Updates with IMF statement in paragraphs 4-5, background in paragraphs 2-3 and 6

COLOMBO, May 27 (Reuters) - The International Monetary Fund said on Wednesday that it approved about $695 million in funding to Sri Lanka under a $2.9 billion program.

The funds will increase Sri Lanka's foreign currency reserves, which dipped 3.8% to $6.7 billion at the end of April from the prior month as the island nation grapples with soaring energy prices as a result of the U.S.- Israel war on Iran.

Sri Lanka's central bank raised its benchmark policy rate by an unexpected 100 basis points on Tuesday to restrain currency depreciation and inflation, which has risen from 2.2% in March to 5.4% last month.

"Gains from the economic reform program helped preserve economic resilience and provided room to respond to cyclone Ditwah and the Middle East war. The latter, however, has significantly worsened Sri Lanka’s economic outlook and tilted risks to the downside," IMF Deputy Managing Director Kenji Okamura said in a statement.

"For 2026, growth is projected to slow down to 3%," Okamura added.

Supported by a $2.9 billion program with the IMF, the South Asian nation grew 5% last year after a severe financial crisis pushed its economy into freefall four years ago.