Last week brought two economic news stories that must be read together. 

Fitch upgraded Sri Lanka’s Long-Term Issuer Default Rating from ‘CCC+’ to ‘B-,’ with a Stable Outlook. Soon after, an International Monetary Fund (IMF) staff mission ended without announcing a Staff-Level Agreement (SLA) for the Seventh Review, although discussions will continue. 

The first headline shows how far we have come. The second reminds us how easily the gains can be lost.

Fitch’s upgrade is good news. A credit rating is similar to the Credit Information Bureau (CRIB) report a bank examines before approving a loan. An improvement means the borrower looks safer. But ‘B-’ is still well below investment grade. Sri Lanka remains a high-risk borrower and one notch does not make money cheap. Moody’s and S&P kept their ratings unchanged in their latest reviews. We have moved away from the edge, but we are not yet on firm ground.

Fitch recognised macroeconomic stabilisation, better fiscal and external balances, and a modest rebuilding of foreign reserves. It forecasts a primary surplus of 2.6% of Gross Domestic Product (GDP) in 2026, Government debt falling from 96.7% of GDP in 2025 to 92.9% this year, and the interest-to-revenue ratio declining to 41%. Yet the interest burden is still roughly three times the median for countries in the ‘B’ rating category. Too much of every tax rupee is still spent servicing past debt rather than improving public services.

The external side remains fragile. Fitch expects the energy shock to turn the current account into a deficit of 1.2% of GDP in 2026. It expects reserves to reach $ 7.7 billion by year-end, but calls the buffer modest because foreign debt repayments will rise after 2028. Its message is simple: maintain primary surpluses, reduce debt, build reserves, and expand exports. Weaker fiscal discipline or persistent current account deficits can push the rating down again.

The IMF carried a similar message. Staff acknowledged 4.2% growth in the second quarter, gross official reserves of $ 6.9 billion at end-August, a strong fiscal outcome in the first half, and a largely completed debt restructuring. But no SLA was announced. Talks will continue on the Seventh Review and the 2026 Article IV Consultation. The priorities are clear: a credible medium-term revenue strategy, cost-reflective energy pricing, better public investment, stronger social protection, and continued structural reform.

Is relief possible?

Against this background, the President’s remarks on tax relief and fuel concessions deserve careful examination. 

Relief is politically attractive and, after several difficult years, understandable. Many professionals feel squeezed by personal income tax, while households and businesses feel higher energy costs. But sound policy cannot be measured only by popularity. We must ask who receives the benefit, who pays for it, and whether the country can afford it.

Tax relief is possible without weakening stability. If the Government changes Advance Personal Income Tax (APIT) thresholds or rates, any revenue loss must be offset through lower wasteful expenditure, a broader tax base, fewer exemptions, and better collection from those who avoid tax. The answer cannot be to keep increasing the burden on the same compliant taxpayers. Cutting a tax without cutting expenditure merely transfers the bill to more borrowing, inflation, or another tax later. The 2027 Budget must improve fairness while protecting the revenue base.

Fuel requires even more care. A temporary, capped, and fully budgeted subsidy may be justified during an extraordinary shock. An open-ended blanket subsidy is different. It hides the true cost, weakens the incentive to conserve, and pressures the Treasury. Because Sri Lanka imports its fuel, holding prices below cost can sustain higher demand, increase the import bill, and slow reserve accumulation. This does not automatically cause a currency crisis, but it adds pressure to the current account and the rupee.

Blanket fuel relief is also poorly targeted. Estimates indicate that the highest-income 30% of the population consumes about 70% of fuel. Much of the benefit therefore goes to those who consume the most, not those who need help the most. A household with several vehicles receives more than a low-income family that uses the bus. The sensible response is cost-reflective pricing and protection through Aswesuma, with temporary and transparent support for affected groups such as public transport operators, farmers, and fishermen.

The Government should not ignore cost-of-living pressure. Relief must be targeted, temporary, and shown in the budget. If the Treasury absorbs a cost, Parliament and the public should know its size, duration, beneficiaries, and financing. The emergency package covering fuel, electricity, fertiliser, and Aswesuma was capped at Rs. 100 billion and scheduled to end by 30 September. Any new support should meet the same test. Otherwise, a subsidy first appears cheap at the filling station and later returns through taxes, debt, inflation, or a weaker currency.

SL’s next step 

The timing matters. Sri Lanka’s current IMF programme ends in March 2027 and the 2027 Budget will test whether discipline can survive as programme supervision begins to ease. Fitch says a follow-on IMF facility is possible. It may provide a policy anchor and financing backstop. But no IMF programme can substitute for domestic political ownership. Stability maintained only because the IMF is watching is not durable stability.

Our next step must be growth. Fiscal discipline can keep us from falling back, but only reform can move us forward. Sri Lanka needs easier trade, predictable taxes, competitive factor markets, better land and labour rules, reformed State-owned enterprises, and a climate in which investment and exports can expand. Those reforms may not produce immediate applause at a rally, but they create jobs, incomes, and revenue without repeatedly raising tax rates.

Fitch has rewarded the progress Sri Lanka has made. The IMF has reminded us that the work is unfinished. The 2027 Budget should not become a bridge from economic stability to election economics. It should become a bridge from stability to growth. If we return to our old habits of broad subsidies, ad hoc tax changes, protected markets, and loss-making State enterprises, ‘B-’ may become the ceiling. If we maintain discipline and begin the harder growth reforms, it can become only the first step.

(The writer is the Chief Executive Officer of Advocata Institute. He can be contacted via dhananath@advocata.org) 

(The opinions expressed are the writer’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute)