Institute of Political Economy

Trump Tariffs and IMF

Sri Lanka Needs a Plan B.

 

Introduction

 

Sri Lanka stands at a critical juncture in its economic recovery, with the forthcoming performance review of IMF’s Extended Fund Facility (EFF) agreement shaping the course of its financial future and with Donald Trump imposing a 44% tariff on Sri Lanka’s exports to the USA. While the IMF agreement promises stability, the underlying conditions and debt restructuring framework raise serious concerns. The IMF’s Debt Sustainability Analysis (DSA) contains overly optimistic projections, significant errors, and a framework that ultimately prioritises the interests of international creditors over the well-being of the Sri Lankan people. The government must carefully assess the agreement’s implications and seek a more sustainable and just approach to economic recovery.

 

The restructuring agreement negotiated by the previous government, as it stands, risks deepening economic inequality, imposing severe austerity measures, and compromising national sovereignty. Sri Lanka must ensure that the debt relief plan aligns with its development goals, fosters economic growth, and safeguards the welfare of its citizens. The government must leverage its strong electoral mandate to negotiate from a position of strength, ensuring that IMF policies do not disproportionately burden the most vulnerable segments of society.  Sri Lanka should propose revisions to the restructuring agreement that prioritises debt sustainability by committing a fixed percentage of its foreign exchange revenue to debt servicing. Additionally, the performance review should be limited to assessing progress in expanding foreign exchange earnings, ensuring a growth-oriented and realistic approach to sustainably overcoming its external debt crisis.

 

The IMF’s Misguided Approach: Flaws in Debt Sustainability Analysis

 

The IMF’s Debt Sustainability Analysis (DSA) is the foundation of Sri Lanka’s debt restructuring process. However, it contains several flaws. The IMF assumes high GDP growth rates and unrealistic increases in government revenue, ignoring external shocks and domestic constraints. The analysis does not adequately account for fluctuating foreign exchange reserves, threat of inflation, and global economic instability. Additionally, the agreement ensures creditors receive payments at the expense of public sector investments, essential services, and social welfare programs.

 

By focusing exclusively on repayment targets rather than economic recovery, the IMF’s approach could push Sri Lanka into a deeper financial crisis rather than a sustainable recovery. The government must demand a restructuring framework that prioritises economic resilience and social equity rather than imposing further hardships on its citizens.

 

The Need for a Progressive Negotiating Team

 

Sri Lanka’s government must assemble a negotiating team that includes members committed to protecting national interests and free from IMF influence. The team must prioritise solutions that promote social welfare, economic growth, and sovereignty while resisting external pressures that enforce harmful austerity measures. The inclusion of independent economists, policy experts, and representatives from civil society is essential to ensure that negotiations reflect the needs of the people rather than the demands of international creditors.

 

Developing a Credible Plan B: A Viable Alternative to IMF Dependence

 

A well-structured alternative plan will strengthen Sri Lanka’s renegotiating position, allowing the government to resist unfavourable IMF terms. Sri Lanka defaulted because it was unable to service external debts. Sri Lanka should propose restructuring agreement where it is willing to pay a fixed percentage of foreign exchange revenue towards debt servicing.   A Plan B should focus on growing and diversifying foreign exchange revenue sources by expanding value-added exports, attracting strategic Foreign Direct Investments (FDIs), strengthening tourism, encouraging remittences and reducing illicit financial flows. It must also discourage non-essential imports to utilise scarce foreign exchange for critical imports such as food, medicine, high-technology and energy. A sustainable debt payment model should determine a manageable percentage of foreign exchange revenue for annual debt servicing to prevent economic strain. Additionally, strengthening economic sovereignty by ensuring that the domestic rupee economy remains independent of IMF-imposed constraints and focuses on sustainable growth is crucial. This strategy would empower Sri Lanka to renegotiate IMF terms from a position of strength rather than dependency.

 

Public Awareness and Support: Strengthening the Government’s Position

 

Public awareness and support are crucial in reinforcing the government’s bargaining power. Clear communication about the potential consequences of the IMF agreement will prepare the nation for all possible outcomes, including the option to exit the agreement if it threatens long-term stability. Educating citizens on economic policies, debt sustainability, and alternative solutions will build a broad-based consensus against harmful IMF conditions.

 

External Debt Audit: Exposing Unjust Financial Burdens

 

Sri Lanka must conduct a comprehensive external debt audit to assess the legitimacy of its financial obligations. This audit should investigate loans issued without proper due diligence, unfair interest rates imposed by creditors, and instances of financial mismanagement or corruption. An independent audit will provide a factual basis for demanding greater debt relief and exposing creditors who have profited at the expense of Sri Lanka’s economic distress.

 

Addressing Illicit Financial Flows: Recovering Lost Revenue

 

Sri Lanka loses an estimated $2-3 billion annually due to illicit financial flows. By establishing a dedicated task force to tackle under-invoicing, over-invoicing, and fraudulent invoicing schemes, the government can recover lost revenue and redirect funds toward economic development. Additionally, strengthening anti-money laundering frameworks and collaborating with international agencies will help track and repatriate stolen assets.

 

IMF Negotiation Strategy: Advocating for Fairer Terms

 

To secure a just debt restructuring agreement, Sri Lanka must adopt a negotiation strategy that emphasises good faith in debt restructuring by demonstrating commitment to working with bondholders and bilateral creditors while advocating for more equitable terms. Governance and economic reforms must be highlighted to improve anti-corruption measures, revenue generation, and financial transparency to strengthen investor confidence. Additionally, the government must push for flexibility in debt repayment, advocating for a model that adjusts based on actual foreign exchange revenue growth rather than rigid IMF targets. Resisting IMF-imposed austerity measures is essential to prevent disproportionate harm to the poor and middle class.

 

Defending the Rupee-Based Economy from IMF Control

 

The IMF’s influence over domestic fiscal policies threatens Sri Lanka’s economic autonomy. The government must ensure that rupee-based revenue and expenditures remain independent of IMF restrictions. Key measures include implementing progressive taxation by establishing a high-threshold wealth tax to ensure economic elites contribute fairly to national revenue, supporting local industries and SMEs by providing financial relief to struggling businesses through state-backed loans and debt forgiveness programs, and expanding public investment by allocating funds to infrastructure, education, healthcare, and agriculture to drive domestic economic growth.

 

Strengthening Regional and South-South Cooperation

 

Sri Lanka must continue exploring partnerships beyond the IMF by engaging with regional financial institutions, such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), to access alternative funding sources. Strengthening economic ties with South Asian and ASEAN nations can create opportunities for trade, investment, and knowledge exchange, reducing dependence on Western financial institutions.

 

Additionally, Sri Lanka should actively participate in BRICS initiatives to access new credit lines that do not impose the same stringent conditions as IMF loans. By diversifying its financial partnerships, the country can build a more resilient economic framework that prioritises long-term development over short-term debt obligations.

 

Preparing for the Worst: Consequences of Challenging the IMF Agreement

 

While renegotiating or reshaping the IMF agreement is a necessary consideration, the government must prepare for potential consequences, including credit rating downgrades that could make it harder to access global financial markets in emergencies, foreign reserve decline due to reduced external funding, bondholder litigation as creditors may pursue legal action to recover debts, and market volatility that could deter investors and cause fluctuations. However, with a strong economic recovery plan, increased foreign exchange revenue, and strategic alliances with alternative financial institutions (such as BRICS and regional development banks), Sri Lanka can mitigate the worst of these risks and transition toward a more self-sufficient economy.

 

Way Forward: A Sovereign Approach to Economic Recovery

 

Sri Lanka must assert its economic sovereignty by rejecting IMF conditions that undermine social equity and sustainable growth. By assembling a progressive negotiating team, developing a credible alternative economic strategy, and mobilising public support, the government can secure a fairer debt restructuring agreement that prioritises national interests over creditor profits.

 

The Sri Lankan government must demonstrate confidence and determination in fostering sustainable economic growth, strengthening social protection, meeting debt obligations, and managing external economic shocks. To reinforce its commitment to debt servicing—especially in light of the external debt crisis of 2022—it should establish a clear framework by allocating a fixed percentage of its foreign exchange revenue toward debt repayments.

 

The IMF agreement, in its current form, is not a solution but a liability. The Sri Lankan government must take bold steps to protect its people, ensure economic justice, and forge a path toward long-term stability and prosperity. The time to act is now.

 

Author:  Charith Gunawardena, a co-founder of the Institute of Political Economy (ipe-sl.org) and a former local councillor in London.  charith@ipe-sl.org

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