Last updated: February 2022
Sri Lanka remains a lower-middle-income country; GDP per capita is below the average for emerging Asian countries. Measures of the business climate, growth and creditworthiness are also below the regional average. Public debt and balance of payments problems, political risks, security and geopolitical issues and environmental risks all remain prominent challenges. Amid these challenges, a highly literate population, diversified economy and moderately strong institutions support robust growth and investment potential.
The above chart is a cobweb diagram showing how a country measures up on four important dimensions of economic performance—per capita income, annual GDP growth, business climate rank and creditworthiness. Per capita income is in current US dollars. Annual GDP growth is the five-year average forecast between 2022 and 2026. Business climate is measured by the World Bank’s latest Ease of Doing Business ranking of 190 countries. Creditworthiness attempts to measure a country's ability to honour its external debt obligations and is measured by its OECD country credit risk rating. The chart shows not only how a country performs on the four dimensions, but how it measures up against other countries in the region.
The economy grew by 3.6% in 2021 from a low base, supported by growth in manufacturing, trade, financial services, and real estate activity. Rising COVID-19 infections weakened the pace of recovery in the second half of 2021, and the rapid spread of Omicron clouds an already challenging outlook.
The IMF forecasts 3.3% growth in 2022. This reflects the ongoing effects of the pandemic, subdued tourism and deteriorating government liquidity and external financing. Moreover, rising economic hardship, higher inflation and fuel and food shortages raises the risks of further protests and social unrest, as occurred in late 2021. A weak economic recovery worsens the outlook for debt sustainability. Public debt is expected to reach 111% of GDP by 2022 and remain high over the forecast period to 2026. Public interest payments absorb over 60% of public revenues, leaving the government with challenging tradeoffs in rationalising social spending and development expenditure.
Beyond the pandemic, growth potential hinges on attracting more foreign investment, diversifying trade and reviving tourism. Sri Lanka's strategic location on key shipping routes, as well as its expanded port capacity, position it well to benefit from increased trade, particularly in South Asia. Effective implementation of reforms to facilitate trade and investment would boost competitiveness and support longer-term growth.
Significant progress in socio-economic and human development indicators, alongside continued economic growth has supported increasing incomes over the past two decades. But GDP per capita has fallen from above US$4,000 in 2017 and 2018 to an estimated $3,700 in 2020 and 2021 in part due to lost jobs and lower incomes related to the COVID-19 pandemic. As a result, the World Bank projects the poverty rate (earnings less than US$3.20 per day) to have increased from 9.2% in 2019 to 11.7% in 2020.
Country risk in Sri Lanka is high. The OECD has a country credit grade of 7. The three major ratings agencies have sub-investment grade sovereign credit ratings. The increasingly strained external-debt repayment position, a sharp rise in the government debt-to-GDP ratio associated with the COVID-19 shock and economic downturn, and narrowing financing options have all heightened debt sustainability risks. This has prompted all three major rating agencies to downgrade the sovereign rating over the past year. This indicates an elevated risk of Sri Lanka being unable and/or unwilling to meet its external debt obligations.
The World Bank ranks Sri Lanka 99th out of 190 economies in the ease of doing business survey. Sri Lanka lags the emerging Asian average in contract enforcement, registering property and getting credit. Trading across borders, protecting minority investors and starting a business are somewhat easier in Sri Lanka.
Sri Lanka’s scores on Worldwide Governance Indicators are broadly in line with, or even stronger, than the average for emerging Asian countries. The unconstitutional nature of political developments in late 2018 highlighted the effectiveness of the rule of law. The government has in recent years stepped up efforts to curb corruption, including amending the Bribery Act in July 2018 to hear bribery and corruption cases. Still, most indicators rank in the bottom half of all countries.
The risk of expropriation in Sri Lanka is moderate, consistent with governance scores around control of corruption and rule of law.
Political risk in Sri Lanka is moderate. The return of a majority government has restored stability to the political environment. But ethnic and social tensions remain a risk to growth prospects.
Sri Lanka was Australia’s 42nd largest trading partner in 2020. Total goods and services trade amounted to $1.3 billion in 2020, about 0.2% of Australia’s total trade portfolio. The COVID-19 pandemic disrupted bilateral trade over the past two years. Goods exports to Sri Lanka consist mostly of vegetables, wheat, paper and paperboard, motor vehicles and milk. Goods imports from Sri Lanka are made up of mostly of clothing, textiles and tea.
The COVID-19 pandemic and associated international travel restrictions disproportionately hurt services trade over the past two years. Before the pandemic, Sri Lankan students studying in Australia had been increasing significantly from a low level. Enrolments remained broadly stable in 2020. This is partly because many Australian education providers that operate in Sri Lanka, including Monash University, the Australian College of Business and Technology and the Royal Melbourne Institute of Technology all offer distance learning programs.
As in education, Sri Lanka had been a growing market for Australian tourism prior to the pandemic. The launch of direct flights between the two countries in 2017 further boosted Sri Lankan demand for Australian tourism; more than 40,000 Sri Lankans visited Australia in 2018 and 2019 before the pandemic cut arrivals in 2020 and 2021. The ongoing pandemic points to another year of uncertainty for education and tourism exports in 2022.
Bilateral investment between Sri Lanka and Australia remains small. Australia’s development program will support Sri Lanka’s efforts to enhance health security and advance economic development.