• Interest rates, tax delays, fuel shortages add to financial stress
• Govt. moves to stabilise sector, ground-level challenges persist
• Supply chain disruptions, logistics hurdles limit export potential
• Demand slowdown raises fears of deeper contraction

For Sri Lanka’s small-scale exporters and local manufacturers, long regarded as the backbone of the economy, 2026 was expected to mark a period of recovery and relative stability following years of economic strain.

Instead, the sector now finds itself navigating a renewed wave of uncertainty following the Middle Eastern war and the closure of the Strait of Hormuz, which triggered an energy crisis, with little time to recover from the devastating impacts of Cyclone Ditwah. For many businesses already operating on thin margins, the disruption caused by the disaster has compounded existing vulnerabilities.

Small and Medium-sized Enterprises (SMEs) account for approximately 52% of the national Gross Domestic Product (GDP) and support over 4.5 million livelihoods, highlighting their central role in sustaining both economic activity and household incomes. However, as global volatility intensifies following the war, the distance between a workstation in Colombo and a conflict in the Middle East has never felt shorter, with distant geopolitical tensions and supply chain breakdowns now directly impacting local industries.

While the ‘External Sector Performance – February 2026’ report published by the Central Bank of Sri Lanka (CBSL) on 31 March shows a cumulative current account surplus of $ 487 million, the headline masks a brewing storm. The report confirms that the stability of the rupee weakened in late February, triggered by the Middle East crisis. For the SME sector, this 1.6% depreciation within a single month signals higher energy costs and more expensive raw materials, effectively ending the ‘honeymoon period’ of the 2025 recovery.

Against this backdrop, entrepreneurs and economists warn that the SME sector is entering a critical phase, driven by volatile supply chains, rising energy costs, and weakening demand – trends that could undermine Sri Lanka’s export competitiveness and stall its broader economic recovery.

Concerns on supply chain disruptions

Dulanjana Vithanage, an export-oriented entrepreneur engaged in value-added food production, described how structural vulnerabilities within supply chains had severely disrupted operations, particularly for manufacturing-based SMEs that depended on both local inputs and imported materials.

“As an SME, the primary problem we encounter is the total collapse of the supply chain, which limits our access to every necessary material,” he said, explaining that while his business relied on local agricultural produce such as jackfruit and cassava, it remained heavily dependent on imported packaging.

“The prices for these imports change in an unimaginable way due to inflation, which makes it nearly impossible for us to maintain a consistent pricing strategy or even a clear idea of our future costs,” he added.

Beyond pricing instability, logistical disruptions – particularly linked to the fuel crisis – have compounded production delays. Vithanage noted that although global supply chain breakdowns occasionally create export opportunities, local producers are often unable to capitalise on them due to cost pressures and operational constraints.

“We sometimes see opportunities in the export market when supply chains in other countries break, but we can only take advantage of those chances if we have the capacity and a lower cost of production,” he said.

Despite proactively expanding production capacity by between 100% and 300% in response to previous crises, Vithanage warned that looming energy uncertainties threatened to undermine these gains.

“Based on our experience with previous crises, we proactively increased our production capacity. Therefore, we are currently able to meet demand. However, the main threat to our future is a potential energy crisis or power cuts, which would cause us to lose these market opportunities,” he said.

He further cautioned that escalating energy and fuel costs would inevitably be passed on to international buyers, eroding Sri Lanka’s price competitiveness.

“If our energy and fuel costs continue to rise uncontrollably, our product prices will follow. This would result in the loss of our economic advantage, not just as a single company, but as a country. If our costs become too high relative to other nations, we simply will not be able to compete in the global market.”

Currently exporting to markets including New Zealand, Canada, Bahrain, Qatar, and Dubai, he noted that demand in parts of the Middle East had already shown signs of softening.

Champika Vincent, who manages a specialised enterprise centred on kithul-based products, said that his business, though export-driven and diversified, was increasingly under strain due to rising costs and structural inefficiencies.

Operating a portfolio of around 15 products, Vincent explained that his company was heavily reliant on international markets. 

“Seventy percent of our production is exported to 10 countries, including Japan, the US, the UK, Canada, South Korea, New Zealand, and China,” he said, noting that the remaining 30% was distributed through local supermarkets primarily to maintain brand visibility rather than profitability.

His supply chain begins at the source, with fresh kithul sap collected directly from farmers in the Sinharaja forest region, particularly in Neluwa. To maintain quality, Vincent has introduced a system where farmers are provided with freezers to immediately store the sap upon collection. Transport is then coordinated every two days to collect the frozen sap for processing, which is carried out using a combination of electricity and gas.

However, sustaining this model has become increasingly difficult amid escalating input costs. Vincent pointed to a sharp rise in utility expenses as one of the most immediate pressures. 

“My monthly electricity bill, which was around Rs. 155,000, will likely increase by another Rs. 200,000 under the new rates,” he said. At the same time, fluctuations in gas prices and supply shortages have forced him to double his stock of gas cylinders, tying up already limited working capital to ensure uninterrupted production.

These cost increases are particularly problematic for export-oriented businesses operating on fixed contracts. 

“When we agree on a fixed price for an export market like Japan, we cannot change that price for six months to a year,” Vincent explained. “When our internal costs increase week by week or month by month, it becomes a huge problem to maintain operations; it often results in losses.”

Logistical challenges further compound these pressures. A single collection round for raw materials covers approximately 350 km, with fuel price hikes nearly doubling transport costs.

At the same time, the prevailing tax structure is placing additional strain on cash flow. Vincent noted that more than Rs. 1 million in Value-Added Tax (VAT) refunds owed to his business remained unsettled. 

“They hold our money for months while our expenses are rising,” he said, adding that access to bank financing had also tightened, with lending slowing significantly.

Broader macroeconomic matters

Providing a broader macroeconomic perspective, University of Colombo (UOC) Department of Economics Professor Priyanga Dunusinghe highlighted that SMEs were confronting a “multi-dimensional crisis,” with impacts varying across sectors but disproportionately affecting industrial enterprises due to their high energy intensity.

According to Prof. Dunusinghe, the sector is being hit by what he described as a triple shock comprising an energy cost surge, balance of payments pressures, and widespread supply-side disruptions. These disruptions, he explained, extended beyond initial fertiliser shortages to include critical raw materials such as phosphates, aluminium, and plastics, alongside systemic logistical inefficiencies.

A key concern, he warned, was the risk of stagflation, where rising costs coincided with stagnating economic activity.

“As energy costs rise and fluctuate frequently, the competitiveness of local industries drops significantly,” Prof. Dunusinghe noted, adding that sustained cost pressures would force many SMEs out of operation, triggering broader economic contraction and social consequences.

In the short term, the sharp increase in interest rates has further intensified financial strain on businesses. Prof. Dunusinghe emphasised that borrowing costs were now a major component of production expenses.

“Interest cost is just as much a component of production as fuel and energy,” he said, warning that rising Non-Performing Loans (NPLs) were likely as businesses struggled to service debt.

He further noted that declining creditworthiness may push many SMEs towards urgent debt restructuring, while export activity itself was becoming increasingly expensive due to rising trade costs, insurance premiums, and shipping charges.

Prof. Dunusinghe also pointed to a cascading effect of price increases across the economy. The initial surge in energy and fuel costs has directly impacted transport, triggering a second wave where higher costs are transmitted across goods and services. He stressed that import-dependent economies such as Sri Lanka were particularly vulnerable in this environment, with smaller production units facing the greatest constraints.

To mitigate the crisis, he called for targeted policy interventions, including tax relief for SMEs engaged in both domestic production and exports. He noted that delaying the imposition of VAT on digital services was a positive step, as additional tax burdens would have further increased production costs.

Govt. response

From a policy standpoint, Deputy Minister of Industry and Entrepreneurship Development Chathuranga Abeysinghe acknowledged that the SME sector remained highly fragile, particularly in the face of potential disruptions to economic activity.

“The most significant threat currently facing the SME sector is the possibility of the country closing for even a single day,” he said, noting that unlike large corporations, smaller enterprises lacked the financial buffers to withstand even short-term shutdowns.

“For this reason, the Government has developed a strategy specifically to keep the country open and functional,” he added, emphasising that maintaining economic continuity remained a priority. “We are focused on making the economic mechanism energetic, even if that requires increasing prices to sustain operations.”

However, the Deputy Minister acknowledged that even in the absence of supply disruptions, weakening consumer demand posed an additional challenge.

“We recognise that even if business disruptions are avoided, a demand shortage is likely because people’s purchasing power is decreasing compared to 2025,” he said, adding that while demand could not be directly controlled, the Government aimed to cushion vulnerable groups through targeted relief measures.

Abeysinghe noted that such interventions may be triggered if inflation reached critical thresholds, such as 10% or 15%, in an effort to stabilise consumption and support economic activity.

Ministry of Industry and Entrepreneurship Development Secretary Thilaka Jayasundara stated that the Government had introduced a “systematic mechanism to provide fuel to enterprises to ensure that industrial activities continue without interruption” amid ongoing concerns over supply stability, noting further that the process was being implemented in coordination with her ministry, the Ceylon Petroleum Corporation (CPC), and the Ministry of Power and Energy.

Jayasundara explained that fuel distribution had been categorised based on the volume required by industries. “Small-, medium-, and micro-scale industries requiring less than 400 litres of diesel can obtain fuel from their nearest filling stations with a recommendation from the respective divisional secretary,” she said.

Highlighting measures taken to streamline the process, Jayasundara stated that data collection on industrial fuel requirements had commenced on 16 March across 20 sectors. “We are gathering details such as the industry’s location, nature, and specific use of fuel to ensure a more targeted and efficient distribution process.”

Jayasundara clarified that the current mechanism was primarily focused on manufacturing activities. “While the present arrangement prioritises manufacturing industries, fuel for goods distribution is being coordinated through the Ministry of Trade,” she said.

Emphasising supply continuity, she stated that fuel was being issued on a weekly basis, noting: “The Government has arranged for fuel to be supplied on a weekly basis, and enterprises are advised not to engage in unnecessary hoarding or panic buying.”

Providing an update on implementation, Jayasundara noted that demand remained high but was being processed steadily. “As of the morning of 27 March, we have received 2,846 requests for fuel (both SMEs and large-scale), of which 2,551 have already been recommended to the CPC for fulfilment,” she said.

However, Vincent raised concerns over bureaucratic inefficiencies and the lack of timely institutional support. He said that requests for fuel assistance, particularly regarding allocations and regulatory clarity, often faced prolonged delays without resolution.

The fuel crisis and the QR-based allocation system have also severely hampered his logistics. Vincent’s vehicles must travel approximately 350 km per round trip to collect sap, but the standard weekly QR quota of 25 litres is insufficient, as he requires at least 45 litres for a single trip.

“To survive, I have to find fuel through unofficial means, because otherwise I cannot collect the raw materials,” he said, adding that fuel price hikes had increased transport costs from Rs. 10,000 to Rs. 15,000 per trip, with four such trips required each week.

He noted that although he had requested an increased allocation of 280 litres through the Ministry of Industry, the request had only been forwarded to the CPC after a 12-day delay. “While the Government talks about support, the ground reality is very different,” he said.