The World Bank projects the Sri Lankan economy will grow by 4.4% in 2024 as the country recovers from an economic crisis. However, the recovery depends on maintaining macroeconomic stability and continuing reforms, such as ending incentives to attract FDIs and abandoning inward-looking policies to boost global trade.
The recent economic stabilization – marked by four quarters of growth and a current account surplus in 2023 – is a significant milestone, said David Sislen, World Bank Regional Country Director, in a statement in early October 2024.
Over 21 quarters since the beginning of 2019 (to March 2024), the economy had negative growth rates in 14, including six consecutive quarters of negative growth from Q1-2022 to Q2-2023, with a recovery taking hold since then.
Sri Lanka has an opening to deepen its participation in global value chains and take advantage of its geography and evolving global landscape to generate jobs and sustain growth, Sislen said.
Export potential includes services like tech and tourism. However, Sri Lanka needs to reduce bureaucratic barriers and attract both local and foreign investments to realize this potential, World Bank Country Manager Gevorg Sargsyan said,
The World Bank noted that Sri Lanka could increase exports by an additional $10 billion annually, with current monthly exports at about $1 billion.
Sri Lanka should focus on attracting more export-oriented foreign direct investment that existing tax incentives have failed to attract. Tax breaks are not helping, Sargsyan said.
He also pointed to bureaucratic obstacles and inward-oriented policies.
The World Bank Sri Lanka Development Update: Opening to the Future, published in October 2024, highlights a decline in export performance over the past two decades as the country adopted a more inward-focused economic approach. In the early 2000s, actual and potential exports were closely aligned, but this trajectory diverged as other Asian economies grew successful exports. The trade-to-GDP ratio fell sharply from 88.6% in 2000 to 42.8% in 2023, while exports as a share of GDP dropped from 39% to 20.5%. This shift has led to a significant decline in Sri Lanka’s share of global exports, the World Bank noted.
Despite offering a broad range of discretionary tax exemptions, Sri Lanka has attracted limited foreign direct investment (FDI). The cost of foregone revenue reached 56% of the total tax revenue in 2022, far exceeding regional norms, while FDI inflows as a share of GDP remained below the regional average. Tax incentives tied to Strategic Development Projects (SDP) and Board of Investment (BOI) initiatives amounted to 1.7% of GDP in 2022, with foreign investors benefiting from over half of these incentives, primarily through Customs Duties and VAT relief.
Sri Lanka’s approach to investment incentives diverges from global best practices, which emphasize policy stability and predictability to attract FDI. Exemptions without clear transparency, cost-benefit analysis, or sunset clauses have likely led to economic distortions, an increased tax burden on non-exempt entities, and questionable effectiveness in drawing investments. Investor perceptions indicate that such incentives have a limited influence on decision-making. At the sector level, incentives are unevenly distributed, with about a third benefiting non-export sectors like infrastructure and power. Performance data for tax-exempt firms is not publicly disclosed, underscoring the need for a thorough review to enable better targeting and effective incentives.
The World Bank is funding an initiative to support economic recovery and reforms. In October 2024, the World Bank and the Government of Sri Lanka signed a $200 million agreement for the Second Resilience, Stability, and Economic Turnaround (RESET) Development Policy Operation (DPO), following the first $500 million operation disbursed in June and December 2023. This second phase, part of a two-part series initiated in 2022, aims to drive key reforms that strengthen economic governance, promote growth, and safeguard vulnerable populations.
The RESET DPO focuses on establishing a stable macroeconomic environment to rebuild investor confidence. Key reforms include enacting a new Public Debt Management Act, tax administration reforms to enhance revenue, and measures to mitigate financial sector risks. Additionally, it will focus on amendments to the Telecommunications and Electricity Acts to improve service delivery and initiatives to enhance export competitiveness by reducing para-tariffs.
A crucial element of the programme is bolstering social protection systems to help vulnerable communities manage the lasting effects of the economic downturn and price adjustments. It also emphasizes gender equality and women’s empowerment as drivers of sustainable growth.