By Asoka S. Seneviratne –

“No nation can rise to prosperity on the wings of others; true progress is built by the hands of its own people.”

The recent World Bank forecasts predict that Sri Lanka’s GDP growth will drop to 3.5% in 2025 and 3.1% in 2026–2027, a path that significantly lags behind its regional counterparts. For instance, countries like India are expected to grow above 6.5%, Bangladesh around 6.2%, and even Vietnam, though outside South Asia, remains a relevant export competitor projected to sustain growth rates above 6% during the same period. This stark contrast highlights the lingering economic scars from Sri Lanka’s 2022–23 crisis, compounded by weak domestic reform momentum and growing vulnerability to global shocks. Without urgent structural reforms and credible policy direction, Sri Lanka risks falling further behind in an increasingly competitive regional landscape. This is indeed a serious concern.

Sri Lanka’s post-crisis economy faces a precarious future. While macroeconomic stabilization efforts have provided temporary relief, the structural foundations of economic fragility remain largely unaddressed. A key reason for this is the ongoing lack of enforcement in cutting wasteful or politically motivated public spending. For example, despite repeated warnings from the Auditor General and the Committee on Public Enterprises (COPE), state-owned enterprises such as Sri Lankan Airlines and the Ceylon Petroleum Corporation continue to incur massive losses, often subsidized by the Treasury. These losses persist not due to economic necessity but rather because of political interference in management, misallocation of resources, and resistance to restructuring or privatization. Such expenditures, which benefit narrow political interests rather than national priorities, divert scarce public funds away from critical sectors like health, education, and infrastructure, undermining both fiscal stability and development outcomes.

Despite the existence of budgetary frameworks and reform roadmaps, successive governments have struggled to implement meaningful fiscal discipline. Wasteful spending, often in the form of redundant projects, excessive state-sector recruitment, or politically targeted subsidies, continues to absorb scarce public resources. These expenditures are frequently justified on political grounds rather than economic merit, diluting the effectiveness of public investment and eroding the foundation for inclusive development.

What makes this issue particularly urgent is that the inefficiencies are known and documented, yet action remains limited. Independent audits, civil society reports, and international development partners have consistently highlighted these weaknesses. However, political constraints, bureaucratic inertia, and vested interests hinder decisive interventions. As a result, budget deficits persist, debt pressures resurface, and public confidence in reform commitments declines.

To break this cycle, Sri Lanka must move beyond mere rhetorical commitments and establish institutional mechanisms that enforce fiscal rules. Strengthening accountability, depoliticizing public finance, and ensuring transparency in budget execution are not just technical reforms; they are political imperatives. Without these measures, even well-designed economic recovery programs will be compromised, and the country risks falling into a pattern of recurring instability.

Given all the above, this article attempts to provide a policy response to break the cycle.   

Key Issues and Challenges

1. Post-Crisis Fatigue and Weak Recovery

Despite facing the worst of the 2022–23 crisis, Sri Lanka’s recovery has stalled. Macroeconomic stability remains fragile, and investor confidence is low. Temporary measures, such as import controls and bilateral bailouts, are insufficient to promote long-term growth. Sustained growth is crucial for economic stability.

Sri Lanka’s economic recovery continues to be hindered by a troubling combination of slow fiscal reform implementation, weak tax collection, and rising social discontent—all symptoms of a deeper institutional malaise. Despite commitments made under IMF and donor-supported frameworks, the government has struggled to implement critical structural reforms, particularly those aimed at improving public financial management, broadening the tax base, and curbing politically motivated expenditures, such as the ongoing maintenance and expansion of provincial-level political offices and staff positions, especially within non-essential ministries and regional development authorities, many of which duplicate the work of central government agencies. These offices often serve as vehicles for political patronage, providing employment to loyalists and local operatives with minimal accountability or measurable output. For instance, reports have highlighted excessive spending on personal staff, vehicles, and allowances for provincial political figures, even as critical sectors like public health face funding shortages. Such expenditures persist not due to national development needs, but because they help entrench political networks, particularly ahead of elections, reflecting a broader pattern where budgetary decisions are influenced by electoral considerations rather than fiscal responsibility (This is based on COPE or Auditor General Reports).

This lack of credibility regarding reform has eroded public trust, constrained revenue mobilization efforts, and intensified socio-economic pressures on vulnerable communities. Without decisive action to implement the institutional changes already pledged, Sri Lanka risks further drifting into a cycle of fiscal fragility and widespread unrest, thereby undermining both investor confidence and the broader recovery agenda.

2. Structural Impediments to Growth

Sri Lanka’s growth model remains driven by consumption and relies heavily on an oversized public sector. Structural inefficiencies in governance and regulation hinder productivity growth.

A trio of structural inefficiencies severely constrains Sri Lanka’s long-term economic resilience: (i) loss-making state-owned enterprises (SOEs), (ii) a challenging business environment, and (iii) an undiversified export base. With over 400 state-owned enterprises (SOEs) suffering from political interference and persistent inefficiency, they continue to drain public resources while offering little in return. Meanwhile, regulatory uncertainty, bureaucratic red tape, and widespread corruption deter both domestic entrepreneurship and foreign direct investment, stifling innovation and private sector growth. Compounding these challenges is an outdated export structure that heavily relies on garments and remittances, providing minimal value addition or technological advancement. Together, these bottlenecks create a systemic drag on productivity, job creation, and sustainable growth—issues that require urgent, coordinated reform.

3. Weak Investment and Domestic Demand

Investment, both public and private, has sharply contracted due to high interest rates, unstable inflation, and a lack of clarity on medium-term policy. Consumer demand remains low due to falling real incomes and high household debt.

Sri Lanka’s growth engine is further weakened by a dual constraint on both private sector vitality and public investment capacity. Small and medium enterprises (SMEs), which form the backbone of employment and innovation, face prohibitively high borrowing costs that stifle their growth. Meanwhile, larger investors remain on the sidelines amid ongoing uncertainty regarding fiscal and tax policies. In parallel, to meet IMF conditionalities, the government has made sharp cutbacks in capital expenditure on critical sectors such as infrastructure, education, and healthcare, undermining long-term development potential. This combination of a struggling private sector and reduced public investment is eroding the foundations of economic recovery, further delaying the transition toward inclusive and sustainable growth.

4. External Vulnerabilities and Global Headwinds

The World Bank warns of worsening external conditions—including rising trade barriers, tighter global financial markets, and the effects of climate change—all of which affect Sri Lanka due to its open and import-dependent economy.

Sri Lanka’s external vulnerabilities are intensifying due to a convergence of global trade, financial, and environmental risks. Rising global protectionism has started to dampen demand for Sri Lankan exports, particularly in key markets, undermining the country’s already narrow export base. Simultaneously, tighter global monetary conditions pose the risk of capital flight, which could lead to (i) potential rupee depreciation (ii) inflationary pressures, and (iii) renewed strain on the balance of payments. Compounding these risks is the escalating impact of climate disruption, as floods, droughts, and rising sea levels exert severe stress on agriculture, fisheries, and rural livelihoods. Together, these external shocks could destabilize hard-won macroeconomic gains unless preemptive resilience strategies are urgently implemented.

5. Human Capital and Productivity Gaps

A slow-growing economy cannot sustain employment without enhancing productivity. Yet education and skill development in Sri Lanka continue to be misaligned with current economic needs.

Sri Lanka’s human capital potential is being compromised by a skills mismatch, declining health outcomes, and an innovation deficit, all of which are eroding the country’s long-term productivity. An increasing number of university graduates remain unemployed or underemployed due to the lack of demand-driven training and technical skills, highlighting a disconnect between education and labor market needs. Meanwhile, post-crisis malnutrition and limited access to healthcare are hindering workforce participation and diminishing labor resilience. Compounding these issues is Sri Lanka’s minimal investment in research and development, along with a fragile and underfunded startup ecosystem, which stifles innovation and technological advancement. Unless these challenges are addressed through coordinated reforms in education, health, and innovation policy, these deficits will continue to undermine the country’s competitiveness and inclusive growth prospects.

Policy Recommendations

1. Deepen Structural Reforms

Structural transformation must begin with depoliticizing state institutions and modernizing the economy’s backbone.

Reviving investor confidence and ensuring sustainable development in Sri Lanka will require bold institutional reforms, with a focus on state-owned enterprises (SOEs), legal clarity, and effective anti-corruption enforcement. A comprehensive SOE reform agenda must include performance-based governance frameworks and the privatization or restructuring of chronically loss-making entities that drain public resources. Equally important is the establishment of consistent and transparent legal frameworks governing investment, land use, and taxation, providing both domestic and foreign investors with the predictability they need. To anchor these reforms in accountability, independent anti-corruption institutions like CIABOC must be empowered and operationalized to restore public trust and uphold the rule of law across all levels of governance.

2. Accelerate Fiscal and Debt Sustainability

Macroeconomic stability is essential for growth. The government must go beyond austerity to adopt innovative fiscal management.

To ensure a sustainable and equitable economic recovery, Sri Lanka must adopt a comprehensive fiscal reform strategy centered on (i) progressive taxation, (ii) smarter spending, and (iii) debt transparency. Expanding the tax base with measures that target wealth, property, and digital transactions will enhance revenue without overburdening lower-income or middle-class populations. At the same time, public expenditure should be reprioritized toward critical areas such as health, education, climate resilience, and innovation—sectors that directly contribute to long-term productivity and social equity. Complementing these efforts, the government must commit to complete transparency in debt management, including the regular publication of domestic and external debt data, as well as open engagement with creditors to build trust and ensure fair and sustainable restructuring.

3. Promote Private Sector Investment and SME Growth

The private sector must be empowered as the engine of growth.

To stimulate private sector growth and attract high-quality investment, Sri Lanka must implement targeted measures that enhance credit access, streamline business operations, and foster the development of sector-specific zones. Establishing public credit guarantee schemes and easing collateral requirements will enable SMEs—the backbone of the economy—to access affordable financing and scale operations. Simultaneously, the creation of investment promotion zones with well-defined tax incentives and regulatory clarity in sectors such as (i) renewable energy, (ii) technology, and (iii) agro-processing can position Sri Lanka as a competitive regional hub. To support this ecosystem, a one-stop digital portal for business registration, permits, and tax compliance should be introduced to significantly improve the ease of doing business and reduce bureaucratic inefficiencies.

4. Diversify Trade and Enhance Export Competitiveness

Sri Lanka must diversify both markets and products to insulate itself from global shocks.

Strengthening Sri Lanka’s external sector requires a forward-looking trade and logistics strategy focused on market diversification, export incentives, and infrastructure modernization. Proactively engaging with regional blocs like RCEP and pursuing new Free Trade Agreements (FTAs) with emerging markets in Africa and Southeast Asia can unlock new demand for Sri Lankan goods and services. To capitalize on these opportunities, targeted incentives should be introduced for high-potential sectors, such as green products, organic agriculture, software development, and logistics services—areas with strong global demand and significant value-added potential. At the same time, comprehensive logistics reform, including (i) the modernization of ports, (ii) streamlined customs procedures, and (iii) improved inland connectivity, is essential to reduce transaction costs and enhance the country’s competitiveness in global trade.

5. Invest in Human Capital and Skills Development

People are the most valuable economic asset—yet they remain underdeveloped and underutilized.

To prepare a workforce ready for the future, Sri Lanka must adopt a transformative approach to skills development and human capital investment. A comprehensive overhaul of TVET is essential to align vocational education with the evolving demands of the labor market, particularly in high-growth sectors such as IT, healthcare, and green technology. Additionally, nationwide digital literacy campaigns should be launched to integrate essential digital skills into both school curricula and adult education programs, ensuring broader participation in the digital economy. Importantly, public-private partnerships (PPPs) must be nurtured to co-design training programs, facilitate internships and apprenticeships, and create robust pathways for continuous upskilling, bridging the gap between education and employment and enhancing the productivity of Sri Lanka’s labor force.

6. Strengthen Governance and Policy Credibility

Without public trust and stable institutions, reforms will not succeed.

Ensuring long-term fiscal sustainability and effective governance in Sri Lanka requires establishing robust institutional frameworks that promote accountability, transparency, and citizen engagement. Creating an Independent Fiscal Council with the authority to monitor compliance with fiscal rules and enhance parliamentary oversight would act as a crucial safeguard against unsustainable spending and political interference. Furthermore, the government should adopt medium-term policy frameworks—lasting 3 to 5 years—for essential sectors such as investment, infrastructure, education, and energy, thus providing predictability and guiding public and private sector planning. Equally important is the active participation of civil society and the private sector in monitoring reforms, particularly in areas such as anti-corruption, budget allocation, and regulatory development, to ensure that reforms are not only well-structured but also effectively implemented and socially accountable.

Summary

The recent World Bank’s projection of Sri Lanka’s GDP growth—3.5% in 2025 and 3.1% in 2026–2027—reveals a troubling lag behind regional peers like India, Bangladesh, and Vietnam. This slowdown is a direct result of the unresolved aftermath of the 2022–23 economic crisis, coupled with poor fiscal discipline, institutional inertia, and politically driven public spending.

Despite temporary macroeconomic stability measures, Sri Lanka’s growth remains constrained by:

* Persistent political interference in state-owned enterprises (SOEs) continues to incur massive losses.

* Redundant public sector spending, especially at the provincial level, diverts resources from essential services like health and education.

* Delayed structural reforms, particularly in SOE governance, tax reform, and public investment management.

* External vulnerabilities include rising trade barriers, volatile global markets, and the growing impact of climate change.

* Weak domestic demand and investment, with SMEs struggling to access credit and capital expenditure cuts hampering long-term development.

* Underdeveloped human capital, as education and training remain poorly aligned with labor market demands.

The article identifies five critical policy areas requiring urgent action: structural reform, fiscal credibility, private sector revitalization, trade diversification, and investment in human capital. Without progress in these areas, Sri Lanka risks prolonged stagnation and increasing economic instability.

Conclusion

Sri Lanka is at a crossroads. The country’s sluggish growth trajectory, compounded by institutional inefficiencies and politicized economic decision-making, demands bold and credible policy action. Reform must move beyond rhetoric, targeting wasteful expenditures, restoring public trust, and enabling private sector dynamism.

Effective leadership, robust governance, and inclusive policy frameworks are crucial to reversing the economic decline. Only through sustained structural transformation, transparent fiscal practices, and investment in human capital can Sri Lanka build resilience, attract investment, and secure a more prosperous and equitable future.

*The writer, among many, served as the Special Advisor to the President of Namibia from 2006 to 2012 and was a Senior Consultant with the UNDP for 20 years. He was a Senior Economist with the Central Bank of Sri Lanka (1972-1993), asoka.seneviratne@gmail.com