As Sri Lanka navigates a crucial juncture in its economic journey, the new administration faces significant challenges, having inherited a country freshly emerging from a complex external debt restructuring process. The path ahead requires a delicate balance between fiscal prudence and the need for sustainable economic growth, all while maintaining investor confidence. The new administration’s ability to swiftly engage with international partners, like the IMF, and its pragmatic stance on maintaining key economic policy officials have already bolstered market confidence, reversing earlier apprehensions.
Amana Takaful PLC’s Executive Edge event featured a panel discussion showcasing insights from leaders across the industry. The panel included: Thilan Wijesinghe, Chairman of TWCorp and Former Chairman of the Board of Investment and National Agency for Public-Private Partnerships of the Finance Ministry of Sri Lanka; Naveen Gunawardane, Co-founder, Chief Investment Officer of Lynear Wealth Management, and Gayathri Manatunga, Head of Assurance of Ernst & Young Sri Lanka and Maldives. The customer forum was part of several initiatives to mark Amana Takaful’s 25th Anniversary this year and its contributions to the insurance industry of Sri Lanka.
Stretching the concept of insurance cover to something more, the Amana Takaful Executive Edge event brought together leaders from banking, insurance, and financial services along with selected Amana Takaful Life Insurance clientele to share insights and strategies, network and collaborate to inspire and push boundaries for a better future amidst a pivotal moment in the country’s history.
The discussion revolved around the key issues on the path to sustained growth; such as the need for the current administration to avoid the pitfalls of past administrations, particularly in resisting the allure of large, non-viable projects that drain financial resources. The focus on reforming core institutions, improving regulatory efficiency, and fostering innovation in sectors such as finance and infrastructure were also raised as critical to Sri Lanka’s economic trajectory.
With Sri Lanka having just finalized its external debt restructuring, what kind of challenges lie ahead, especially with a new government?
Wijesinghe: This new era demands a break from the past’s tendency to invest in costly, non-viable projects. Instead, the focus must shift to a more prudent, disciplined fiscal approach, ensuring that every investment aligns with long-term stability and growth. A key priority is restoring and maintaining investor confidence. The government’s early decisions—like re-engaging with the IMF and retaining key officials instrumental in the debt restructuring—have sparked positive market reactions.
History offers a precedent: in 1994, Sri Lanka saw a similar political transition when President Chandrika Bandaranaike Kumaratunga took office. Despite initial concerns about her pro-labour and anti-privatization stance, her administration pivoted towards a more centrist economic approach, guided by key advisors like A.S. Jayawardena (former Secretary to the Treasury) and Dr. Lal Jayawardena (Economic Adviser to the President). The shift led to significant reforms, including successful privatizations and public-private partnerships in sectors such as telecommunication and ports and increasing foreign direct investment amidst fiscal constraints and internal conflict.
Today, Sri Lanka is at a similar crossroads. Key figures in the economic advisory team, including experienced professionals and entrepreneurs like Duminda Hulangamuwa, Arjuna Herath and Haniff Yusuf, bring hope that the country can avoid a lengthy adjustment period.
As Sri Lanka is about to sign off on the commercial debt restructuring, how do you think the banks and the financial sector will be impacted, and by extension, what will happen to their ability to lend to customers?
Manatunga: The impact of the commercial debt restructuring on the banking sector is poised to be significant yet manageable, thanks to preemptive measures taken during recent crises. Over the past four years, banks have faced intense challenges, but the regulator’s early interventions have been crucial in maintaining stability. These measures included building capital buffers to absorb shocks and issuing timely directives to address emerging risks, such as rising non-performing loans. These steps allowed banks to prepare for potential setbacks well in advance, helping them remain resilient throughout the economic turmoil.
Currently, based on the proposals announced recently, banks have made sufficient provisions against impairments related to International Sovereign Bonds (ISBs). In the event the restructuring is concluded as announced, there is hope that banks could begin to reverse some of these provisions, further strengthening their financial positions. Such reversals could translate into a more robust capacity to lend, enhancing customer confidence, especially among depositors. This improved stability should enable banks to support economic recovery by extending credit more freely, potentially leading to better lending rates and increased economic activity.
A stable banking system not only reassures depositors but also lays the groundwork for broader economic recovery, making it an essential component of Sri Lanka’s path forward.
What are the likely or anticipated changes in the structure of the Sri Lankan economy that it will have to make to keep the IMF programme on track in the next two years and how should a government go about setting the groundwork to make that happen?
Wijesinghe: Meeting the IMF’s stringent targets—such as debt-to-GDP ratios and achieving a primary surplus—requires decisive leadership from the central bank and finance ministries. A significant hurdle lies in reforming key revenue-generating agencies like the Department of Inland Revenue, Excise, and Customs. Past efforts to streamline these institutions have failed due to a lack of political will and resistance to external expertise.
For example, a McKinsey study in 2018 suggested methods that could have potentially generated $500 million worth of additional revenue to the State by plugging tax leakages; yet implementation faltered over the government’s reluctance to pay consultancy fees and lack of will within the Finance Ministry. Beyond revenue reform, the government must also address inefficiencies in state-owned enterprises (SOEs). Privatization or strategic partnerships, such as for SriLankan Airlines or infrastructure projects like the Colombo East Terminal, could enhance efficiency and reduce the fiscal burden on the state. Yet, these decisions must rise above political rhetoric and focus purely on whether such action enhances sector competitiveness.
Thilan Wijesinghe
What are the challenges Sri Lanka will have around achieving some of the IMF’s EFF-specified targets, particularly the primary surplus goal of 2.3% of GDP that it has to record in 2025?
Gunawardane: This target is ambitious, as Sri Lanka has historically run primary deficits, making any surplus a notable shift. The country is currently well ahead of its target of 1% for 2024 and was tracking to 2.1% as of the end of August 2024. The 2.3% target for 2025 looks achievable with some adjustments. The government must address both revenue generation and cost management. Increasing revenue as a share of GDP is crucial, but it is only part of the equation. The cost side, often overlooked in IMF discussions, presents a critical challenge.
A substantial portion of government spending is tied to wages, making reductions difficult without impacting public sector employment and services. In the past, governments have resorted to cutting capital expenditure to meet targets—an approach that undermines long-term investment and growth. A consistent primary surplus can help avoid spikes in market interest rates, which is crucial for fostering investment and economic stability. Historically, due to the government being a large borrower in the market, a small pick-up in private-sector credit was often enough to drive sharp movements in interest rates. If the government continues to run a primary surplus this may no longer be the case and we could be looking at a period of relatively stable interest rates.
To succeed, the government will need to balance fiscal discipline with policies that encourage growth, ensuring that the path to meeting the IMF targets does not come at the expense of sustainable economic progress.
Naveen Gunawardane
How likely is the provision reversal ballpark going to be, with the haircuts that are to take place, and in light of the excess liquidity right now, what’s going to happen?
Manatunga: The prospect of provision reversals in Sri Lanka’s banking sector, particularly following debt haircuts and in the context of current excess liquidity, holds important implications for the economy. As banks strengthen their balance sheets through these reversals, they gain the capacity to extend more credit, especially to critical sectors like SMEs (Small and Medium Enterprises). This is key to economic recovery since SMEs form the backbone of the economy.
With a more robust capital position, banks can support initiatives that stimulate growth, such as providing funding lines or participating in government-led development projects. These might include efforts to build up Sri Lanka’s position as an education hub or support targeted sectors like women-led enterprises. Such activities could help inject much-needed liquidity into the SME sector, spurring broader economic activity.
Incentives for banks could further accelerate this process. Measures like concessions for those supporting SME development or accessing specific funding lines could motivate banks to actively participate in the recovery. In the context of following through with the IMF programme, this approach not only strengthens the financial sector but also lays a foundation for sustainable growth.
Gayathri Manatunga
What do you anticipate particularly with regards to consumer credit net interest margins in the financial services sector, and on the other side what are consumers doing, what does the evidence you see suggest about the health of the consumer?
Gunawardane: The demand for consumer credit has been mixed, reflecting a broader economic divide between rural and urban areas. Consumer activity has been picking up since last year; we say the early signs of recovery in finance companies and now banks are also seeing a slow pick-up in the demand for credit. This resurgence is driven in part by a rebound in the rural economy, particularly in the agricultural and tourism sectors, which have seen improved performance, thereby boosting consumption in these regions.
In contrast, urban areas, especially those reliant on the services sector, have faced a slower recovery. High taxes and inflation have significantly dampened purchasing power, meaning it could take three to four years for urban incomes and consumer spending to return to pre-2021 levels. The disparity is evident as rural consumers start spending more, while urban areas are still struggling with the financial aftershocks of the past few years.
Consumer companies saw 30 – 40% volume drops in 2022, but price inflation meant that these companies saw growth in absolute gross profits. As borrowing costs normalize, these companies are beginning to see growth in net profit alongside a gradual recovery in volumes.
The financial services sector, especially banks and lending institutions, must adapt to this uneven landscape, balancing the stronger demand from rural consumers against the delayed recovery in urban areas. With stabilization in some macroeconomic indicators, there is cautious optimism, but the path to a full recovery, particularly in urban markets, is expected to be gradual.
What are your final thoughts in closing?
Gunawardane: Sri Lanka’s financial services industry faces a pressing challenge: innovation. To meet changing consumer demands, banks must diversify beyond traditional deposit products by introducing innovative investment and wealth management options. This shift can attract new customers and enhance their experience. Similarly, insurance companies should expand into investment-linked products. Embracing fintech solutions and data analytics will drive efficiency and personalization. Regulatory support is essential to foster an innovative environment, simplifying compliance and promoting financial literacy.
Wijesinghe: With the stabilization of Sri Lanka’s financial system, regulators must embrace innovative ideas to consolidate the banking sector, particularly prioritizing the public listing of a strategic stake of the Bank of Ceylon and People’s Bank can enhance their accountability and competitiveness. Encouraging mergers of private banks will streamline operations, benefiting consumers including evolving regulatory frameworks essential to foster fintech growth and dismantle barriers to innovation. Ultimately, a more efficient financial system will improve products, reduce costs, and enhance financial inclusion, benefiting the economy.