Colombo: Sri Lanka has signed a deal with Japan on Friday to restructure $2.5 billion in loans, marking the first agreement with official creditors who had pledged debt relief to the financially struggling nation last year.

Japan announced that it would grant concessions on a 369.45 billion yen ($2.5 billion) loan as part of a comprehensive debt treatment plan, which the International Monetary Fund (IMF) views as crucial for Sri Lanka's economic recovery.

"The development of Sri Lanka, which is located at a strategic point in the Indian Ocean, is essential for the stability and prosperity of the entire Indo-Pacific region," stated the Japanese foreign ministry. "Japan intends to further contribute to the sustainable development of Sri Lanka."

Sri Lanka's finance ministry expressed gratitude, saying Tokyo had played a "pivotal role" in facilitating the country's debt restructuring. "Its leadership, commitment, and constructive engagement have been instrumental in helping Sri Lanka navigate the challenges of economic recovery," the ministry said in a statement.

Sri Lanka announced in June that it had reached an agreement with all its bilateral lenders to delay repayments until 2028. However, formal agreements had been delayed due to prolonged negotiations, making Friday's deal with Japan the first of its kind with an official creditor.

China remains Sri Lanka’s largest bilateral lender, holding $4.66 billion of the $10.58 billion the island nation owes to other countries. Japan ranks as the second-largest creditor, with loans totalling just over $2.5 billion. Sri Lanka had already finalised debt agreements with the Export-Import Bank of China and the China Development Bank in 2023.

Japan is the first country in Sri Lanka's 17-member Official Creditor Committee (OCC) to conclude a debt deal. Notably, China is not a member of the OCC.

The government of leftist President Anura Kumara Dissanayake, who assumed office in September, had hoped to finalise debt deals by the end of last year. Sri Lanka defaulted on its $46 billion external debt in April 2022 after depleting its foreign exchange reserves, which left the country struggling to finance essential imports such as food and fuel.

The economy has since shown signs of recovery, bolstered by an IMF rescue package and austerity measures aimed at restoring the government’s finances. In November, Dissanayake confirmed that Sri Lanka would honour a restructuring deal secured by his predecessor to restructure $12.55 billion in international sovereign bonds, a key condition for the $2.9 billion, four-year IMF bailout loan.

In September, a majority of Sri Lanka’s private creditors agreed to a 27 percent haircut on their loans. Following this, Sri Lanka secured its IMF bailout in 2023 after doubling taxes, eliminating energy subsidies, and increasing prices on essential goods to bolster state revenue.