• Arutha Exec. Director Yolani Fernando on Budget 2026 not being about expansion or austerity

Sri Lanka’s next year’s (2026) Appropriation Bill pegs spending at a staggering Rs. 4,434 billion. But, with soaring debt and International Monetary Fund (IMF) targets looming, can the Government really deliver? Big money is going to finance, defence, health, and Local Government (LG) — but, will this budget mark real change or more of the same?

To break it down prior to Budget 2026, Arutha Executive Director Yolani Fernando sat down with ‘Kaleidoscope’ last week.

Following are excerpts from the interview:

How does the Government expenditure figure of Rs. 4,334 billion reflect its broader economic priorities?

It’s not much different from the previous (this year [2025]) Budget. There’s about a 5% increase, which can mostly be attributed to changes in prices and factors beyond control – like debt payments and other fixed costs. So, there isn’t really much that can be said from the overall number, except that the budget in March wasn’t very surprising, and we don’t expect many surprises in the one to come.

Is this what you would have expected?

Yes, pretty much. These are provisional numbers, so we’ll have to wait for the actual Budget Speech to give a more in-depth analysis.

Defence gets something like Rs. 455 billion, while health and mass media get Rs. 554 billion. Do you see a shift in priorities here?

That’s a bit difficult to say because health and mass media come under two different ministries, technically, so it’s hard to gauge that accurately. This is also reflective of the 2025 Appropriation Bill – the numbers look quite similar. So, we can’t really say that there’s been a major shift, but, defence is still taking a significant chunk of our budget, which leaves less fiscal space for everything else. Also, the Health Ministry Budget doesn’t reflect all health-related expenditure, because a lot of it gets allocated to Provincial Councils (PCs).

So, why is our Defence Budget so high?

Many would point to personnel costs – wages, pensions and allowances, which all take up a big portion. Within the Defence Budget, we also see what many would consider a misallocation of funds. Even the tri-forces often agree that they need more allocation for equipment and systems that require updating, rather than personnel-heavy expenses.

The allocation for PCs and LG is Rs. 618 billion, among the highest. What might this mean for decentralisation and service delivery?

The PCs Budget is generally one of the highest, so, it is not necessarily a shift in Government policy or priority. The number itself isn’t surprising because PCs provide many key services – like health, education, and administration – so, they require a large budget. What will be interesting to see is what exactly is being funded through this.

The Government has also been trying to encourage the Local Authorities to generate more revenue themselves and cover part of the officials’ salaries, which were earlier fully funded by the National Budget. Let’s see if this shift continues in the new budget.

Education is relatively low at Rs. 301 billion. How does this point to the Government’s ability to address urgent social needs, especially given that Sri Lanka is in post-crisis recovery?

Our health and education budgets have been declining over time. There is an increase nominally, but, in real terms, not so much. There’s limited fiscal space because of large obligations like defence spending, which crowds out other areas. Post-crisis, we don’t have access to international financial markets, so we have to make do with what we have. It then becomes a case of prioritising the money that we do have. 

Even within health and education, there is a tendency to prioritise hard infrastructure – like buildings – over soft infrastructure, such as the human capital. There really needs to be a shift in focus towards the latter.

Given our large debt burden and IMF commitments, how much fiscal space does the Government have to meet its expectations and targets?

The IMF’s primary balance objective is 2.3% of the gross domestic product this year – that’s the budget deficit minus interest payments – and we’re on track. The targets themselves don’t necessarily put unreasonable pressure on the budget.

Where do you see revenue coming from?

The Government has announced that no new taxes will be introduced, and we hope that means that it will focus on tackling tax evasion, which is rampant in this country. That applies to both income tax and Value Added Tax (VAT). Broadening the tax base is much harder than raising rates, but it’s necessary.

It’s easy to increase tax rates to meet revenue targets – it was necessary post-crisis – but now, we have to fix our tax administration. Hopefully, that means more taxpayers in the net in the medium term, which would allow us to bring rates down eventually. Right now, we’re compensating for decades of inaction with a smaller pool of taxpayers than we should have.

From what you see in the Appropriation Bill, does this set the tone for Budget 2026 as one of austerity, expansion, or a balancing act?

Expansion is off the table, simply because of our constrained fiscal space. Some people refer to the current adjustment period as austerity, but, I would argue that true austerity was when we had 70% inflation in 2022 – because inflation is the cruellest tax, hitting the most vulnerable. Since then, we haven’t actually reduced Government expenditure. In fact, social spending has increased through programmes like ‘Aswesuma’. 

People often see the reduction of subsidies as austerity, but, subsidies tend to be poorly targeted welfare. Cutting them allows for better-targeted spending instead. I’d say that this budget isn’t about balancing expansion or austerity – it’s about coming to terms with the structural constraints that every Government faces. The 2025 Budget wasn’t one to rock the boat, and I don’t expect major waves in this one either.

We’re in an era of domestic constraints and global uncertainties. What would you identify as key risks or opportunities in the coming months, given this budget?

Globally, Sri Lanka has taken a few hits this year. The United States tariffs will continue to create uncertainty for key sectors like apparel, and the deep-sea port in Trivandrum, Kerala, India, poses competition for transshipment. Sri Lanka remains cut off from international financial markets, which limits our options. The Central Bank is exploring new instruments, but we will have to see how those unfold.

Domestically, tax reforms will continue to cause disruptions. The tax administration needs to soften the impact of reforms – like the removal of Simplified VAT (SVAT), which could have been phased out more gradually. Everyone agrees that SVAT had issues, but removing it abruptly created a shock.

Ultimately, the biggest domestic constraint for reform is the public sector – its capacity, outdated systems, and human capital challenges. As long as those persist, we’ll have our hands tied. That will be the key bottleneck when it comes to implementing large-scale reforms in taxes, State-owned enterprises, and beyond.

(The writer is the host, director, and co-producer of the weekly digital programme ‘Kaleidoscope with Savithri Rodrigo’ which can be viewed on YouTube, Facebook, Instagram and LinkedIn. She has over three decades of experience in print, electronic, and social media)