough this week in reaching debt sustainability, a key step to unlocking more funds that will ramp up foreign reserves and enable it to stock up on essentials such as food and fuel.

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The South Asian nation this week announced plans to restructure $19.8 billion of bills and bonds, equivalent to half its local debt, to meet bailout terms. To smooth the process, the government declared a five-day bank holiday and shut financial markets from Thursday.

Here are key milestones as Sri Lanka emerges from crisis:

Overhaul domestic debt

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Sri Lanka’s cabinet on Wednesday approved a blueprint for an overhaul of domestic debt that excluded commercial banks, while offering to re-profile rupee-denominated bonds held by pension funds. Authorities are also negotiating with international bond holders and bilateral creditors for a plan to reduce the external financing gap by $17 billion. Lawmakers are expected to ratify the strategy on Saturday.

Rising cash inflows

The IMF approved Sri Lanka’s bailout after half-a-year of negotiations. The four-year loan program is reviewed every six months, with funds disbursed based on its ability to meet reforms that includes bringing inflation back to target.

Meanwhile, improving investor sentiment, rising remittances from nationals working overseas and increasing tourist arrivals are helping boost dollar reserves and ease balance-of-payments constraints. Optimism over Sri Lanka’s debt and economic recovery has made the local rupee one of the best-performing currencies this year.

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READ: Sri Lanka’s Economic Slump Eases as IMF Loan Program Kicks in

Inflation cools

The island’s inflation slowed for a fifth month in June, after bolting last year in Asia’s fastest price gains. 

Easing price pressures enabled the Central Bank of Sri Lanka to cut borrowing costs earlier this month for the first time in nearly three years to spur the economy. The CBSL raised the key rate by a total of 950 basis points during the crisis.

The monetary authority expects inflation to “decelerate notably in the period ahead” and ease below 10% in the early third quarter. The IMF wanted to see the headline gauge back to within target band of 4%-6% by early 2025.

READ: Sri Lanka Cuts Rate First Time in 3 Years as Inflation Cools 

Higher income taxes

To secure the IMF’s approval, Sri Lanka implemented difficult measures including increasing taxes, cutting energy subsidies, returning to a more flexible exchange rate regime and of course, jacking up the policy rate to the most since 2001 to keep a lid on inflation. 

READ: Key Takeaways From IMF’s $3 Billion Sri Lanka Bailout

—With assistance from Ruchi Bhatia.

(Updates with latest inflation data)