Hidden risks behind Sri Lanka’s multi-billion rupee guarantees
Sri Lanka’s extensive reliance on government guarantees has become a double-edged sword, intertwining public finances with the fortunes of state-owned enterprises (SOEs) and state banks.
As of September 2024, outstanding government guarantees and letters of comfort totalled Rs 1,660 billion, roughly 5.5 per cent of GDP according to the Finance Ministry.
While these instruments have been critical in financing infrastructure and public services, the International Monetary Fund (IMF) has repeatedly warned of the fiscal risks they carry if left unchecked.
The IMF’s 2025 Technical Assistance Report highlights that “fiscal risks in areas such as state-owned enterprises, guarantees, public-private partnerships, financial sector, and natural disasters remain substantial.”
Much of these guarantees stems from currency swaps and trade credits provided by the Reserve Bank of India to Sri Lanka’s Central Bank, backed by government guarantees. Prominent SOEs, including the Ceylon Electricity Board, Ceylon Petroleum Corporation, Road Development Authority, SriLankan Airlines, and the National Water Supply and Drainage Board, account for over half of these outstanding obligations.
State banks – the Bank of Ceylon, National Savings Bank, and People’s Bank, have emerged as the biggest local lenders of these guaranteed loans, increasing systemic risks.
Historically, guarantees and on-lending were issued without rigorous credit assessments or safeguards. This approach often subsidised loss-making SOEs to sustain essential services and infrastructure projects, while the absence of clear eligibility criteria allowed indiscriminate guarantee issuance exposing the government to mounting fiscal vulnerability.
In response, Sri Lanka introduced the Public Debt Management Act (PDMA) in June 2024, creating a legal framework for responsible management of guarantees and on-lending.
The PDMA obliges the Public Debt Management Office (PDMO) to conduct credit risk assessments before issuing guarantees, capping support to non-distressed parties. This is complemented by the Public Finance Management Act (PFMA), which lowered the outstanding guarantee ceiling to 15 per cent from 7.5 per cent of GDP, improving sustainable debt management.
Despite these reforms, the IMF indicates that fiscal risks “remain substantial”. The government has been working on the regulations to implement into operation the PDMA, including the credit risk assessment, mitigation, monitoring, and reporting procedures. These policies will seek to enhance reporting and transparency requirements and closing previous loopholes in fiscal coverage.
Sri Lankan experience provides an example of the delicate balancing act that must be achieved between employing government guarantees to foster economic activity and limiting fiscal risk inherent in them. The success of the PDMA and PFMA will determine whether guarantees prove to be a long-term growth impetus or a chronic fiscal drain.
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