By Uditha H. Palihakkara –

Uditha H. Palihakkara

Four years after default, Sri Lanka has moved from crisis to a degree of macroeconomic stabilisation—but the deeper question is whether this progress reflects genuine structural recovery. The answer will ultimately determine whether recent gains endure or prove difficult to sustain.

In April 2022, Sri Lanka did not encounter an unexpected shock—it confronted the consequences of long-accumulating structural imbalances. The sovereign default marked the most visible breaking point in a system that had been under strain for years. Four years on, the country has moved from acute crisis to a degree of macroeconomic stabilisation. Yet the central question remains: while a degree of stabilisation has been achieved, can it be sustained over the medium to long term?

To understand the present moment, it is useful to revisit the trajectory across three broad phases: the build-up of pressures, the period of adjustment under stress, and the current phase of recovery. What emerges is not merely a story of economic adjustment, but one of institutional strength—and its limits.

The Build-Up: Stress Recognised. Not Resolved

In the years leading up to 2022, particularly from 2020 onwards, Sri Lanka experienced mounting macroeconomic stress. Foreign exchange shortages, import restrictions, and fiscal pressures became increasingly evident. Policy responses were introduced, reflecting recognition of emerging risks. However, these measures were largely reactive and insufficient to address underlying structural imbalances.

Fiscal deficits widened, revenue mobilisation remained constrained, and public debt accumulated steadily. Continued reliance on external financing, often without adequate buffers, further increased vulnerability. These pressures were compounded by policy responses such as monetary expansion and the drawdown of external reserves, including gold holdings, which provided temporary relief but weakened underlying macroeconomic buffers.

At the same time, institutional constraints—including limited data integration, weak coordination across agencies, and the absence of forward-looking policy frameworks—restricted the effectiveness of decision-making. Without robust data systems, economic management remained largely reactive.

The exchange rate remained relatively stable for a period, despite declining foreign reserves—reflecting sustained policy intervention rather than underlying market strength. This apparent stability masked deeper fragility.

Sri Lanka’s crisis was therefore not the result of an unforeseen external shock, but the culmination of risks that had been building over time. The underlying issue lay in the inability to respond with coherence and urgency—exacerbating the economic and social disruption of 2022.

Adjustment Under Stress: The Cost of Delay

The events of 2022 marked a period of severe economic and social disruption. The depletion of foreign exchange reserves constrained essential imports, including fuel, food, and medicine. Inflation surged to unprecedented levels, eroding household purchasing power and deepening economic hardship.

The suspension of external debt servicing reflected the scale of macroeconomic imbalance. It also underscored the interconnected nature of fiscal, monetary, and external sector dynamics. As pressures intensified, limitations in institutional capacity and coordination became evident.

This phase was characterised not only by economic contraction, but also by a broader loss of confidence—both domestic and international. The cost of delayed adjustment was significant and widely borne across the economy, particularly by more vulnerable segments of society.

The repercussions of this delay continue to be felt. The erosion of real incomes, the contraction of economic activity, and the loss of investor confidence have had lasting effects that extend beyond the immediate crisis period. Recovery must therefore be assessed not only in terms of current indicators, but also in relation to these enduring economic and social costs.

The Recovery: Stabilisation with Constraints

In 2023, Sri Lanka entered into an Extended Fund Facility arrangement with the International Monetary Fund, marking the beginning of a structured stabilisation process. The programme focused on fiscal consolidation, monetary discipline, exchange rate flexibility, and debt restructuring.

By 2024–2025, key macroeconomic indicators showed measurable improvement. Inflation moderated significantly, foreign exchange reserves increased, and economic activity began to recover gradually. These developments reflect both domestic policy adjustments and support from international partners.

These gains, while encouraging, remain contingent on continued policy discipline and reform continuity.However, stabilisation at the macro level does not necessarily imply that underlying structural weaknesses have been fully addressed. The International Monetary Fund has noted that Sri Lanka’s recovery remains precarious, with elevated poverty levels, uneven distribution of benefits, and continued exposure to external shocks.

This perspective is echoed in recent policy assessments, which emphasise the need to balance optimism with realism. Sustaining recovery will depend on maintaining reform momentum and avoiding the fatigue that has undermined past adjustment efforts.

The Risk of Premature Optimism

The current phase presents a more subtle but equally important risk: the possibility of interpreting short-term stabilisation as a sign of sustained recovery.

Macroeconomic indicators can improve relatively quickly once adjustment measures take effect. However, the institutional foundations that support long-term stability—data systems, policy coordination mechanisms, and governance frameworks—require sustained attention and reform. Without integrated, real-time data systems, economic management risks remaining reactive—limiting the ability to anticipate and respond to emerging risks.

Recent developments in the financial sector have further underscored these institutional vulnerabilities, highlighting gaps in oversight, risk detection, and governance that cannot be addressed through macroeconomic adjustment alone.

There is also a broader governance dimension. Economic crises often expose not only policy weaknesses, but also institutional limitations—gaps in accountability, fragmentation in decision-making, and delays in implementation. Unless these issues are addressed, the conditions that contributed to the original crisis may persist beneath improving indicators.

From Stabilisation to Resilience

The period since 2022 has provided an opportunity to stabilise key indicators and initiate reform measures. The next phase must focus on deepening these reforms to support long-term resilience. As stabilisation takes hold, the policy focus must shift from crisis management to long-term structural transformation—ensuring that reforms are institutionalised and sustained over time.

This includes strengthening public financial management, improving revenue mobilisation, enhancing transparency in State-Owned Enterprise operations, and reinforcing institutional coordination. Equally important is the development of integrated data systems that support evidence-based decision-making.

Resilience is not achieved through policy adjustment alone. It depends on the quality of institutions, the credibility of governance frameworks, and the ability to anticipate and manage risk. These elements are less visible than headline indicators, but they are critical to sustaining stability over time—strengthening the system’s ability to withstand future shocks.

Conclusion

Four years after sovereign default, Sri Lanka stands at an important juncture. The country has moved beyond the most acute phase of the crisis and has regained a degree of macroeconomic stability. This is a significant achievement—but it is not the end of the journey.Sri Lanka’s experience underscores a broader lesson: crises often arise not from sudden shocks alone, but from systems that fail to recognise and respond to risks in time.

While progress has been made, sustaining recovery will depend on the continuity and depth of reform. The challenge ahead is not merely to maintain stability, but to strengthen the institutional and governance foundations that support it—ensuring that future growth is resilient, inclusive, and durable.

*Uditha H. Palihakkara is a former Chairman of the Finance Commission of Sri Lanka and  a financial management professional with experience across public, private, and international institutions. He has served as a Financial Management Specialist at the Commonwealth Secretariat (CFTC) and writes on governance, fiscal policy, and institutional reform in a comparative context.