By Sugath Amarasekera –

President Anura Kumara Dissanayake’s (AKD) government is facing an increasingly difficult economic situation, despite the President’s upbeat assessment of the substantial budget surplus achieved during the current fiscal year. While the government presents this surplus as evidence of successful economic management, it is important to examine the broader economic consequences of the policies that have contributed to this outcome.

The surplus appears to have come at a considerable cost to the domestic economy.

Higher taxation, elevated borrowing costs and restrictive monetary conditions have significantly weakened domestic demand for goods and services, placing considerable pressure on businesses, particularly those serving the local market.

Domestic producers are now facing increasingly difficult operating conditions. As consumer purchasing power continues to weaken, many businesses are being forced either to suspend production altogether or to reduce output substantially. This has made it increasingly difficult for producers to recover their operating costs, particularly as many businesses supplying the domestic market operate on relatively thin profit margins.

The combination of a higher tax burden and the Central Bank of Sri Lanka’s (CBSL) restrictive monetary policy, intended partly to contain inflationary pressures arising from higher international oil prices and other imported goods, has compounded these difficulties.

Importantly, inflation driven by external supply-side factors cannot necessarily be addressed effectively through higher domestic interest rates without imposing substantial costs on the productive economy. Higher borrowing costs increase the cost of financing working capital and productive investment. These additional costs may subsequently be passed on to consumers through higher prices, further weakening purchasing power and suppressing demand.

Consequently, the economy risks entering a damaging cycle in which weak demand leads to reduced production, declining business profitability, lower investment and limited employment creation. These developments, in turn, further undermine household incomes and domestic consumption.

The CBSL and the government must therefore carefully assess the cumulative economic consequences of their monetary and fiscal adjustments. Excessively restrictive policies, particularly during a period of weak domestic demand and limited employment growth, risk undermining the very economic recovery the government is attempting to achieve.

There are already indications of a significant slowdown in economic activity. Credit growth, which approached 27% during the first half of the year, is reported to have fallen to below 10%. If confirmed on a comparable basis, such a sharp deceleration would suggest a substantial weakening of credit expansion and potentially of private-sector economic activity.

Against this background, economic growth during the current quarter could slow considerably compared with the first half of the year. A contraction in output cannot be ruled out if domestic demand continues to deteriorate and productive investment remains subdued.

Under these circumstances, the government should prioritise stimulating productive economic activity through carefully targeted public expenditure, affordable credit and policies designed to strengthen domestic production and export capacity.

However, stimulating economic growth should not simply mean encouraging indiscriminate consumption or increasing imports without corresponding improvements in productive capacity and foreign exchange earnings. Sri Lanka must pursue a development strategy that expands domestic production while simultaneously strengthening its external account.

Entrepreneurs and domestic producers urgently need clear policy direction from the government, supported by practical measures to stimulate economic activity over the short, medium and longer term.

In the short term, the government should focus on restoring domestic demand, improving access to affordable working capital and preventing otherwise viable businesses from reducing production or closing down.

Over the medium and longer term, policy should concentrate on expanding productive capacity, improving industrial competitiveness, encouraging investment in value-added manufacturing and strengthening export earnings.

A sustained improvement in foreign exchange earnings would provide the economy with greater capacity to finance essential imports, including machinery, technology, industrial raw materials and other productive inputs. This would support further economic expansion while reducing the risk of recurring balance-of-payments difficulties.

As productive capacity expands, employment and household incomes should improve, creating a more sustainable foundation for domestic consumption and economic growth.

Another serious concern is the extent to which the government’s reported fiscal surplus may have been achieved through the underutilisation of capital expenditure allocations approved in the previous budget.

If a substantial portion of the surplus resulted from underspending on public investment rather than stronger economic activity and sustainable revenue growth, it should not automatically be regarded as a positive economic achievement.

Capital expenditure plays an important role in stimulating economic activity, creating employment, improving infrastructure and strengthening the productive capacity of the economy. Persistent underutilisation of these allocations can therefore have significant negative consequences for both immediate economic activity and longer-term growth prospects.

A government cannot indefinitely pursue fiscal consolidation at the expense of productive investment and expect the economy to achieve sustained growth.

It is also important to distinguish between increased government revenue arising from higher taxation and revenue growth generated through genuine economic expansion.

Higher tax collection does not, by itself, demonstrate that the economy has become more productive. If additional revenue is extracted from households and businesses already struggling with weak demand, the resulting fiscal improvement may come at the expense of private consumption, investment and economic activity.

Similarly, a budget surplus achieved through reduced government expenditure does not necessarily indicate an improvement in the underlying productive strength of the economy.

The fundamental measure of successful economic management should not be the size of the government’s budget surplus, but the extent to which economic policies expand production, employment, real household incomes, productivity and sustainable foreign exchange earnings.

The government should therefore exercise considerable caution before celebrating the reported fiscal surplus as an unqualified economic success.

If the surplus has been achieved largely through higher taxation, restrictive financial conditions and underutilisation of capital expenditure, while domestic demand remains weak and export growth remains insufficient, it may reflect an economy operating below its productive potential rather than one undergoing meaningful economic transformation.

This should prompt the government to critically reassess its current economic strategy we certainly requires fiscal discipline, monetary stability and a sustainable external account. However, these objectives must be pursued alongside policies that actively support productive investment, domestic demand, employment creation and export-led economic expansion.

Fiscal stability should be a foundation for economic development, not an end in itself.

The real challenge facing the AKD government is not simply to demonstrate that it can collect more taxes, contain expenditure and accumulate Treasury surpluses. It is to demonstrate that these achievements can be translated into higher productive output, greater employment opportunities, rising real incomes and a structurally stronger economy.

Unless this transformation takes place, the government risks celebrating fiscal achievements while the productive economy continues to struggle.

A budget surplus achieved at the expense of economic growth should be treated as a warning signal demanding urgent policy reassessment, rather than as evidence of economic success.