IMF says inflation to exceed 5% CBSL limit; BOP deficit to widen by $ 700 m

Sri Lanka faces an economic setback from Cyclone Ditwah that could wipe out between 2.5% and 5% of GDP, widen the balance of payments (BOP) gap by about $ 700 million over the next year, and push inflation higher and over Central Bank of Sri Lanka’s (CBSL) 5% limit in 2026.

This is according to an International Monetary Fund (IMF) staff assessment released last week which noted that the cyclone’s impact is expected to be significant, though subject to a high degree of uncertainty, noting that estimates of losses and macroeconomic outcomes carry wide margins of error. 

Based on experience from past disasters of similar magnitude, staff said the losses would stem from reconstruction of housing, roads, and infrastructure, as well as relief spending, with the burden falling disproportionately on already vulnerable households. 

Damage from Ditwah was assessed as more severe than the floods of 2016 and 2017, when recovery needs amounted to 1.1% and 0.8% of GDP, respectively.

The assessment indicates that economic growth could slow to 2.9% year-on-year (YoY) in 2026, from an estimated 4.2% in 2025, as the cyclone disrupts activity across key sectors. 

Agriculture and tourism, which together account for about 11% of GDP, are expected to be the most affected, with severe crop losses reported and the storm striking at the start of the peak tourism season. IMF staff said construction activity linked to rebuilding is likely to support growth during the recovery phase, partially offsetting the slowdown.

Inflationary pressures have begun to emerge in the immediate aftermath of the disaster. IMF projections show headline inflation rising to 4% YoY in December 2025, from 2.1% in November, while average inflation in 2026 is expected to increase to 5.4%, compared with the 3.3% forecast at the time of the Fourth Review. 

Staff cited price increases of between 30% and 200% for selected food items due to shortages, alongside broader cost pressures from supply chain disruptions caused by damaged infrastructure. During the 2016-17 disasters, food inflation rose sharply from 3% to 14.4% YoY.

On the external front, the IMF said the current account deficit could widen by around $ 700 million, or 0.7% of GDP, over the next 12 months. 

Flooding and landslides have destroyed agricultural land and livestock, increasing food import needs while reducing agricultural exports. Tourism receipts are expected to fall as the cyclone affected several major destinations during peak season, while damage to hydropower facilities may temporarily raise oil imports.

Disaster relief and reconstruction spending will add further to import demand, with higher remittances expected to provide only a partial offset.

The IMF assessed a Rapid Financing Instrument support of about $ 205 million as appropriate to address urgent BOP needs triggered by the cyclone, with total external financing needs estimated at about $ 720 million.

IMF staff noted that Sri Lanka entered the disaster period with stronger macroeconomic fundamentals, after reforms had supported a recovery and restored stability. Gross official reserves had risen to about three months of imports and inflation had remained low before the cyclone. 

On this basis, staff project growth returning to potential at around 3.1% in 2027, with inflation easing back towards target and the current account deficit narrowing as tourism and agricultural exports recover and emergency-related imports subside.

However, the outlook is subject to elevated downside risks. IMF staff warned that the cyclone has disrupted the recovery and heightened external and debt sustainability risks, adding to existing vulnerabilities. 

A re-imposition of higher US tariffs could weaken exports and growth, while prolonged trade policy uncertainty and geopolitical tensions could further weigh on tourism and fuel commodity price volatility at a time when exposure to food and fuel price swings has increased. Administrative capacity constraints could also delay structural reforms as resources are diverted to disaster response and reconstruction.

The IMF said adherence to public financial management rules, transparency in emergency spending, and disciplined public investment management would be essential to ensure that reconstruction supports recovery while safeguarding macroeconomic stability.