Sri Lanka Economic Forecast

GDP shrank at a slower rate in Q2, declining 3.1% year on year compared to 11.5% in Q1. Industrial and services output declined at a softer rate, while agricultural output expanded at a stronger pace. Activity was likely bolstered by lower inflation and surging tourism revenues. Heading into Q3, the economy appears to be remaining on the path to recovery. Services activity rose at the fastest and second-fastest pace since December 2021 in July and August, respectively, according to the PMI, and international reserves have remained at their highest level in over a year in the quarter so far. Moreover, the government is close to clinching the second tranche of its IMF bailout after it agreed to restructure USD 10 billion of debt with domestic bondholders in early September. The IMF is expected to make a decision on the funds by November.

Inflation in the capital fell to 4.0% in August from 6.3% in July. Inflation in Sri Lanka should remain in single digits this year and next on average, owing to a strong base effect. However, the recent relaxation of import and FX controls is a factor to monitor, after the rupee plunged in July. Upside risks include rising oil prices and higher food prices due to El Niño.