Source The World Bank In Sri Lanka
Country Context
The COVID-19 pandemic impacted Sri Lanka profoundly, as is the case in many countries. When the first domestic cases of COVID-19 were reported in March 2020, the government rapidly scaled-up containment measures. Tourist arrivals were suspended, and an island-wide curfew was implemented from mid-March through June 2020. These measures, combined with rigorous case finding, contact tracing, as well as quarantine and isolation, ensured that the first wave was contained successfully. Only 3,380 cases and 13 deaths had been reported by September 30, 2020. However, the country had to contend with a second wave of infections and a rapid increase in cases during the last quarter of 2020. This time, however, the government resorted to targeted lockdowns instead of island wide curfews, to minimize the impact on economic activity.
Recent Developments
Amid the COVID-19 pandemic, Sri Lanka’s economy contracted by 3.6 percent in 2020, the worst growth performance on record, as is the case in many countries fighting the pandemic. Swift measures enacted by the government in the second quarter helped contain the first wave of COVID-19 successfully, but these measures hit sectors like tourism, construction, and transport especially hard, while collapsing global demand impacted the textile industry. Job and earning losses disrupted private consumption and uncertainty impeded investment. The economy began to recover in the third quarter as the first wave was brought under control and containment measures were relaxed. The momentum continued in the fourth quarter as the economy was broadly kept open despite a second wave of COVID-19 infections.
The government took proactive measures to mitigate the impact of the pandemic. Despite limited fiscal space, resources were allocated (approximately 0.7 percent of GDP) for health measures, cash transfers, and postponed tax payments. While public expenditures increased, revenues declined, resulting in a widening of the fiscal deficit in 2020. Due to the economic contraction and the elevated fiscal deficit amid COVID-19, public and publicly guaranteed debt is estimated to have increased to 109.7 percent of GDP. In line with the government strategy to reduce external debt over the medium-term, debt financing relied increasingly on domestic sources.
The Central Bank of Sri Lanka (CBSL) significantly contributed to the crisis response. It undertook considerable monetary policy easing, for which there was room given benign inflation, and additional measures to increase liquidity in the market and support businesses. It also introduced financial sector regulatory measures, like a debt moratorium for COVID-19 affected businesses and individuals. However, despite these efforts, bank lending to the private sector remained low. By contrast, credit to the government and state-owned enterprises surged and accounted for 80 percent of the total credit in 2020. The pandemic likely exacerbated pre-existing financial sector vulnerabilities, although the full impact of COVID-19 cannot yet be observed.
An improved trade balance and strong remittance inflows narrowed the current account deficit. A sharp drop in imports in 2020 more than offset the decline in exports. However, with financial inflows insufficient to meet external liabilities, reserves declined to an 11-year low in February 2021, before a currency swap worth US$ 1.5 billion with the People’s Bank of China was approved in March 2021. Due to a shortage of foreign currency, the exchange rate depreciated by 6.5 percent from January through March 17, 2021. The CBSL took several measures to preserve foreign exchange reserves and reduce pressures on the exchange rate.
Last Updated: Apr 06, 2021
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