Wednesday Oct 21, 2026
Wednesday Oct 21, 2026
Wednesday, 21 October 2026 00:00 - - {{hitsCtrl.values.hits}}
With Sri Lanka’s current IMF Extended Fund Facility (EFF) program set to end in March 2027, the Institute of Policy Studies (IPS) has made a case for continued engagement with the Fund, warning that the country faces a prolonged ‘debt overhang’ of elevated borrowing costs and limited market access as it exits debt distress.
In its flagship report, Sri Lanka State of the Economy 2026, released in early October, the think tank said a precautionary relationship with multilateral institutions could help the country through the post-restructuring transition.
“In this context, maintaining a precautionary relationship with multilateral institutions, including the possibility of a successor IMF-supported arrangement, may provide an important credibility anchor during the post-restructuring transition,” it said.
Such engagement could help sustain policy discipline and reduce sovereign risk premia, the extra return investors demand to lend to a government, while structural reforms aimed at export diversification, reserve accumulation and fiscal consolidation take root.
The IPS said Sri Lanka’s return to international capital markets remains structurally constrained by elevated sovereign risk premia and sub-investment-grade credit ratings. The result has been persistently high external borrowing costs relative to historical norms.
“Empirical evidence from frontier-market sovereigns suggests that countries exiting debt distress episodes typically face a prolonged period of ‘debt overhang’ in international markets, during which spreads remain elevated and market access is either limited or prohibitively expensive,” the IPS said. Spreads are the additional yield investors demand over benchmark Bonds to compensate for a borrower’s risk.
The report cautioned against an early dash for market funding.
“Against this backdrop, premature or large-scale reliance on commercial external borrowing would likely increase rollover risks and reintroduce external liquidity pressures before reserve buffers and export earnings are sufficiently strengthened,” it said. Rollover risk is the danger that a government cannot refinance maturing debt on affordable terms.
The challenge is compounded by heightened global uncertainty and repeated exposure to external shocks, the think tank said. These include climate variability associated with El Niño-Southern Oscillation cycles and extreme weather-related disruptions, which could amplify macroeconomic volatility and weaken investor risk appetite.
Sovereign fragility is determined not solely by debt levels but by the interaction between external debt composition, reserve adequacy and shock exposure, the report said. Where economies remain highly exposed to terms-of-trade and climate-related shocks, market-based financing tends to be pro-cyclical: it flows in during good times and dries up when most needed, reinforcing rather than smoothing external vulnerabilities.
Durable market re-entry typically requires not only fiscal adjustment but also sustained improvements in external resilience and institutional credibility, it added.
The IPS also called for greater debt transparency. It warned that any deterioration in fiscal space tends to increase incentives for governments to hide the true extent of their debt, by moving it off-budget or by using financial or natural assets as collateral for additional borrowing. Before the crisis, Sri Lanka maintained off-budgetary mega development projects in ports, aviation, water supply and sanitation, and power and energy.
Average total capital spending on these projects amounted to approximately 1.3% of GDP during 2017-2020, with foreign financing contributing around 0.7% of GDP. The existing Integrated Treasury Management Information System (ITMIS) does not cover the full project lifecycle, the IPS said, making a unified digital public financial management system covering revenue, expenditure and debt data across all institutions ‘imperative’.
Noting that Sri Lanka’s debt default and economic crisis were partly due to governance failure, the report proposed a fiscal council, operationally independent from the Ministry of Finance. The council would provide independent macro-fiscal forecasts, cost key revenue and expenditure measures, monitor fiscal risks such as contingent liabilities and state-owned enterprise obligations, and report regularly to Parliament and the public.
