• Debt defines policy, welfare softens the blow, and credibility hangs in the balance

After three years of upheaval, an unprecedented default, gruelling International Monetary Fund (IMF) negotiations, and the painful climb back through fiscal tightening, Sri Lankans appear to have stopped expecting miracles from their budgets. 

What people look for now are smaller mercies such as proposals that ease the cost of living, incentives that give them a bit of breathing space, and, if fortune allows, a lighter tax burden in a year when both direct and indirect levies already feel suffocating.

At Rs. 8.98 trillion, the 2026 Budget tries to show that Sri Lanka can live within its means without abandoning its citizens. With revenue projected at Rs. 5.3 trillion against spending nearly 70% higher, the deficit of 5.1% of Gross Domestic Product (GDP) is an improvement on recent years, yet it still underscores how narrow the path to stability really is.

A rule-bound budget in a new era of restraint

This year’s Budget is the first to operate fully under the Public Financial Management Act No.44 of 2024, a law designed to bring some order to the country’s spending habits. It sets hard limits such as primary expenditure being unable to exceed 13% of GDP, while the budget reserve is capped at 2%. For once, Sri Lanka’s fiscal framework looks less like a political wish list and more like a rules-based system with consequences.

Debt servicing alone eats up Rs. 4.5 trillion, roughly half of all Government spending. Of that, Rs. 2.6 trillion goes towards interest payments and Rs. 1.88 trillion towards repaying old loans. The remainder – about Rs. 4.48 trillion in primary expenditure – has to cover everything else including salaries, pensions, and capital projects spread across 24 ministries, 134 Provincial Councils and District Secretariats, and 21 special expenditure units.

Wages and pensions are still enormous drains on the Treasury. Rs. 1.46 trillion is set aside for salaries and Rs. 510 billion for pensions, together amounting to more than 40% of all primary spending. These are politically untouchable areas that every government promises to reform but never quite does. Cutting them risks backlash from public sector unions; ignoring them locks the State into chronic inefficiency.

On the revenue side, the Government expects to bring in Rs. 5.3 trillion, with tax income making up Rs. 4.85 trillion. That is about 14.2% of GDP, a big step up from the 8.3% recorded in 2022, though still shy of the IMF’s 15% target. Non-tax revenue adds another Rs. 455 billion, mostly from State dividends and service fees.

In short, Sri Lanka will keep borrowing to bridge the gap between what it earns and what it spends. This is not new; it has been the country’s fiscal story for nearly 20 years. The only difference now is that the borrowing is finally being monitored, measured, and, at least on paper, restrained.

Economic outlook: Recovery without exuberance

The Government’s Medium-Term Fiscal Framework (2025–2030) projects economic growth between 4% and 5% in 2026. This may appear modest, but it marks a psychological recovery from the contraction that followed the 2022 balance of payments crisis. 

The Government expects revenue to reach 15.4% of GDP, expenditure to stay at 20.5%, and public investment at 4%, yielding a primary surplus of 2.5%, a critical IMF benchmark for debt sustainability.

But growth remains uneven. Consumption is still depressed, investment confidence fragile, and export performance sluggish. The Government’s stated goal, to create ‘A Thriving Nation, A Beautiful Life,’ rests on reviving domestic industries while maintaining fiscal caution. That duality runs through every line of the 2026 Budget, the rhetoric of revival paired with the arithmetic of restraint.

Debt: The shadow over everything

Debt at this stage defines every policy choice. Nearly two-thirds of all Government spending now goes towards debt servicing. Interest payments, Rs. 2.6 trillion, equal the roughly combined budgets for health, education, and social welfare. The numbers show how public spending continues to be consumed by past borrowing instead of future investment.

The country’s public and guaranteed debt remains at elevated levels, despite restructuring efforts and attempts to impose fiscal discipline. In the 2026 Budget, the Treasury has allocated Rs. 700 billion for external repayments and plans to raise Rs. 3.7 trillion through borrowing. This leaves limited space for discretionary spending or new development priorities.

To contain this burden, the Government has introduced a ‘concessional-first’ borrowing strategy, securing low-cost loans from multilateral partners, capping new foreign borrowing at Rs. 235 billion, and relying more heavily on non-banking borrowings and local-currency financing. 

This approach reduces foreign exchange risk but creates domestic pressure. Heavy reliance on local borrowing can tighten liquidity, limit private credit, and raise borrowing costs for businesses seeking to recover.

The Treasury aims to reduce the debt-to-GDP ratio below 95% by 2032, a goal that depends on maintaining consistent primary surpluses, stable interest rates, and an external environment free of shocks.

There is some progress. The IMF recently commended Sri Lanka for notable improvements in fiscal transparency and expenditure control, while warning that persistent weaknesses in revenue mobilisation posed risks to debt sustainability. The 2026 Budget has been structured in response, with tighter borrowing limits, stronger reporting, and efforts to rebuild credibility with lenders.

Taxation: Stabilising after a storm

After two years of sharp tax reforms, from Value-Added Tax (VAT) hikes to income tax reinstatements, the Government has opted for stability. No major new taxes are introduced in 2026, signalling a pause for consolidation.

The tax system now rests heavily on three pillars – VAT, excise, and trade taxes – which together generate nearly three-quarters of all tax revenue. Income tax contributes Rs. 1.21 trillion, a figure the Treasury hopes to raise through compliance rather than rate increases.

Reform efforts focus on digitalisation. The Revenue Administration Management Information System (RAMIS), long criticised for underperformance, is being upgraded; the e-procurement platform is expanding across ministries; and the cashless economy initiative is spreading to State institutions. 

Rebuilding the social contract

Perhaps the most politically resonant part of the Budget is its emphasis on social protection, reflecting a government aware that austerity has a human cost.

The ‘Aswesuma’ programme, expanded to Rs. 232.5 billion under the previous Budget, now anchors Sri Lanka’s welfare architecture. It reaches 1.8 million low-income families, alongside Rs. 19 billion for persons with disabilities, Rs. 54 billion for elderly assistance, and Rs. 6.4 billion for kidney patients. Together with pensions and gratuities worth Rs. 565 billion, welfare spending now totals Rs. 837 billion.

President Dissanayake defended these allocations, saying the aim was “a universal social protection system” that safeguarded dignity without compromising fiscal discipline. Yet the contradiction is visible; welfare expansion coexists with a shrinking revenue base. 

The Government hopes to offset this through improved targeting and digital payment systems, but implementation capacity, particularly at divisional secretariat level, remains thin. Still, after years of crisis-induced hardship, the emphasis on redistribution marks a change. 

Education and health holding the line

In social sectors, the 2026 Budget consolidates rather than expands. Education has received Rs. 704 billion, including Rs. 537 billion for school education, Rs. 133 billion for universities, and Rs. 20 billion for vocational training. The focus is on maintaining access; providing uniforms, textbooks, and nutritional meals for schoolchildren; and expanding university facilities.

Health spending, at Rs. 654 billion, sustains essential services through hospital operations, medical supplies, and staff salaries. A share of Rs. 43 billion has been allocated for hospital development and Rs. 12.9 billion for nutrition, including the ‘Thriposha’ programme. These allocations are stable but not transformative — they protect the core rather than innovate.

Public health experts note that real-term spending remains below pre-crisis levels once inflation is adjusted. The system continues to deliver at impressive efficiency given its budget, but pressures are mounting, particularly in medicine procurement and hospital maintenance.

Infrastructure continuity over vision

Infrastructure spending, traditionally a political showcase, has been reshaped under fiscal restraint. The transport sector, with Rs. 456 billion, remains the largest single capital allocation. Roads and bridges take the lion’s share, with projects such as the Kadawatha-Rambukkana expressway section, Port Access Elevated Highway, and Colombo-Galle-Hambantota-Wellawaya corridor receiving upgrades.

Railways have received Rs. 76 billion, partly for modernisation and digital ticketing, while the Sri Lanka Transport Board has been allocated Rs. 34 billion to maintain bus fleets and subsidise rural routes. The water supply and housing portfolio adds another Rs. 169 billion, targeting one million new pipe-borne connections and 20,000 low-income homes.

These projects sustain employment and demand but rarely catalyse productivity. Economists have long argued that infrastructure alone cannot deliver growth unless linked to industrial policy and exports. In this sense, the 2026 Budget continues Sri Lanka’s pattern of ‘hardware-heavy’ investment — roads before reform, buildings before business confidence.

Energy and climate

The energy allocation of Rs. 23 billion is a gradual movement towards sustainability. Projects include the Kerawalapitiya-Colombo Port underground transmission line, Habarana-Kappalthurai grid development, and several solar rooftop and waste-to-energy initiatives.

The Government’s stated goal to enhance renewable capacity and reduce losses aligns with its climate adaptation agenda, which also spreads across multiple ministries. Initiatives in stormwater management, coastal protection, reforestation, and waste disposal add another Rs. 53 billion under the theme ‘Towards an Evergreen Life.’

Yet, as environmental economists point out, these efforts remain fragmented. Sri Lanka’s climate vulnerability, from floods to droughts, demands integrated planning. The Budget’s numerous line items signal intent but not coherence.

Governance and digital state

Governance reform, long a weak link, has received more explicit attention this year. Under the ‘People-Friendly Public Service’ allocation of Rs. 411 billion, the Government has prioritised administrative modernisation, public sector digitalisation, and provincial service delivery.

Key initiatives include the Sri Lanka Unique Digital Identity (SLUDI), e-Grama Niladhari, and the Digital Economy Advancement Programme, together valued at Rs. 30 billion. These efforts, coupled with the Sri Lanka Public Financial Management Strengthening Project, aim to restore trust in institutions that have been weakened by corruption and inefficiency.

Still, implementation remains the biggest variable. Technology alone cannot compensate for poor governance culture. What will matter is not the number of apps launched but the consistency of enforcement and data integrity.

Entrepreneurship and industry

The 2026 Budget contains several modest but noteworthy credit initiatives. The Rs. 50 billion Small and Medium-sized Enterprise (SME) Loan Scheme offers up to Rs. 50 million per borrower at 8% interest; the Rs. 25 billion Micro, Small, and Medium-sized Enterprise (MSME) Development Fund and the Rs. 7.7 billion SME Development Programme provide targeted financing for micro-entrepreneurs, especially women and youth.

Agricultural credit lines, including Rs. 1.8 billion for smallholder farmers and Rs. 0.75 billion for youth entrepreneurs in agriculture, showcase attempts to push rural innovation. These programmes, if executed with transparency, could ease access to finance. However, their success depends on the banking system’s willingness to lend beyond collateral norms, as well as on monitoring to prevent political capture.

Public sentiment and challenges ahead

For ordinary citizens, this Budget signals mixed emotions. On one hand, inflation is easing, interest rates are falling, and supply chains are stabilising, signs of slow normalisation. On the other hand, wages lag behind prices, taxes remain heavy, and social mobility feels distant.

The absence of populist giveaways, new subsidies, salary hikes, or sweeping tax relief may frustrate voters but reassures creditors. The Government’s wager is that stability, not stimulus, will yield political dividends by the end of 2026. Whether the electorate shares that patience remains to be seen.

Fiscal consolidation, however carefully designed, is only as credible as its implementation. The primary surplus target of 2.5% will test the Government’s discipline, especially if revenue underperforms. Global headwinds, from energy shocks to geopolitical volatility, could further complicate assumptions.

There is also the risk of reform fatigue. The public, after years of sacrifice, may tire of austerity without visible improvement. For businesses, uncertainty about tax enforcement and exchange rate policy continues to cloud investment decisions.

The question is whether Sri Lanka can transition from crisis management to growth planning. This Budget suggests the Government is learning to govern within constraints, but not yet to transcend them.

The 2026 Budget is an act of careful choreography, keeping the IMF engaged, creditors reassured, and citizens minimally protected. In that sense, it succeeds as a document of stabilisation, if not transformation. To rebuild credibility, the Government will have to prove through action that fiscal discipline can coexist with growth and that welfare can coexist with responsibility.

Budget 2026 at a glance 

1. Size and fiscal framework

• Total expenditure: Rs. 7.06 trillion
• Total revenue and grants: Rs. 5.30 trillion
• Budget deficit: 5.1% of GDP, slightly higher than 2025’s 4.5% but within IMF-approved limits
• Primary surplus: 2.5% of GDP, reflecting continued fiscal discipline
• Public investment: Maintained at 4% of GDP, signalling a focus on infrastructure despite tighter budgets
• The 2026 Budget is the first full cycle under the Public Financial Management Act No.44 of 2024, which legally caps primary expenditure at 13% of GDP and the budget reserve at 2%, enforcing long-term spending discipline

2. Revenue and taxation

• Total tax revenue: Rs. 4.91 trillion, or 14.2% of GDP, up from 8.3% in 2022 and approaching the IMF’s 15% target
• Non-tax revenue: Rs. 455 billion, mainly from State-Owned Enterprise dividends, fees, and property income
• Key tax composition
• Taxes on goods and services: Rs. 3.06 trillion (VAT and excise)
• Taxes on income and profits: Rs. 1.21 trillion
• Taxes on external trade and transactions: Rs. 644 billion
• Indirect taxes (VAT, excise, and trade-related) provide nearly three-quarters of all tax revenue, reinforcing Sri Lanka’s dependence on consumption-based taxation
• No new tax increases were announced. The Government instead focuses on improving compliance, expanding the taxpayer base, and using digital systems such as RAMIS and electronic procurement
• Tax incentives remain targeted towards export-oriented industries, renewable energy, and technology start-ups

3. Debt and borrowing

• Debt servicing allocation: Rs. 4.50 trillion, equal to 64% of total spending
• Interest payments: Rs. 2.62 trillion
• Amortisation (loan repayments): Rs. 1.88 trillion
• External debt repayments: Rs. 700 billion
• Domestic borrowing: Rs. 3.7 trillion
• New foreign borrowing limit: Rs. 235 billion under a ‘concessional-first’ policy emphasising cheaper multilateral loans and reduced exposure to foreign exchange risk
• Heavy reliance on domestic borrowing raises concerns about liquidity tightening and limited private sector credit
• Debt-to-GDP ratio: Treasury target to reduce it to below 95% by 2032
• IMF assessment: Noted improvements in fiscal transparency but warned that weak revenue mobilisation continued to threaten long-term debt sustainability

4. Economic outlook

• Projected GDP growth: 4–5% in 2026, after modest recovery in 2025
• Inflation: Expected to remain in the single digits, supported by lower import costs and currency stability
• Unemployment: Forecast at around 4.5–5%, depending on tourism and manufacturing performance
• Fiscal strategy: Sustain the primary surplus, strengthen tax administration, and rebuild reserves while maintaining essential welfare spending

5. Key expenditure areas

Primary expenditure: Rs. 4.48 trillion

• Salaries and wages: Rs. 1.46 trillion
• Pensions: Rs. 510 billion
• Capital expenditure: Rs. 1.38 trillion
• Transfers and subsidies: Rs. 1.35 trillion

Sectoral allocations

• Health: Rs. 654 billion (hospital services, medical supplies, nutrition, Suwa Seriya ambulance network)
• Education: Rs. 704 billion (school education Rs. 537 billion, universities Rs. 133 billion, vocational training Rs. 20 billion)
• Social welfare: Rs. 837 billion, including the ‘Aswesuma’ cash transfer programme (Rs. 231 billion) and pensions/gratuities (Rs. 565 billion)
• Agriculture and irrigation: Rs. 267 billion (fertiliser subsidies Rs. 36.9 billion, irrigation modernisation Rs. 91.7 billion)
• Transport and roads: Rs. 456 billion — the single largest capital allocation, with projects including the Kadawatha-Rambukkana expressway section and Port Access Elevated Highway
• Water supply and housing: Rs. 169 billion (20,000 low-income homes, new pipe-borne water connections)
• Public administration and provincial services: Rs. 411 billion

6. Social protection and welfare

• ‘Aswesuma’ programme: Expanded to cover 1.8 million families, with digital verification to improve targeting
• Elderly, disabled, and kidney patient allowances: Rs. 79 billion combined
• Nutrition programmes: Rs. 12.9 billion for ‘Thriposha’ and maternal health
• Education support: Free uniforms, textbooks, and school meals for four million students; scholarships for university and technical students
• Housing and resettlement schemes: Rs. 3 billion for low-income families, Rs. 2 billion for landslide-affected households
• Women and child protection: Rs. 2 billion for social care and empowerment initiatives

7. Infrastructure and investment

• Public investment: Maintained at 4% of GDP to safeguard growth momentum
• Major projects
• Central Expressway (Kadawatha-Rambukkana) – Rs. 16 billion
• Railway modernisation and safety programme – Rs. 76 billion
• Water and sanitation upgrades – Rs. 35 billion
• Urban development and housing – Rs. 44 billion
• Irrigation rehabilitation and Mahaweli Water Security Programme – Rs. 92 billion
• Energy and environment
• Rs. 23 billion for electricity transmission, renewable energy, and waste-to-energy plants
• Rs. 53 billion across ministries for stormwater management, reforestation, and climate resilience projects

8. Governance and digital transformation

• Digitalisation programme: Rs. 30 billion to strengthen e-government, digital identity (SLUDI), and electronic procurement
• Cashless economy rollout across Government institutions
• Public sector modernisation: Rs. 411 billion for administrative efficiency, performance-based budgeting, and transparency initiatives
• Accountability focus: Reinforced under the Public Financial Management Act, tying spending directly to outcome indicators

9. Support for business and industry

• SME Loan Scheme: Rs. 50 billion offering credit up to Rs. 50 million per borrower at 8% interest
• SME Development Fund: Rs. 25 billion, targeting micro-entrepreneurs and self-employed workers
• Agriculture and youth entrepreneurship funds: Rs. 2.5 billion for smallholder farmers and Rs. 750 million for youth-led agribusiness
• Export promotion and industrial zones: Rs. 1 billion for new manufacturing clusters and Rs. 500 million for export diversification
• Tourism revival: Incentives for eco-tourism and heritage projects; emphasis on digital marketing rather than subsidies

10. Debt and deficit path ahead

• Deficit financing: Rs. 1.76 trillion to be covered through domestic and external borrowing
• Borrowing mix: Roughly 80% domestic, 20% external, in line with debt-risk management policy
• Fiscal anchor: Maintain primary surplus of 2.5% and reduce deficit to below 5% by 2027
• Medium-term goal: Debt ratio under 95% of GDP by 2032; inflation below 5%; reserves equal to at least 4 months of imports

11. IMF programme alignment

• Budget built to meet IMF Extended Fund Facility benchmarks:
• Maintain fiscal deficit below 5.5% of GDP
• Strengthen State-Owned Enterprise governance and cost-reflective pricing in energy
• Continue structural reforms in revenue administration and public financial management

2026 Budget draws praise but little surprise

By The Sunday Morning Business Desk

Sri Lanka’s 2026 Budget, unveiled by President and Finance Minister Anura Kumara Dissanayake, has been broadly welcomed by economists and business leaders as fiscally sound but lacking in novelty. Many described it as a continuation of the 2025 Budget’s reform agenda and stressed that its success would depend on how effectively it was implemented.

Frontier Research Head of Macroeconomic Advisory Chayu Damsinghe said the fiscal outlook appeared stronger than projected, crediting higher-than-expected revenues and constrained Government spending. “On the fiscal side, revenue has been doing consistently better than expected over the last year, but also, while there are structural reasons causing recurrent and capital spending to remain constrained, the fiscal situation remains quite strong,” he said.

He noted that even without vehicle import taxes, Sri Lanka had likely achieved its 15% revenue-to-GDP target, adding that rising consumer demand next year could further boost tax collection. Damsinghe also expressed confidence in the country’s ability to meet its 87% debt-to-GDP target by 2030, pointing out that the International Monetary Fund (IMF) may have already revised its projections based on improved fiscal performance.

Advocata Institute CEO Dhananath Fernando said the 2026 Budget introduced no major spending measures that could strain public finances. “In terms of reforms, it’s largely similar to the 2025 Budget,” he observed, stressing that implementation would be crucial, especially as Sri Lanka prepares to exit the IMF programme in 2027. He cautioned against a return to “old habits” once the programme ended, despite the Government’s commitment to macroeconomic stability.

Fernando said achieving the 7% growth target would require visible progress in public-private partnerships, SOE restructuring, Customs reform, and digital investment facilitation. On welfare spending, he noted the Budget’s limited new initiatives but said refining the existing ‘Aswesuma’ scheme and improving targeting mechanisms should be prioritised.

Free Trade Zone Manufacturers’ Association Chairman Dhammika Fernando commended proposals to strengthen investment facilitation and consistency. He welcomed the planned investment protection act and allocations to develop the National Single Window framework, saying these could address long-standing investor concerns.

Ceylon Federation of MSMEs President Mahendra Perera and National Chamber of Exporters CEO Shiham Marikar both underscored the importance of follow-through. Perera said last year’s SME relief measures had never materialised, while Marikar called for better communication of investment priorities and incentives, adding that local investors should have a “level playing field” with foreign counterparts.

Across the board, experts agreed that Budget 2026 represented a step forward in fiscal discipline but warned that credibility would hinge on tangible progress. As Fernando put it: “The challenge now is to deliver on what has already been promised.”

(For the detailed article, please refer to The Sunday Morning Business page 1 lead story)