May exports were strong, but the export engine is still weak

By Dhananath Fernando

Originally appeared on The Morning

Sri Lanka has reported its highest-ever export performance for the first five months of a year. From January to May 2026, total exports reached $ 7.39 billion, recording a year-on-year growth of 7.5%.

The May numbers are particularly interesting. Merchandise exports grew by around 18%, while services exports also recorded a similar growth rate. For the first four months of the year, export growth was only around 4.3%. With May’s performance, the overall growth for the first five months was pushed up to about 7.5%.

What is more interesting is that this performance has not really come from the apparel industry. Tea exports were also low, partly due to tensions in the Middle East. The growth has come from areas such as electrical and electronic components, processed food and beverages, coconut products, seafood, and a few other sectors. On the services side, Information and Communication Technology/Business Process Management (ICT/BPM) has shown good growth.

This export performance is commendable. But we should not misunderstand one good month as proof that Sri Lanka has solved its export problem.

Building competitiveness

Exports are a function of competitiveness. Some parts of competitiveness come naturally. But most of it has to be built over time.

For example, Sri Lanka’s soil structure and climate may give our cinnamon a unique aroma and our coconut products a distinctive quality. But developing cinnamon and coconut as globally competitive products is a local game. Our coconut has to compete with coconut products from India, Indonesia, and the Philippines. At the same time, coconut-based products also compete with substitutes such as almond-based products, palm oil, and even olive oil in certain categories.

Cinnamon has a similar challenge. Sri Lankan cinnamon has to compete with cinnamon from Indonesia and Vietnam. At the same time, it also competes with other spices such as cloves, cardamom, and nutmeg in the wider global spice market.

So competitiveness is not just about one product competing with the same product from another country. It is also about one category competing with another category. That is where Sri Lanka still has a serious structural problem.

Factor market challenges

The first problem is our factor markets: land, labour, and capital.

For any product category or investor, accessing land has become a major issue. From a cinnamon cultivator to an electronic component manufacturer, land is a binding constraint. The solution is to invest more in Bim Saviya, speed up land titling, and identify industrial zones using underutilised Government land, including land held by major State-Owned Enterprises (SOEs).

But to make this happen, Sri Lanka needs institutions that can move fast. At the moment, we do not have that machinery.

Then comes labour. Sri Lanka has a serious labour problem. On one hand, we do not have enough workers in the domestic market, partly because many skilled people have migrated. On the other hand, female labour force participation remains low. Childcare, unsafe and unreliable public transport, and rigid workplace structures make it harder for women to join and remain in the labour market.

Our labour regulations are also rigid. Hiring is costly. Exiting is complicated. As a result, firms become cautious about expanding. This affects exporters directly, because export competitiveness depends not only on wages, but also on flexibility, productivity, and the ability to scale.

Land and labour constraints also affect access to capital. Because of land title issues, banks are reluctant to accept land as collateral or extend credit easily. For a long time, access to capital was also difficult because the Government was the main borrower in the economy. A large share of credit from financial institutions flowed to the Government and SOEs instead of the private sector.

Now private sector credit is recovering, but these changes take time. Exporters cannot become competitive overnight when the supporting system has been weak for years.

In simple terms, Sri Lanka’s factor markets do not really support our exporters to compete, either on price or quality.

A system lagging behind

Then there are the supporting costs. Construction costs are high. Electricity, which is a key input for almost every export product, is expensive. As a result, energy-intensive industries struggle to maintain their edge under the current cost structure.

On top of that, Customs procedures remain difficult and cumbersome. We still operate with a century-old Customs Ordinance. That does not support a modern export economy. Exporters need speed, predictability, and simplicity. What they often get is delay, discretion, and paperwork.

Another major issue is productivity. Sri Lanka’s productivity drive across sectors is weak. In coconut, tea, rubber, and dairy, the average output per unit remains low compared to many regional peers. Those countries also have problems. But we are far behind. Without improving productivity, we cannot expect our exports to compete purely through branding or sentiment.

In the modern world, competitiveness also comes through market access. When countries sign trade agreements or join trade blocs, their exporters get access to markets at lower tariff rates. That makes a big difference when investors decide where to locate production.

Sri Lanka receives some benefits through arrangements such as the Generalised Scheme of Preferences Plus (GSP+). But countries with wider trade agreement networks have a stronger advantage. They can offer investors access to more markets, better certainty, and greater scale.

Sri Lanka has free trade agreements with India and Pakistan. We also signed the Singapore-Sri Lanka Free Trade Agreement and a trade agreement with Thailand. But the status, implementation, and practical benefits of these agreements are still not very clear to the wider business community. Signing agreements is one thing. Using them to attract investment and expand exports is another.

No other choice

So while May’s export performance is good, Sri Lanka’s export structure is still not properly organised. One strong month has changed the narrative for the first five months of 2026. But it has not changed the fundamentals.

What Sri Lanka needs is export growth driven by structural reforms. That means fixing land markets, improving labour flexibility, expanding female labour force participation, easing access to capital, reducing input costs, modernising Customs, improving productivity, and widening market access.

Of course, structural reforms take time. They are complicated. Multiple teams have to work hand in hand for a reasonable period before we see real results.

But sadly, Sri Lanka has no other choice.

If we want exports to grow sustainably, we cannot depend on one good month. We have to fix the system that produces exports.

It is not a weak rupee, it is weak policy

By Dhananath Fernando

Originally appeared on The Morning

At the end of March, the Sri Lankan Rupee was trading at around Rs. 310 to the US Dollar. By the week before 21 May, it had moved to around Rs. 321–326. On 21 May, the exchange rate moved sharply, fluctuating between Rs. 331 and Rs. 348, before settling again at around Rs. 328–330.

Many looked at this movement and concluded that the rupee was getting weaker. But the exchange rate, by itself, is not the best indicator of whether an economy is performing well or badly. A currency can move for many reasons. What matters is whether the movement reflects market fundamentals or policy mistakes.

In this case, the recent rupee movement tells us less about the weakness of the LKR and more about the weakness of our policy environment.

Market signals

One clear example came from the data shared at a recent press conference by the Deputy Minister of Finance. According to him, after the surcharge on Customs duty for vehicle imports, vehicle-related Letters of Credit (LCs) dropped to about $ 4 million a day. However, one day after the surcharge announcement, the value of LCs opened for vehicle imports was $ 88 million.

That means one policy announcement created 22 times the normal daily demand for dollars in a single day.

The surcharge was announced on 15 May. Whether intended or not, it signalled to the market that dollars were in short supply. When markets receive such signals, they do not wait patiently. Importers rush. Businesses panic. Anyone planning to open an LC tries to do it before the next restriction arrives.

The additional demand was not only for vehicles. It likely spilled over into other non-perishable imports as well. That sudden dollar demand put pressure on the exchange rate. Within a week of the vehicle import surcharge announcement, the pressure became difficult to manage, and the Central Bank reportedly had to release around $ 200 million from reserves to calm the market.

The story did not stop there.

On 24 May, loan-to-value ratios were imposed on vehicles and gold. Again, the signal to the market was obvious: the authorities were worried about dollar demand. But the bigger issue was left untouched.

Impact of policy uncertainty

More than 20% of our import bill is fuel. Yet we continue to delay proper fuel price adjustments. In effect, we are subsidising fuel while burning the hard-earned gains of the primary balance. The failure to adjust fuel prices has now spilled over into vehicle imports, gold loans, and eventually monetary policy.

There is also a revenue contradiction here. The Government earns far more tax revenue per dollar spent on vehicle imports than on many other imports. Vehicles are taxed at around 120% on average, one of the most extreme border tax structures in the world. So when we slow down vehicle imports while failing to address fuel pricing properly, we reduce dollar demand in one place but also lose a major source of Government revenue per dollar spent.

Then came 26 May. To contain demand and absorb excess liquidity, the Central Bank increased policy interest rates by 100 basis points. Given the liquidity conditions, the move was understandable. The market had excess liquidity, and the Central Bank had already been absorbing rupees through repo operations.

But the broader point is this: the reluctance to make the politically difficult decision on fuel prices eventually pushed the burden onto interest rates. What began as a fiscal and pricing problem became a monetary policy problem. The Central Bank then had to do the unpopular job.

On 9 June, another measure followed. The mandatory conversion period for exporters’ foreign currency earnings was reduced from 90 days to 30 days.

This will not build confidence. It will erode whatever little confidence remains.

Exporters will now have even stronger incentives to delay bringing money into Sri Lanka, keep funds offshore for as long as possible, or structure transactions in ways that reduce exposure to forced conversion. That is not because exporters are unpatriotic. It is because policy uncertainty changes behaviour.

Fixing the fundamentals

When we look at the sequence of decisions, the problem becomes clear. The reason for the rupee pressure and the tools used to address it did not match. The pressure came from panic, excess liquidity, fuel pricing failures, and poor policy signalling. But the response was a mix of import surcharges, credit restrictions, higher interest rates, and forced exporter conversion.

This is not a weak rupee story. It is a weak policy story.

The next episode is easy to predict. Exporters will be accused of keeping money offshore. They will be blamed for not bringing dollars into the country. They may even be treated like traitors responsible for the currency movement.

But this is deeply unfair.

For years, we have said exports must grow. We want exporters to bring in dollars. We want them to compete globally. We want them to diversify Sri Lanka’s economy. But what have we given them in return?

We have made exports difficult through para-tariffs, labour regulations, land issues, high energy costs, policy uncertainty, and a generally unfriendly business environment. At the same time, the Ministry of Industry runs special credit schemes for exporters. The Export Development Board takes part in international exhibitions to find new markets. We talk endlessly about export growth.

And after all that, our final policy response is to tell exporters: bring your dollars back faster and convert them within 30 days instead of 90.

This is not how confidence is built. This is how confidence is destroyed.

The exchange rate is only a price. It reflects the demand and supply of dollars. But behind that price are expectations, confidence, policy credibility, and market behaviour. When policy becomes unpredictable, people protect themselves. Importers rush. Exporters delay. Consumers speculate. Banks become cautious. The currency then reflects that uncertainty.

So the real problem is not that the LKR is weak. The real problem is that our economic policy environment is weak.

A strong currency cannot be built on weak policy. It has to be built on predictable rules, market confidence, fiscal discipline, realistic pricing, and an export-friendly economy.

Until we fix those fundamentals, blaming the rupee will not help. The rupee is only telling us the truth.

When the State does business, the taxpayer gets the bill

By Dhananath Fernando

Originally appeared on The Morning

The Ministry of Finance Annual Report for 2025 is now out. One chapter every Sri Lankan should read carefully is the section on State-Owned Enterprises (SOEs), the businesses owned by the Government.

The story is simple. Even in a year where Sri Lanka showed strong fiscal discipline, SOE performance weakened. Profits declined. Several institutions made losses. The return to the Treasury was small. The taxpayer continued to carry the burden.

The President himself recently said that some of these entities may have to be closed down, and that even closing them will cost money. That is the problem with SOEs. They are easy to start, difficult to reform, expensive to maintain, and politically painful to close.

According to the Annual Report, the 51 key SOEs made a profit of Rs. 444.4 billion in 2025. At first glance, that looks impressive. But in 2024, the same group made Rs. 539.1 billion. Profits have fallen by more than 17%. In fact, the 2025 profit is slightly lower than the Rs. 445 billion recorded in 2023.

Sri Lanka has more than 500 State-owned and State-controlled entities, but detailed reporting is usually available only for the main 51. So even the picture we see is not the full picture.

The real story

Many people may still say: “What is the problem? They are making profits.”

But profit alone does not tell the story. We must look at the assets used to generate that profit. The total asset base of these 51 SOEs is about Rs. 16.5 trillion. That is roughly half of Sri Lanka’s GDP. From this massive asset base, the total profit was only Rs. 444.4 billion. That means the return on assets is about 2.7%.

To put it simply, imagine you own a shop worth Rs. 1 million. If that shop gives you only around Rs. 27,000 a year, or about Rs. 2,250 a month, would you call it a good investment? Even an ordinary fixed deposit may give a better return. So while it is easy to declare that they are profitable, it is much harder to say they are good businesses.

Where did most of this profit come from? Banking and finance.

Out of the Rs. 444.4 billion in total SOE profit, about Rs. 304.8 billion came from banking and finance institutions such as the Bank of Ceylon, People’s Bank, the National Savings Bank, and the Employees’ Trust Fund. The Bank of Ceylon alone reported a profit of about Rs. 120 billion, roughly 27% of the total profit of all 51 key SOEs.

But whose money is in these institutions? Largely our own money deposits, savings, retirement funds, and State-linked financial power. A large part of SOE profit does not come from competitive business success. It comes from State banking power, regulatory advantages, monopoly positions, and public funds.

This pattern is visible across many SOEs. The profitable ones are often monopolies or protected businesses. The Sri Lanka Ports Authority, National Water Supply and Drainage Board, and National Lotteries Board are not ordinary businesses competing in an open market.

It is like passing a law saying only I can sell bread in the country and then proudly declaring that my bakery is profitable. Is that business excellence, or monopoly privilege?

Now look at the loss-making side. The biggest hit in 2025 came from the Ceylon Electricity Board (CEB). The CEB recorded a loss of Rs. 38.7 billion. In 2024, it made a profit of Rs. 141.6 billion. In one year, it moved from a large profit to a large loss.

The CEB is also a monopoly. In 2024, high electricity tariffs helped it show a profit. In 2025, with tariff reductions, cost problems, and operational inefficiencies, it returned to losses. According to reported data, the average sales price per unit fell from Rs. 36.01 to Rs. 26.24, while the cost per unit was Rs. 30.23. When electricity is sold below cost, the final bill does not disappear. It comes to the taxpayer.

There is another lesson here. When the State operates in areas where there is competition, it often struggles. Construction-sector SOEs recorded losses. SriLankan Airlines, Lanka Sugar, the State Plantations Corporation, and the Sri Lanka Rupavahini Corporation also remained loss-making.

The message is simple. Give a monopoly and the SOE may show a profit. Put it in competition and it often struggles. Then the problem is not only management. It is ownership, incentives, and structure.

The real cost

The most important question is this: how much of this so-called profit actually came to the Treasury?

The answer is very little.

The total levies and dividends paid by SOEs to the Consolidated Fund in 2025 amounted to Rs. 56.5 billion. In the same year, the Government provided about Rs. 103 billion in budgetary support to SOEs. In simple terms, SOEs gave the Treasury Rs. 56.5 billion, but received about Rs. 103 billion from the Budget.

The total losses of loss-making institutions amounted to about Rs. 69.8 billion. When we consider the budgetary support of about Rs. 103 billion, and deduct the Rs. 56.5 billion received as dividends and levies, the net burden on the taxpayer is still around Rs. 117 billion.

That is the real cost of SOEs.

Rs. 117 billion is not just a number in an Excel sheet. It is money that could have gone to the poor through Aswesuma. It is money that could have gone to hospitals, medicine, schools, courts, policing, and basic public services. Every rupee used to keep a failing State business alive is a rupee not spent on a poor family.

Many people believe that if honest people are appointed to these institutions, the problem will be solved. Honesty is important. Competence is important. Good boards are important. But they are not enough. The problem is structural.

The State already has a share in every profitable business through corporate tax. With Value-Added Tax and other taxes, the Government receives even more. Therefore, the Government does not need to run businesses to earn revenue. It can earn revenue by creating the conditions for businesses to grow.

The proper role of the State is not to sell sugar, fly planes, grow tea, sell fish, run lotteries, manage hotels, sell cashew, or operate construction companies.

The role of the State is to maintain law and order; protect national security; provide a targeted safety net for the poor; improve education and healthcare; fix the courts, Police, and regulatory system; and create fair competition.

When the Government tries to do everything, it ends up doing the most important things badly.

That is why SOE reform is not only about profit and loss. It is about priorities. It is about whether the State should use scarce public money to protect poor families or to protect failed businesses.

The 2025 data tells us something clearly. Even after an economic crisis, even under fiscal discipline, and even with better political intentions, the SOE problem has not gone away.

The taxpayer is still paying the bill.

The IMF programme is not a growth strategy

By Dhananath Fernando

Originally appeared on The Morning

Sri Lanka received about $ 695 million after the combined Fifth and Sixth Reviews of the International Monetary Fund (IMF) Extended Fund Facility. It is an important milestone. It gives the country some breathing space. It also confirms that we have done many things right since the crisis. But it also brings us closer to a reality check.

After almost four years of crisis management, we are beginning to realise that we have done very little beyond stabilisation. We fixed many of the things the IMF asked us to fix. We increased taxes. We restored cost reflective pricing. We improved fiscal discipline. We passed some important laws. We rebuilt some confidence.

But we have not done the big growth reforms this column has been arguing for over many years. The IMF programme has about nine months to go. The uncomfortable question is simple. What have we done to grow after the IMF programme ends?

Better numbers don’t mean a stronger economy

The answer is not very encouraging.

Land reforms for industries have been slow. Labour reforms that can respond to a declining labour force and very low female labour force participation have been pushed back. State-Owned Enterprise (SOE) reforms that can unlock economic resources and reduce fiscal risks have not moved at the required speed. Investment reforms, including a serious reform of the Board of Investment, are still largely under discussion. Trade agreements and better access to global markets have been kept on the backburner for political convenience.

What we have mainly done is revenue enhancement. Even there, a significant part of the recent improvement has come from vehicle imports. This is not a sustainable growth strategy.

Vehicle imports were reopened after years of restrictions. Naturally, there was pent-up demand. Imports surged. The Treasury received a large amount of revenue from duties and taxes. But this is a one-off source. We cannot import the same volume of vehicles every year and call it fiscal strength.

Already, vehicle registrations are slowing. The Government has also imposed an additional surcharge on Customs duty. That may bring some short-term revenue, but it also signals how dependent we have become on taxing imports rather than expanding the productive economy.

This is precisely the danger. We may come out of the IMF programme with better numbers, but without a stronger economy.

Some reforms have been scheduled so far into the future that they may never happen. Para-tariff removals, for instance, are expected to be phased out only by 2029; that is after the current IMF programme. The longer the delay, the more time lobbying groups have to protect their privileges. In Sri Lanka, reforms postponed are often reforms abandoned.

The post-IMF landscape

So what happens after the IMF programme?

Without growth reforms, we will slowly slide back. Not immediately. Not dramatically. But gradually. First, investment will remain weak. Then jobs will not grow fast enough. Then tax revenue will disappoint. Then debt repayment pressure will rise. Then the exchange rate will come under pressure. Then the same old arguments will return: control imports, subsidise energy, print money, blame external forces.

Unfortunately, external forces are not helping us either.

The IMF itself has warned that Sri Lanka’s 2026 growth outlook has weakened, with growth projected at around 3%. The Middle East conflict and the aftermath of Cyclone Ditwah have tilted risks to the downside. Higher oil prices can increase inflation, weaken the current account, and affect tourism. These are not theoretical risks for Sri Lanka. We are an energy-importing country. We do not have much room to absorb large shocks.

If rainfall weakens and hydropower generation drops, diesel-based power generation will rise. That means electricity costs will rise. If global diesel and crude prices rise further, the pressure will come through fuel, electricity, transport, food, and construction materials. Aluminium, steel, fertiliser, and agricultural products will also feel the impact through energy and logistics costs.

This is the problem with a weak economy. A global shock becomes a domestic crisis very quickly.

The IMF has also been clear that debt sustainability risks remain high. The debt trajectory can improve only if we maintain strong fiscal performance, keep inflation under control, and sustain growth. From 2027 onwards, Sri Lanka is expected to return to a primary balance target of 2.3% of GDP. That is not easy if growth is weak and revenue depends heavily on temporary windfalls such as vehicle imports.

In other words, the IMF programme can help us stabilise. But it cannot make us rich. It cannot create jobs for us. It cannot make our exports competitive. It cannot bring investors if our land, labour, tax, trade, and regulatory systems remain difficult. It cannot make our SOEs efficient if we do not have the political courage to reform them.

The IMF is not a substitute for a national growth strategy.

Building an economy that can stand on its own

What are the solutions?

There is no shortcut. We have to become responsible and do the growth reforms ourselves. The crisis forced us to do stabilisation reforms because the alternative was collapse. But growth reforms require a different kind of political courage. They do not always produce immediate results. They upset vested interests. They require explaining difficult choices to the public.

That is why we have avoided them.

If we cannot build that political will ourselves, we may again be pushed towards another IMF arrangement after this programme. There are IMF arrangements that may not require new money but can still provide policy credibility. Such an arrangement can reassure investors, reduce risk premiums, and lower borrowing costs. But politically, an IMF programme without money is a very difficult message to sell.

More importantly, another IMF programme can also become another way of kicking the can down the road. If growth reforms are not front-loaded, we will again reach the end of the next programme and ask the same question: what have we done for growth?

The better option is to build a domestic political consensus before the pressure returns.

Just as we have a Constitutional Council for important appointments, Sri Lanka needs a minimum national growth agenda agreed by the main political parties. It need not cover everything. It should focus on a few reforms that can deliver growth and jobs: land for investment, labour flexibility, public transport, SOE reform, faster investment approvals, trade facilitation, and a predictable tax regime.

The objective must be clear: Sri Lanka should aim for 5–8% growth, not 3% survival.

Some reforms can show results faster than others. Public transport reform can improve productivity quickly because millions of people lose time every day in bad transport. Labour reforms can help more women and young people enter the workforce. Investment approval reforms can quickly improve investor confidence. SOE reforms can release assets, reduce fiscal risks, and open space for private sector activity.

But these reforms must be owned by Sri Lanka, not outsourced to Washington.

The IMF has helped us avoid collapse. For that, the programme has been useful. But avoiding collapse is not the same as building prosperity. Stabilisation is the floor, not the ceiling.

The next nine months are important not because the IMF programme is ending, but because our excuse is ending. We can no longer say we are only managing the crisis. We now have to decide whether we are building an economy that can stand on its own.

By failing to reform, we are preparing ourselves to fail once again.

Why is the Sri Lankan Rupee depreciating?

By Dhananath Fernando

Originally appeared on The Morning

Why has the Sri Lankan Rupee depreciated over the last few days? Many people want to know the reason. Many also want to predict where the exchange rate will stabilise.

In simple terms, the exchange rate is the price we pay in rupees to buy one US Dollar. It is similar to buying a cake of soap from a shop. If the price of soap increases, we say soap has become more expensive. Likewise, when the price of a US Dollar increases in rupee terms, we say the rupee has depreciated.

Like any other good, the price of the US Dollar is determined by demand and supply.

On the supply side, dollars come into the banking system through merchandise exports, service exports, tourism earnings, worker remittances, foreign direct investments, and other capital inflows.

The real trick is in understanding the demand side. Dollars are demanded for merchandise imports such as raw materials, fuel, vehicles, and medicine. Dollars are also needed for outbound tourism expenditure, foreign salaries, profit repatriation, and outward remittances. In addition to importers and individuals, the Central Bank too buys dollars from the market to build reserves.

So, when the demand for dollars exceeds the supply of dollars, the rupee depreciates. In other words, the price of the dollar goes up.

But there is one important point many people miss. Demand for dollars is created through rupees. If there is more rupee liquidity in the banking system, and if that liquidity is converted into credit, it can create more demand for imports and therefore more demand for dollars.

How USD demand is created: Story of excess credit

Everyone who goes to a bank to buy dollars either pays in cash or obtains a loan from the bank.

If banks lend from depositors’ money, it does not necessarily create excess demand. This is because someone has already saved money by reducing consumption. That saved money is then lent to someone else with interest. In that case, overall demand in the economy does not increase in the same way.

But the situation is different when the Central Bank buys dollars from the market to build reserves.

The Central Bank does not collect deposits from the public like a commercial bank. When the Central Bank buys dollars, it pays rupees into the banking system. In simple terms, it creates new rupees.

One may then ask: is it wrong for the Central Bank to buy dollars and build reserves? The simple answer is no. The Central Bank must build reserves, especially after a crisis. It has to buy dollars from the market to do so.

However, when the Central Bank buys dollars, new rupees enter the banking system. Over the last three years, the Central Bank has bought a cumulative $ 6,528 million from the market, injecting rupees into the banking system in the process.

Once this additional rupee liquidity is in the banking system, banks cannot earn much by simply keeping it idle. They have two options:

They can deposit the money back at the Central Bank and earn interest – This is linked to what we call the overnight policy rate. At present, if banks deposit excess money at the Central Bank, they earn about 7.25% interest.

They can lend this money to customers – These loans can take many forms: letters of credit for imports, credit cards, housing loans, overdraft facilities, business loans, and other forms of credit.

When banks extend loans using this additional rupee liquidity, credit in the economy expands. Part of this credit eventually moves into imports because people and businesses buy more goods, many of which are imported. This creates additional demand for dollars.

According to the Central Bank’s Annual Economic Review 2025, private credit expanded sharply. Credit growth increased from around 25%, and in value terms, credit expanded from about Rs. 790 billion in 2024 to about Rs. 2,000 billion in 2025. This means the economy created more demand for dollars through credit expansion.

When the economy is growing strongly, new rupee liquidity may not immediately create trouble because the new money is also used to produce and consume more goods and services. But when credit expands faster than dollar inflows, the economy becomes vulnerable. Usually, the pressure becomes visible after an internal or external shock.

In simple terms, while Sri Lanka had excess dollars in the market for some time, excess rupee liquidity and credit expansion continued to create demand for imports. That import demand eventually created pressure on the exchange rate.

Speculation effect

The second reason for the recent depreciation is speculation.

When the currency starts to depreciate, those who bring dollars into the market may hold back, expecting the rupee to depreciate further. Exporters, remitters, and others who have dollars may delay conversion.

At the same time, those who need dollars try to buy them as early as possible to avoid a further loss. Importers and businesses rush to cover their dollar needs.

As a result, demand increases while supply is delayed. This can push the exchange rate up quickly.

If this continues, informal markets can also get activated. When people feel they cannot access dollars easily through the formal banking system, or when they expect the rupee to depreciate further, they may start looking for dollars outside the formal market.

That creates another problem. The informal rate can move above the official rate, more dollar holders may delay bringing money into the formal system, and confidence in the exchange rate can weaken further.

Fuel price adjustments and vehicle import ban

Adjusting diesel prices to market prices is essential to contain dollar demand. Fuel is one of our largest import items. In March, fuel accounted for about 23% of our imports. Therefore, fuel prices have to reflect market costs.

If fuel prices are kept artificially low, consumption does not adjust. People continue to consume fuel as if global prices have not changed. But the country still has to find dollars to pay for those imports. That is how a fuel subsidy becomes an exchange rate problem.

There is another argument that vehicle imports should be banned again to save dollars. This sounds attractive, but it does not solve the real problem.

If vehicle imports are banned while excess rupee liquidity remains in the banking system, banks will lend that money to other sectors. Credit may then move into construction, electronics, consumer goods, or other import-heavy categories. So while vehicle imports come down on one side, imports in another category can increase.

Therefore, banning one import item does not necessarily reduce overall import demand. It only shifts demand from one category to another.

If the objective is to reduce overall import demand, the real tool is interest rates. When market interest rates increase, banks have a better incentive to deposit money at the Central Bank instead of lending aggressively to customers. Higher interest rates also discourage people and businesses from taking new loans. Consumption slows down, credit slows down, and import demand comes down.

Of course, this is not painless. When interest rates go up, the economy slows. Businesses face pressure. Small and Medium-sized Enterprises (SMEs) face a difficult time. Borrowers feel the pain.

But this is the difficult choice in economic management. Either we adjust early through prices and interest rates, or we are forced to adjust later through a currency crisis.

The real reasons for exchange rate depreciation are a mix of global shocks, credit expansion, and speculation. The tools available are also clear: fuel prices must be cost-reflective, and interest rates must be used when credit expansion creates pressure on the currency.

Both actions are politically unpopular. But if we fail to adjust to reality, the reality we will face later will be far more unpopular.

Fuel subsidies are not social protection

By Dhananath Fernando

Originally appeared on The Morning

This column previously warned that when prices lie, crises follow. Sri Lanka learnt that lesson the hard way in 2022. Yet today, we are once again moving towards the same dangerous path by moving away from cost-reflective fuel pricing.

The Government has now effectively admitted that fuel is being subsidised by around Rs. 100 per litre for diesel and around Rs. 20 per litre for petrol. Sri Lanka consumes roughly 180 million litres of diesel a month and a similar volume of petrol. Even if this subsidy applies only to fuel sold through the State-owned Ceylon Petroleum Corporation (CPC), the cost is staggering. The monthly subsidy bill could easily exceed Rs. 15 billion and amount to Rs. 150–200 billion annually.

To put that into perspective, Rs. 200 billion is equivalent to building nearly two expressway phases of Rambukkana to Galagedara or financing several major infrastructure projects. Instead, we are distributing that money through subsidised fuel largely to those who consume the most energy.

The reality is simple. The non-poor consume far more fuel than the poor. Around 70% of Sri Lanka’s fuel consumption comes from higher-income groups and commercial users who are relatively capable of absorbing price increases. In effect, the subsidy becomes a transfer of public money to people who can already afford to pay market prices.

The bigger issue

The President recently stated at a meeting that, according to CPC calculations, diesel prices should be around Rs. 720 per litre, while it is currently being sold at around Rs. 392. Even after accounting for the estimated Rs. 100 subsidy, there still appears to be a significant gap between the actual cost and the selling price.

The bigger issue, however, is not merely the subsidy itself but the pressure it creates across the entire economy. The President himself acknowledged that Sri Lanka’s monthly fuel import bill, which was previously around $ 200–300 million, was now expected to rise towards $ 500 million.

Artificially low prices encourage higher consumption, especially among those who can afford it. The likely Government strategy may be to hold prices down temporarily in the hope that global oil prices will eventually decline, allowing losses to be recovered later. Unfortunately, this is exactly the same mistake Sri Lanka made before the economic crisis.

Fuel and electricity were both sold below cost for prolonged periods based on political calculations rather than economic reality. Once subsidies are introduced, politics makes it extremely difficult to reverse them. Politicians facing elections and public pressure continue postponing necessary price adjustments, and temporary subsidies slowly become permanent fiscal burdens.

Severe consequences

The consequences do not stop there. Fuel and vehicle-related taxes remain among the Government’s largest sources of revenue. With vehicle imports already constrained, the resulting tax shortfall will eventually need to be filled either through new taxes, lower tax thresholds, or wider tax collection efforts.

It is far more transparent and economically rational to allow consumers to pay the true market price for fuel at the point of purchase rather than recovering the same money later through additional taxes on income, consumption, or businesses.

Sri Lanka’s agreement with the International Monetary Fund clearly emphasises the importance of cost-reflective pricing for fuel and electricity. Even if the Government argues that subsidies can be financed through alternative revenue streams, the signal sent to investors, businesses, and international lenders is deeply concerning. It suggests that Sri Lanka is beginning to drift away from the very stability framework that restored confidence after the crisis. The same concerns apply to delays in electricity tariff revisions.

There is also a dangerous monetary risk beneath the surface. Subsidising fuel for those who do not need support eventually creates pressure on the Government to seek financing elsewhere. Historically, that ‘elsewhere’ has often been the Central Bank.

Today, with greater Central Bank independence, direct monetary financing is no longer easily possible. But political pressure can quickly emerge to weaken those safeguards. Once people are convinced that printing money can keep fuel prices low and distribute more subsidies, the pressure to dilute hard-earned reforms becomes politically attractive. That is precisely how Sri Lanka entered the spiral that led to the 2022 collapse.

Without some level of demand contraction through market pricing, fuel consumption will continue increasing, placing greater pressure on the dollar market. Sri Lanka will then face two painful choices: allow the rupee to depreciate sharply or spend down scarce foreign reserves defending the currency.

Both options carry severe consequences. A weaker rupee pushes inflation and fuel prices even higher, creating a vicious cycle. Meanwhile, depleting reserves damages investor confidence, weakens creditworthiness, and raises concerns about debt sustainability.

None of this means high fuel or electricity prices are desirable. Prices should come down. But sustainable price reductions can only come through productivity improvements, competition, efficiency gains, and better management, not through unsustainable subsidies.

At the same time, rising energy prices do hurt the poorest households disproportionately. The solution, however, is not universal subsidies that benefit the wealthy most. The correct approach is targeted social protection. Sri Lanka must strengthen its social safety nets and increase direct cash transfers for the poorest families rather than subsidising fuel consumption for those who can comfortably afford market prices.

In simple terms, subsidies should protect the poor, not cheap fuel consumption for the rich.

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Tariff reform vs. the high-tariff lobby

By Dhananath Fernando

Originally appeared on The Morning

There was a recent news story that the Government is considering a new tariff policy. That may sound technical. It is not. It goes to the heart of how expensive life is in Sri Lanka.

A tariff, in simple terms, is a tax imposed by a government on goods imported from another country. The definition is straightforward. The system is not.

Millions of products cross borders every year. In Sri Lanka, each of these items is taxed at different rates at the point of entry. Every product that crosses the border is classified under what is known as an HS Code – the Harmonised Commodity Description and Coding System developed by the World Customs Organization (WCO).

At the global level, goods are identified using a six-digit code. Countries can then add additional digits to create more detailed classifications. That is where complexity begins. With eight or 10 digits, categories become narrower, rates become different – and discretion enters the system.

There are generally two types of tariffs. The first is an ad valorem tariff – a percentage of the value of the good. For example, a vehicle may be taxed at 20% of its declared value. The second is a specific tariff – a fixed amount per unit, such as a certain number of rupees per pair of shoes or per kilo of cement.

Not all tariffs are created equal. In principle, tariffs discourage trade. Governments justify them either as revenue measures or as tools to protect domestic industries. But when tariffs become excessively high, they stop being revenue instruments. They become barriers. Products simply do not enter the market because, after taxes, they are no longer affordable.

The type of tariff also matters. A specific tariff can disproportionately hurt lower-income consumers. Imagine a flat Rs. 500 tax on a pair of shoes. A pair worth Rs. 1,000 faces a 50% tax. A pair worth Rs. 30,000 faces less than 2%. The burden falls heavier on those buying lower-value goods. That is not progressive policy; that is distortion.

Sri Lanka’s deeper problem, however, is structural. We have operated for decades with a highly complex, cascading tariff system. Multiple rates across thousands of HS codes. Para-tariffs layered on top of Customs duties. Different treatment depending on how a product is classified.

Complexity creates discretion. Discretion creates room for corruption. When tariff rates differ significantly between similar HS codes, the official determining the classification holds enormous power. A small change in classification can mean a large difference in tax payable. That gap becomes fertile ground for rent-seeking.

But that is only one side of the story.

The real push for high tariffs does not primarily come from customs officials. It comes from vested interests within the private sector.

There are companies in selected industries that mainly serve the domestic market. If cheaper or better-quality imports were allowed to enter freely, many of these firms would struggle to compete. Instead of improving productivity or innovating, they lobby for protection.

Construction materials are a clear example. Tariffs in some segments go as high as 70% or 80%, often through para-tariffs such as Commodity Export Subsidy Scheme (CESS) and Ports and Airports Development Levy (PAL).

Over time, the high-tariff lobby has become highly organised. It operates almost like a cartel. It finances political campaigns across party lines. It frames the narrative around ‘saving dollars’ and ‘protecting local industry’ while consumers quietly pay the price. Many of these protected industries function as monopolies or oligopolies, operating in near-cartel structures with limited competition.

To further entrench protection, many of these products are placed on what is known as the ‘negative list.’ Even when Sri Lanka signs a free trade agreement, items on the negative list are excluded from tariff reductions. In effect, the agreement becomes hollow for those sectors.

The proposed new tariff policy seeks to address this. It is expected to introduce a simplified structure, perhaps four tariff bands such as 0%, 10%, 20%, and 30%, and to remove para-tariffs like CESS and PAL. If implemented properly, this would be one of the most significant trade reforms in decades.

But reform in Sri Lanka is never a straight road.

Lobbying groups typically use three tactics to dilute such reforms. First, they demand long phase-out periods of three to five years, arguing that the industry needs time to adjust. In practice, those years allow political pressure to build and reforms to stall.

Second, they push to expand the negative list, adding more items under protection so that even with a simplified tariff structure, meaningful competition never materialises.

Third, they invoke anti-dumping measures to reintroduce barriers through another door, effectively recreating protection under a different label.

Many governments have attempted tariff reform. The fact that we are still debating simplification after decades is itself evidence of how strong vested interests are.

Moving towards a four-band tariff system and eliminating para-tariffs is commendable. But it must be done decisively. Without expanding the negative list. Without excessive phasing. Without hidden backdoors.

Every delay strengthens cartels. Every compromise keeps prices high. And every year of hesitation quietly squeezes consumers, especially the poor, by denying them access to affordable goods and better living standards.

Tariff reform is not a technical adjustment. It is a test of political courage. The question is simple: do we design policy for protected producers, or for the broader public?

The answer will determine whether Sri Lanka remains a high-cost economy trapped by interests or becomes a competitive one driven by opportunity.

Tourism, like cricket, needs better fundamentals

By Dhananath Fernando

Originally appeared on The Morning

Sri Lanka tourism is a lot like Sri Lanka cricket. For cricket, everyone has an opinion. Who should be captain, what the team should look like, what the game plan should be. Tourism is the same. Almost everyone has a different idea of how to ‘fix’ it.

And, like cricket, tourism is emotionally connected to the hearts and minds of people. That is why we get disappointed so easily after even a small setback, and why we bounce back so quickly too. The love for the game and the industry is real.

Tourist arrivals are now picking up and we are hitting record highs. But estimated earnings are declining. We need to remember that ‘earnings’ are an estimate. We calculate earnings by multiplying the number of arrivals by average length of stay, and then by average spending per night. The most sensitive part of that equation is average spending, which is based on surveys of tourists, on what they spend on categories such as accommodation, travel, shopping, and so on.

A few months ago, the Sri Lanka Tourism Development Authority (SLTDA) with Australia’s Market Development Facility (MDF) launched results of a survey with a sample of about 11,000 inbound travellers and 5,000 outbound travellers, covering about 50 countries.

According to those results, average spending per tourist is now $ 148, down from the earlier $ 171. That shift alone helps explain why earnings can fall even while arrivals rise. The same survey shows that about 18% of visitors are repeat visitors and 58% are women. Of total spending, 55% goes to accommodation. Interestingly, 46% of travellers booked through Online Travel Agents (OTAs) and 62% are non-package travellers.

In this context, another SLTDA study has made headlines: out of about $ 3 billion in earnings in 2024, around $ 900 million is said to have “leaked,” and the Government is now trying to prevent this leakage. According to the study, around $ 500 million is leaking through inbound travel operators and another $ 250 million through accommodation. Based on these findings, there is a renewed push for measures to minimise leakage.

The obsession with leakage

The intentions are good. But the problem is the way we are diagnosing the disease. In my view, there is a poor understanding of monetary economics behind this obsession with ‘leakage.’

Yes, OTAs charge commissions. Yes, some payments are settled overseas, so not every tourism dollar will enter Sri Lanka through our banking system. But the idea that regulating OTAs or tightening rules on parts of the tourism value chain will meaningfully ‘save’ dollars is not first principles thinking. Oversight matters. Compliance matters. But oversight is not a monetary strategy.

Here is why.

Leakage of dollars is largely a function of excess rupees in the system, not simply the behaviour of tourism stakeholders. When we create excess rupees, people will try to convert those rupees into dollars. The most common way this happens is through imports.

Let’s simplify it. When we buy a mobile phone, we are effectively buying dollars with rupees. We pay the shop in rupees. The shopkeeper goes to the bank, buys dollars using those rupees, and pays the overseas supplier. The transaction is initiated by rupees. If we have excess rupees the demand for USD is higher.

Now imagine we ban mobile phones, thinking those dollars will stay in the country. They will not. The bank will sell those dollars to someone else who wants to import something else, because banks are in the business of converting currencies, and because demand for dollars does not disappear simply because one item is restricted. If there is excess rupee liquidity, the dollars will find a way out through whatever channel is available.

The same logic applies to tourism. Even if you restrict OTAs or tighten certain import segments, there will be no ‘dollar saving’ if the rupee side remains loose. Any dollars entering the market will still leave as long as there is excess rupee liquidity chasing foreign exchange. Restrictions shift routes. They do not remove the pressure.

At the same time, we should be honest about why some businesses prefer to keep foreign currency outside Sri Lanka. It is not only about commissions or convenience. It is also about the difficulty of moving money across borders when regulations are heavy, approvals are unclear, and conversion rules are tight. If you are running a cross-border business, you will naturally park funds where transactions are smoother and risk is lower. That is exactly what is happening.

There is another reality we cannot ignore: there is a limit to how much import content we can cut in tourism without damaging the product.

A visitor expects a basic standard. Rooms need air-conditioning. Air-conditioners are imported. Tourism transport needs reliable vehicles and fuel. Vehicles and fuel are imported. There is a minimum quality bar in a competitive global market, and trying to cut our way below that bar will not save us; it will simply push tourists elsewhere.

Even in services, ‘local only’ is not always practical. World-class restaurants and wellness experiences often depend on specialised inputs and, sometimes, specialised talent. In some cases, salaries have to be paid in foreign currency.

You cannot run a top-tier Japanese restaurant or a great Thai experience with good intentions alone. We need talent from those countries to be located here for an authentic experience. If we attempt to ‘save dollars’ by lowering quality, we will end up losing the very customers who bring the dollars in the first place.

So what should we focus on?

Instead of hunting ‘leakage’ like it is the main villain, we should focus on value creation. If tourists see value, they spend more. Higher spend improves earnings, supports better jobs, and creates stronger businesses that can invest in quality.

The path to stronger tourism earnings is not to squeeze the system tighter; it is to make Sri Lanka a place where people are happy to spend, and businesses are confident to bring money in and reinvest.

And this is where monetary stability becomes central. If we stabilise the monetary system, avoid excess rupee creation, and reduce unnecessary friction in capital flows, tourism earnings will naturally improve. Yes, there will always be some money that is paid abroad, just as Sri Lankans will always spend money abroad too. That is normal in an open economy.

The solution is not to treat tourism stakeholders as the problem. The real fix is to get the monetary foundations right and make Sri Lanka easy to do business with. Otherwise, we will keep arguing about captains and game plans while losing the match in the middle overs.