COLOMBO: Sri Lanka’s economy shrank 2.3 percent in 2023, official data showed on Friday, as the island nation struggled to break out of its worst financial crisis in decades.

But the economy grew 4.5% in the fourth quarter setting the stage for a recovery this year, Sri Lanka’s Census and Statistics Department said in a statement.

Sri Lanka’s agriculture sector grew 2.6% from a year earlier, but industrial output shrank by 9.2%%, while services decreased by 0.2%.

“Growth benefited from a stronger currency, higher remittances and better tourism revenue in the second half of 2023, which fuelled positive economic sentiment,” the statement added.

Sri Lanka’s economy contracted 7.8% in 2022 as a severe foreign exchange crisis coupled with political instability devalued its currency and sent inflation and interest rates soaring.

Helped by a $2.9 billion International Monetary Fund bailout secured last March, Sri Lanka’s economy began a painful path towards recovery and is expected to grow 1.8% this year.

“We expect recovery to be stronger in the second half of the year driven by sectors such as tourism and financial services,” said Dimantha Mathew, head of research at First Capital.

“Lower interest rates and moderating inflation will also give people more disposable income and improve consumption.”

But challenging reforms also lie ahead, such as higher taxes, reforms of loss-making state enterprises and a restructuring of Sri Lanka’s foreign debt.

An IMF delegation is in Colombo for the second review of the programme.

Some analysts expect the Central Bank of Sri Lanka (CBSL) to reduce interest rates later this month, continuing its policy easing having slashed interest rates by 650 basis points since June to boost growth, with inflation having fallen to 5.9% in February from a high of 70% last September.