On 22 June, the Government approved a plan to switch three of Colombo’s busiest railway lines from diesel to electricity – the Main Line to Ragama, the Kelani Valley Line to Makumbura, and the Coastal Line to Panadura.
Although a transition to electric railways was first suggested nearly a century ago in 1928, at present, all of Sri Lanka’s common railways run on diesel, making the plan’s approval a turn in the right direction. Yet, how the Government plans to produce the funds for such a project remains uncertain.
Government statements
Government ministers claim that the project will be financed through the Treasury, aligning with the larger claim that Sri Lanka can now complete major infrastructure projects without relying on external international support.
According to figures from recent budget discussions, this plan would require approximately Rs. 200 billion annually over the project lifecycle, which is around four-and-a-half years. This totals nearly Rs. 900 billion, or approximately $ 3 billion at current exchange rates.
However, two critical points require clarification from the end of the State.
1. The role of existing foreign aid: This is not the first time international funding has been tied to this railway corridor. The Asian Development Bank (ADB) previously pledged up to $ 600 million to electrify the Veyangoda-Fort-Panadura line, following an earlier $ 160 million loan, the ADB’s first-ever financial package for Sri Lanka’s railways (ADB, 2019). The Government has yet to explain how this new Treasury-funded plan fits with the existing ADB commitment. It remains unclear whether the $ 3 billion is an entirely new budget, an addition to the ADB funds, or a replacement for them. The Ministry of Transport must be clear and transparent regarding this.
2. The reality of domestic funding: Regardless of whether or not foreign loans are in the picture, in general, a government’s domestic capital relies on taxation and borrowing locally, and both options carry great economic costs. Therefore, even if the project is entirely funded by the Treasury, these funds are in no way ‘free’.
The cost of borrowing locally
If the Government chooses to fund this project by borrowing money domestically using Treasury bills and bonds, it will directly compete with private companies for the same pool of local currency. Even before accounting for the railway’s financial demands, interest rates on Treasury bills have already risen in the most recent auctions: the three-month bill has risen to 10.14%, the six-month to 10.21%, and the 12-month to 10.17%. Inserting a massive new demand of roughly Rs. 200 billion annually into the market will cause a further rise in interest rates.
In economics, this dynamic is known as crowding out; capital that could have funded a local export processing factory expansion or a small business loan is swallowed by government borrowing instead. Currently, Sri Lanka urgently needs fresh private investment to diversify its economy beyond traditional exports like garments and tea, so choosing a funding strategy that chokes off credit for private businesses is a major setback.
The cost of taxation
Due to Value-Added Tax (VAT) and Income Tax reforms mandated by the International Monetary Fund (IMF) programme, Sri Lanka’s tax-to-GDP ratio successfully climbed from 8.2% in 2022 to approximately 13.5% in 2024 (Central Bank of Sri Lanka, 2025). However, allocating Rs. 200 billion annually of this hard-won revenue entirely to railway infrastructure leaves little else to be used for other, more critical sectors, including meeting the IMF’s budget surplus targets, funding stretched health and education sectors, and rebuilding national reserves before the current IMF agreement concludes in 2027.
In any case, the Government’s financial flexibility may already be strained. Just two days after the Cabinet approved the railway project, officials abruptly reversed a planned policy to lower the VAT registration threshold. This sudden cancellation is evidence of the Government’s inadequate fiscal space relative to its radical ambitions.
The myth of ‘no impact on the exchange rate’
The reality of transitioning the railway system from fossil fuel to electricity is that it cannot be paid for in local currency alone, regardless of the domestic lines used.
The core components for the project like the overhead power cables, digital signalling equipment, electric trains, and the highly specialised engineering required to design the system must be imported and paid for in foreign currency and it is about 75% of the cost. It should be noted that earlier stages of this very project already relied on foreign consulting firms hired through the ADB and imported electric trains, neither of which could be settled in rupees. Therefore, there is a continuous demand for foreign exchange throughout the project process.
International consultants bill in dollars, equipment must be imported, and long-term maintenance contracts for electrified systems typically require foreign currency for years to come. Whether the Government raises the rupees through borrowing, taxation, or monetary expansion, those rupees will be converted into dollars to pay international suppliers. This process will drive up the demand for foreign currency and put pressure on the exchange rate, regardless of how the Government labels the project’s funding source, resulting in the Government’s answer of a Treasury-funded project to become a non-answer.
Better alternatives available
The first option is simply utilising the concessional ADB financing that is already on the table for this very corridor. ADB loans carry lower interest rates and longer repayment periods than domestic Treasury bonds. ADB funds are disbursed in foreign currency, the exact currency needed to pay international suppliers. This avoids forcing the Treasury to raise rupees first and convert them later, a process that incurs double conversion costs.
The second option is a Public-Private Partnership (PPP). Under a PPP model, private investors fund the construction in exchange for future revenue streams, such as passenger fares, station retail leases, or fixed Government payments. While Sri Lanka has previously struggled to implement impactful transport PPPs, this model would shift a significant portion of the financial risk away from the Treasury while still delivering productive new infrastructure.
The Transport Ministry, the Board of Investment (BOI), and the National Agency for Public-Private Partnership (NAPPP) have already received such investment proposals which the bureaucrats have failed to negotiate promptly and structure them with prospective investors.
On the question of accountability
When Government spokespersons make claims to the general public that a $ 3 billion project will be funded by the Treasury with zero impact on the exchange rate, the question of whether the Ministry of Finance’s own debt management team signed off on this claim arises.
Did the Public Debt Management Office, an entity established under the Public Debt Management Act, analyse such fiscal risks, review, and approve this strategy? A project that relies on so many important aspects and runs parallel to an existing foreign loan or foreign direct investment cannot possibly have no impact on the country’s balance of payments. The Government’s teams should either analyse what has been hidden from the public or Parliament must demand a truthful answer.
(The writer is Senior Professor in Economics and Head of the Department of Economics and Statistics of the University of Peradeniya)
(The views and opinions expressed in this article are those of the writer and do not necessarily reflect the official position of this publication)