IMF says Sri Lanka's economic recovery shows signs of improvement but challenges remain

A vendor waits for customers at a market place in Colombo, Sri Lanka, Thursday, June. 1, 2023. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena)

A vendor holds currency notes as he sells vegetables at a market place in Colombo, Sri Lanka, Thursday, June. 1, 2023. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena)

Sri Lankan currency notes are kept in a bowl at a market place in Colombo, Sri Lanka, Thursday, June. 1, 2023. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena)

A man buys goods at a market place in Colombo, Sri Lanka, Thursday, June. 1, 2023. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena)

FILE- Street hawkers open up their business for the day at a market place in Colombo, Sri Lanka, Nov. 14, 2022. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena, File)

A vendor counts currency notes as she sells vegetables at a market place in Colombo, Sri Lanka, Thursday, June. 1, 2023. The Central Bank of Sri Lanka reduced its interest rates Thursday, June 1, 2023, for the first time since the island nation declared bankruptcy last year. Stern fiscal controls, improved foreign currency income and help from an International Monetary Fund program has resulted in inflation slowing faster than expected. (AP Photo/Eranga Jayawardena)

COLOMBO, Sri Lanka (AP) — Debt-stricken Sri Lanka, which declared bankruptcy last year, is showing signs of economic improvement but its recovery still faces challenges, the International Monetary Fund said Friday.

The Indian Ocean island nation declared bankruptcy in April 2022 and said it was suspending repayment of its foreign debt. It reached an agreement with the IMF in March on a nearly $3 billion bailout program over four years.

“Sri Lanka’s economy is showing tentative signs of improvement, in part due to the implementation of critical policy actions. But the economic recovery remains challenging," said IMF deputy managing director Kenji Okamura after concluding a visit to Sri Lanka, where he met with the country’s top leaders and officials.

Okamura said he welcomed Sri Lankan authorities’ “strong commitment to implement their ambitious economic program, which is supported by the IMF.”

IMF previously said Sri Lanka’s economy is expected to resume growing in 2024 after contracting 3% this year. The expected economic growth of 1.5% next year hinges critically on the economic reforms Sri Lanka has agreed to undertake.

“Now, more than ever, it is essential to continue the reform momentum under strong ownership by both the authorities and the Sri Lankan people,” Okamura said in a statement early Friday.

Sri Lanka’s foreign debt exceeds $51 billion, of which $28 billion must be repaid by 2027. Sri Lanka has now started negotiations with its creditors on debt restructuring.

“The current economic crisis has its genesis in policy missteps aggravated by external shocks. We discussed the importance of fiscal measures, in particular revenue measures, for a return to macroeconomic stability. I was encouraged by the authorities’ commitment to negotiate a debt strategy in a timely and transparent manner. Continued open dialogue with the creditors will help to reach restructuring agreements to restore debt sustainability in line with the program targets,” Okamura said.

Sri Lanka’s economic crisis and resultant shortages of essentials sparked riots last year, forcing then-President Gotabaya Rajapaksa to flee the country and later resign.

Unsustainable debt, a severe balance of payment crisis on top of lingering scars of the COVID-19 pandemic, along with the government's insistence on spending scarce foreign reserves to prop up the Sri Lankan rupee, led to a severe shortage of foreign currency and essentials such as fuel, medicine, cooking gas and food.

Although there are some signs of progress — with shortages reduced and day-to-day functions restored — under current President Ranil Wickremesinghe, the government is still struggling to find money to pay its employees and conduct other administrative functions.

There’s been growing public dissatisfaction over the government’s recent move to increase taxes and electricity bills that came as part of the commitment to obtain the bailout package from the IMF.

The government announced 6% cuts in the budgets of each ministry this year and plans to nearly halve the size of the military, which had swelled to more than 200,000 personnel due to a long civil war that ended in 2009.