(Reuters) - Crisis-hit Sri Lanka must convince IMF officials that it has met key goals under a $2.9 billion bailout to push forward debt restructuring efforts crucial to a recovery for its battered economy.

The officials, set to arrive in Colombo on Thursday, will assess the island’s performance under a four-year program secured last March.

Sri Lanka needs to meet the IMF’s performance criteria in order to unlock further bailout funds.

The country of 22 million suffered its first foreign debt default in May 2022, after a severe shortage of dollars triggered its worst financial crisis since independence from Britain in 1948.

What has happened so far

The IMF bailout program has helped Sri Lanka to build up reserves, stem a fall in its currency and tame runaway inflation.

As part of the terms of the bailout the island has to secure assurances of debt restructuring from bondholders and key bilateral lenders including China, Japan and India.

Sri Lanka has asked foreign investors for a 30% haircut to help restructure its debt and the negotiations, which kicked off last September, are still ongoing.

Under a domestic debt restructuring program announced in June Sri Lanka accepted offers to exchange about $10 billion worth of defaulted local debt for new bonds, the Finance Ministry said on Tuesday, taking it a step closer towards meeting debt restructuring requirements.

A total of 3.2 trillion rupees ($9.99 billion) of the 8.7 trillion rupees in bonds eligible for exchange were accepted, the Finance Ministry said in a statement.

The settlement date of the exchange has been set at Sept. 14.

The domestic restructuring is likely to set the stage for foreign debt renegotiations on $36 billion of external debt, including $24 billion held by bondholders and bilateral creditors such as China, Japan and India.

Sri Lanka is aiming to finalise bilateral debt restructuring talks by September to align with the first review of its IMF programme.

What else does the imf want?

In addition to reducing debt to GDP to 95% by 2032 from 120% of GDP now, Sri Lanka also has to ensure average gross financing needs remain below 13% of GDP between 2027-2032 and annual foreign exchange debt service cost of the central government should remain below 4.5% of GDP during the same period.

Once the debt restructuring is completed Sri Lanka hopes to reduce its overall debt by $16.9 billion.

The debt restructuring is also crucial for Sri Lanka to reach a 2.3% primary budget surplus by 2025, the key fiscal target set by the IMF.

What’s next?

The IMF delegation will hold talks with finance ministry and other government officials during their stay from September 14-27.

Sri Lanka is likely to discuss fresh revenue measures with the delegates, including new tax measures that will be rolled out in the next budget in November.

If a staff-level agreement is reached the IMF is likely to announce it in Colombo and if there is no consensus the delegations is expected to continue further discussions on its return to Washington.

The first review is expected to be presented before the IMF Executive Board in October.

Once it receives approval the IMF will release the second tranche of funds, about $330 million, to Sri Lanka.