Opinion: Neoliberal policies slowing down Sri Lanka

By Indika Hettiarachchi

Key Points:

• Sri Lankan economy is slowing down as indicated by declining Velocity of Money. 
• There are convincing evidence higher Velocity of Money is associated with healthy GDP growth in Sri Lanka. 
• Government’s focus on fiscal consolidation has a direct impact on reducing growth. 

Despite 5.1 percent GDP growth during the first quarter of 2026, IMF predicts Sri Lanka’s GDP growth will remain around 3 percent in 2026 and 2027. Many investors are concerned as to why measures to catalyze post crisis economic recovery are not producing higher economic growth. One of the first economic variables foreign investors look before investing in a country is “sable and expanding GDP”. 

Government’s economic policy framework which is aligned with the IMF Extended Fund Facility program is believed to be the underlying cause of slowdown in GDP growth. There are empirical evidence and research findings highlighting that IMF programs have dampening effect on economic growth. This is mainly because IMF programs are primarily based on neoliberal policy framework which slows down “real” economic activity while expanding the “financial” economy. 

Empirical evidence suggest that neoliberal policy tools such as deregulation, privatization, free trade, and lower government spending often lead to slow economic growth. These policies also increase wealth inequality, reduce public investments in infrastructure and education fueling financial instability rather than increasing long-term productive output.  Many economists point out that even in the US, neoliberal policies have reduced “Main Street” real economic activity while increasing “Wall Street” financial activity and assets. 

In order for us to establish if neoliberal policies have a dampening effect on the economic growth in Sri Lanka, we need to examine: 

(1) If Sri Lanka is currently experiencing a decline in the level of “economic activity” 

(2) If there are convincing evidence of positive link between the level of “economic activity” and real economic growth in Sri Lanka, and also 

(3) What are the possible channels through which neoliberal policies have reduced GDP growth in Sri Lanka? 

(1) Is there a decline in economic activity in Sri Lanka? 

One of the commonly used tools to examine the level of “economic activity” is Velocity of Money (“VM”). VM is a simple measure of how fast a money changes hands to “buy goods and services” within a specific period of time. VM is used as an indicator of the overall health of an economy 

Being a small country with less complex financial sector, VM is a good proxy to evaluate the level of real economic activity in Sri Lanka. Higher VM is associated with high level of economic activity while low VM indicate slow economic activity.  

Data: CBSL

As shown in the table above, Sri Lanka’s VM has declined steadily during last decade, and in 2025 VM has declined to 2.16 – a level seen in 2019 during the onset of the economic crisis. (VM has marginally improved to 2.17 during the first quarter of 2026). From above data we can argue that the level of “real economic” activity is declining!  

(2) Empirical evidence of the link between economic activity and GDP growth in Sri Lanka?  

Although economists generally agree higher VM is associated with higher GDP growth, we need to establish that such relationship prevail in Sri Lanka. As shown in the table below, statistical analysis of the relationship between VM and real GDP growth during the last three decades (1994 – 2025) shows a strong and positive correlation. As shown in the table below the relationship has got stronger during 2009 and 2025 period with a 0.66 correlation coefficient. 

Table below shows a comparison of average GDP growths and average VMs during three main policy regime periods. As clearly seen from the table, periods with higher VM have experienced steady GDP growth – Specifically during 2005 and 2015 where both GDP growth and VM have been higher.  

(3) How neoliberal policies reduce economic activity?

Academic findings show many channels through which neoliberal policies reduce economic activity through reducing VM. Highlighted below are some popular channels. 

Fiscal Austerity and Public Spending Cuts: 

Neoliberalism favors balanced budgets and reduced state spending on public services and social safety nets. Public sector jobs and welfare transfers inject high-velocity money directly into the real economy. Cutting these spending reduces purchasing power from everyday consumers, stalling routine retail transactions and slowing overall economic circulation. Hence government’s efforts to increase budget surplus while increasing taxes have likely caused major decline in VM. 

Wealth Concentration and Inequality: 

Usually neoliberal policies (especially tax policies) result in higher income for large companies and wealthy individuals. As a result wealthy households and corporations save or invest excess capital in financial assets rather than spending. Because the poor and middle class spend a much higher percentage of every extra rupee they receive (high marginal propensity to consume). This results in overall decline in VM overtime. Sri Lanka, has also seen increased concentration of wealth among a very small portion of the population while poverty level keep rising. 

Financialization and Asset Bubbles:  

Deregulating financial markets encourages capital to chase speculative paper assets, real estate, etc. rather than productive physical investment. Money trapped in speculative stock loops or high-net-worth savings accounts circulates slowly through the actual goods-and-services economy. It inflates asset prices while starving Main Street commerce of active transaction volume resulting in decline in VM. Recent rise in demand for high end apartments and super luxury cars (which are similar to financial assets in Sri Lanka due to abnormal duties) are good indicators of this trend. Moreover latest data clearly show that financial sector in Sri Lanka is expanding at a very fast rate. 

Deregulation and Corporate Monopolies: 

Free-market fundamentalism often permits relaxed antitrust enforcement, allowing marge businesses to form oligopolies and monopolies. These result in large profits form large companies and wealthy individuals amid suppression of competitive wage growth. This cause volume of independent local transactions to decline. Consolidated corporate cash hoards move much slower than decentralized, competitive market spending thus reducing overall VM. Sri Lanka has many examples of large corporates dominating in many industries and their power have increased sharply during last few years! 

Conclusion 

As discussed above, we can argue that at present Sri Lankan economy is heading for a phase of slower growth due to neoliberal policy framework. We can easily relate to many developments we observe in the economy to this effect. Policy planners must rethink the suitability of neoliberal policies for a small developing country like Sri Lanka. Such policies may work for large and already developed countries which do not need to achieve higher GDP growth.  

The writer is an Investment, Strategy and Policy Advisory professional. He has a Master’s degree in Economics (Colombo), an undergraduate degree in Business (Wisconsin, USA), and also obtained CFA charter (USA). He is contactable on indika.h@jupitercapitalpartners.com