IMF debt trap in Sri Lanka: How conditionalities stifle investment and growth

SRI Lanka’s economic crisis has been exacerbated by its reliance on International Monetary Fund (IMF) bailout packages, which come with stringent conditions that often undermine long-term growth.

- By Luxman Siriwardena

One of the most damaging aspects of IMF-imposed austerity is the restriction on tax incentives, including tax holidays for foreign and local investors. By preventing the Government from offering competitive tax breaks, the IMF effectively discourages investment in export-oriented industries—precisely the sectors Sri Lanka needs to generate foreign exchange and repay its debts. This creates a vicious cycle: without investment, the economy stagnates, debt becomes unsustainable, and the country remains trapped in perpetual dependency on IMF loans.

IMF conditionalities and the tax holiday dilemma

A key feature of IMF loan agreements is the insistence on broadening the tax base and increasing revenue collection. While fiscal discipline is necessary, the IMF’s rigid approach often forces governments to eliminate tax incentives, including tax holidays, which are crucial for attracting foreign direct investment (FDI).

In Sri Lanka’s case, the IMF has pushed for higher corporate taxes and the removal of exemptions, arguing that these measures will increase government revenue. However, this ignores the reality that developing economies like Sri Lanka rely on tax incentives to compete for investment in a globalised market.

Countries such as Vietnam, Bangladesh, and Cambodia have successfully used tax holidays and other incentives to attract export-oriented industries, boosting employment and foreign exchange earnings.

By restricting Sri Lanka’s ability to offer similar incentives, the IMF makes the country less attractive to investors, particularly in manufacturing and export sectors. Without new investments, Sri Lanka cannot expand its export capacity, worsening its trade deficit and making debt repayment even more difficult.

The Catch-22 of debt repayment without growth