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Sri Lanka’s Macroeconomic Challenges: A Tale of Two Deficits

Sri Lanka’s macroeconomic landscape has been characterized by fiscal dominance—high deficits and public debt. This has manifested in a high degree of macroeconomic volatility, evidenced by its frequent balance-of-payments crises and instability. The paper provides a narrative of Sri Lanka’s history of twin deficits, examines macroeconomic performance from the lens of twin deficits, and discusses the policies adopted to address macroeconomic imbalances. Recent efforts toward a revenue-based fiscal consolidation have started yielding improvements in the ratio of tax revenue to gross domestic product, and show promise in repairing the fiscal accounts. However, fiscal policy efforts need to be supported by reforms to generate nondebt-creating foreign currency inflows to stabilize the external sector and assist in building up a buffer stock of official foreign exchange reserves.