Sri Lanka’s headline inflation increased further in May, with Year-on-Year (YoY) non-food inflation climbing to 7.8%, driven largely by price escalations in housing, water, electricity, gas, and other fuels. This has been heavily influenced by the escalating conflict in the Middle East, which has disrupted global oil supplies and triggered a depreciation of the Sri Lankan Rupee.

Against this backdrop, The Sunday Morning looked into the implications of these macroeconomic pressures on the domestic construction and real estate sectors, as well as on housing affordability, which already remains a growing concern across urban and suburban markets. Experts outline that escalating imported material costs and high import taxes could lead to project halts, contract disputes, and uncompleted developments.

SL’s exposed economy and the real estate market

Speaking to The Sunday Morning, Research Intelligence Unit (RIUnit) Founder and CEO Roshan Madawela said that Sri Lanka remained highly vulnerable to external shocks.

“When the global economy catches a cold, we get sick. Sri Lanka is an extremely exposed economy. We rely heavily on external markets that are beyond our control. These are structural issues. We have gone to the International Monetary Fund (IMF) several times since independence, but we have never really been steered towards industrialising and building a foundation that is able to withstand volatile global situations. 

“For the most part, successive governments and our international development partners have made us as vulnerable as we can be. We do not have much national economic self-dependence and the latest crisis is exposing exactly where we stand,” he said.

Looking specifically at the housing market, Madawela said that the impact of the geopolitical situation needed to be assessed from both demand and supply perspectives. From the demand side, he pointed to possible opportunities stemming from shifting global investment flows.

Referring to the Savills Impacts report of January, he noted that around $ 1 trillion in global investment had been forecast and earmarked for 2026, with emerging markets expected to attract a larger share of those funds.

According to Madawela, the current instability in the Middle East could prompt investors to reconsider previously preferred destinations and look towards other emerging markets, including Sri Lanka.

“In this situation, Sri Lanka may have an opportunity, specifically in the context of the Port City. Even 1% of a trillion dollars can have a significant impact if Sri Lanka plays its cards right. We can stand to gain from it,” he said.

He also highlighted the logistics sector as another area that could benefit in the long term from ongoing regional tensions, noting that increased shipping activity through Sri Lanka could generate higher revenues and support economic activity if such trends continued over the longer term.

In addition, Madawela said that uncertainty abroad could strengthen interest among the Sri Lankan diaspora in investing in property locally or returning to the country.

On the supply side, however, he noted that Sri Lanka’s dependence on imported construction inputs would place upward pressure on development costs. “Sri Lanka is a very unintegrated economy. There are no significant backward linkages within the construction industry. This will hurt in terms of cost. Developers who failed to factor these risks into their projects and pre-sold units before securing materials could face serious difficulties,” he said.

While lessons from the 2022 crisis appeared to have reduced that risk, he noted that higher construction costs would ultimately be reflected in property prices.

Madawela further observed that exchange rate movements could create mixed outcomes for the sector. A weaker rupee could make Sri Lankan real estate more attractive to foreign investors and members of the diaspora earning in stronger currencies, but it would also increase the cost of imported inputs.

Assessing the wider economic implications of a prolonged geopolitical crisis, he said the overall effect on Sri Lanka would be negative. He added that export markets in the Middle East remained important for Sri Lanka, especially for tea exports, and that any significant disruption could reduce export earnings. At the same time, remittance inflows from Sri Lankans working in the Gulf could also come under pressure if the conflict were to escalate.

Although he identified high-end real estate and logistics as sectors that could potentially weather the situation better than others, Madawela acknowledged that the outlook for housing affordability was less encouraging, noting: “The cost of construction will be passed on. It will become harder for people to own a house in Sri Lanka. That does not help the average citizen.”

Commenting on the broader policy response, he explained that Sri Lanka needed to strengthen its economic resilience rather than rely solely on short-term measures.

“We must relook at how an economy such as ours can be connected to the global economy while ensuring resilience, resistance, and independence. There are steps that we should take as a country, such as maintaining a minimum level of food security, even if it is not always the most profitable option.”

Madawela also expressed hope that the development of oil and gas resources in the Mannar Basin would finally move forward, noting that their strategic importance moved beyond mere commercial considerations.

He further highlighted the need to reduce energy costs through expanded investment in renewable energy sources, including solar and hydropower, while continuing efforts to strengthen domestic production capabilities.

According to Madawela, Sri Lanka’s long-term challenge lies in reducing its dependence on imported inputs by developing stronger backward linkages across industries whilst concurrently focusing on providing affordable energy prices for manufacturing.

While inflation driven by global cost pressures remains difficult to control, he said that Sri Lanka would be better placed to withstand future shocks if it focused on improving self-sufficiency and reducing external vulnerabilities affecting key sectors of the economy.

He also noted that Sri Lanka should double-down on its ‘non-aligned’ stance on the current conflict whilst maintaining a principled approach based on upholding human rights and international law.

Underlying causes and macroeconomic implications

Sri Lanka’s YoY headline inflation accelerated to 5.5% in May and YoY non-food inflation accelerated to 7.8% in the same month. Beyond the immediate price hikes, the wider macroeconomic implications of this inflationary pressure are likely to be largely negative as well. 

Analysing the specific drivers behind these inflationary figures, ETIS Lanka Chief Operating Officer (COO) Dr. Bram Nicholas noted that the sharp upward trend had actually begun in April, when YoY inflation reached 5.4% from 2.2% the month prior (and hovering at around 2% in the months before that), further increasing slightly in May to 5.5%.

Based on the monthly Colombo Consumer Price Index (CCPI) press releases of the Department of Census and Statistics, he highlighted that the main drivers of the spike in April and May were actually Liquefied Petroleum Gas (LPG), electricity, petrol for transport, and vehicles. 

“It could not have been housing rent because these figures are only updated every July and December based on semi-annual surveys, which are problematic for two reasons: they cannot explain monthly movements during those six-month periods, and the figures are based on historical surveys as opposed to surveys done in the months in question. Thus, for the January–May 2026 period, the figure has been fixed at 0.32 (contribution to the YoY CCPI) based on a survey done in December 2025/January 2026,” he added.

Dr. Nicholas explained that perhaps the most important cause of the upward pressure on inflation was the rise of global oil prices and Sri Lanka’s over-reliance on oil imports from the Middle East, which had experienced a major disruption due to the closing of the Strait of Hormuz. 

“Obviously, both are due to the US-Israel-Iran war. A second cause could well be the surcharge on imported vehicles. The third cause is the recent depreciation of the Sri Lankan Rupee against the US Dollar, which exerted upward pressure on rupee costs of imported goods and thus rupee prices. 

“The depreciation itself was inevitable given Sri Lanka’s long-standing structural trade imbalance, which has hovered around -9% of GDP since the 1970s and stood at around -6% of GDP as of Q1 2026. The timing of the depreciation of course has everything to do with the sudden rise of the fuel import bill, the fall in tourist arrivals, and the depreciation of the Indian Rupee,” he said. 

Dr. Nicholas added that the macroeconomic implications of this were likely to be substantially negative, explaining that real wages – meaning money wages discounted for inflation – had already been stagnant since the so-called recovery of the Sri Lankan economy. 

“At the beginning of this year, they were still 10% below their pre-crisis highs. If we now get another round of inflation, real wages will drop even further. The rise in inflation and weakening currency have also prompted the Central Bank of Sri Lanka (CBSL) to raise its policy rate for the first time since the 2022 crisis. This is likely to further dampen economic growth, without doing much to curtail inflation, at least over the short-term.”

Construction sector concerns affecting housing affordability 

Explaining how cost concerns translated directly to the housing market, Construction Industry Development Authority (CIDA) Chairman Prof. Chandana Jayalath noted that while the housing sector had shown signs of improvement, increasing construction costs remained a significant concern.

“The main issue at the moment is the price of building materials. The majority of these materials are imported, and around 50% of the price consists of taxes and various charges imposed on imports. This is one of the main reasons why housing prices in Sri Lanka have become extremely high. Compared to other countries in the region, construction costs here are relatively high. In fact, they are more than double the cost in India,” he said.

According to Prof. Jayalath, reducing this dependence will require better use of locally available materials and wider adoption of circular construction practices. He noted that while considerable research had already been carried out in this area, the knowledge had not sufficiently reached those directly involved in construction work.

The CIDA Chairman also addressed concerns raised by some industry stakeholders regarding construction price indices and their ability to accurately capture market conditions. He said that CIDA had been publishing Colombo-based construction indices for approximately 45 years and had successfully navigated previous crises, including the Covid-19 pandemic and other periods of economic hardship.

He further explained that the price adjustment formula used by CIDA was based on a broad range of inputs and was designed to provide an objective representation of construction costs.

“Our formula is a composite formula. We collect prices for 54 different construction materials, three categories of labour, and five categories of plant and equipment. Altogether, we track nearly 65 indices on a monthly basis. All information is gathered through a formal process. These figures cannot be manipulated,” he stated.

Prof. Jayalath also revealed that CIDA’s next initiative would be the introduction of district-based construction price indices, replacing the current reliance on a single Colombo-based benchmark. As construction costs vary across the country, district-level indices would provide a more accurate reflection of local market conditions.

Potential project suspensions 

National Construction Association of Sri Lanka (NCASL) Chairperson Darinton Paul added that, due to fuel price escalations and rupee depreciation, the construction sector was facing a significant increase in material costs.

“Building material prices have increased by 30%. This increase is difficult for investors, clients, and contractors to handle across the entire sector, including residential and commercial real estate, as well as Government construction. This leads to disputes and potentially the halting of certain projects, especially if clients are unable to pay the increased costs to contractors. This is because contractors do not bid by accounting for these margins in the initial stages,” he said.

Paul also explained the issues regarding capturing price fluctuations in Government contracts, urging more accurate updates in the monthly price bulletin based on the price fluctuation formula. He noted that the current delays prevented contractors from recovering increased costs, which could ultimately halt Government projects. Thus, he highlighted the urgent need to maintain and manage these procedures and systems more effectively.

Investor confidence affected

Meanwhile, Chamber of Construction Industry of Sri Lanka (CCI) President Archt. Jayantha Perera noted rising construction costs as the key factor influencing the real estate market, noting that Sri Lanka’s heavy reliance on imported building materials had made the sector highly vulnerable to exchange rate fluctuations. This, in turn, significantly increases overall construction costs and affects investor confidence.

“Those who have already invested more than 70% may look for ways to complete their projects. However, those who have invested less than 50% are thinking twice and deciding to hold back for a while,” he said.

Perera noted that this situation was creating upward pressure on property prices, especially for completed developments already available in the market. According to him, developers and property owners recognise that fewer new projects are likely to enter the market due to higher construction costs.

“Projects that are already completed will adjust their prices because they know that new construction is not going to come up easily. Whatever new projects do come up will involve heavy costs. There is already a trend in the industry for prices to increase because construction costs are rising,” he stated.

Commenting on the perspective for the market, he said that prices were likely to increase further in the short term, although future movements would depend on broader economic conditions. Describing the current environment as uncertain, Perera said that the rising costs, labour shortages, and external economic pressures together had created a volatile situation for the industry.

“We can look at temporary or short-term solutions and possible ways forward, but it is difficult to identify long-term solutions because of the uncertainty we are facing,” he added.

Attempts by The Sunday Morning to contact the Ministry of Housing, Construction, and Water Supply were unsuccessful.