Sri Lanka budget faces post-IMF test as energy costs bite

A post-IMF test asks whether Sri Lanka can manage its economy without relying on the discipline and financing of a major rescue programme. The IMF programme is nearing its end, so the 2027 budget must show investors that recovery can continue independently. It must support investment and growth without reopening the debt problems that caused the crisis.

The budget sets the government’s intended path. It targets a 2.6 per cent primary surplus in 2027, a 4.5 per cent overall deficit, revenue and grants equal to 15.5 per cent of GDP, and public investment above 4 per cent. At the same time, fuel and electricity subsidies are meant to protect households from higher energy costs.

Sri Lanka has rebuilt reserves and recorded growth for 12 straight quarters, but its recovery remains uneven. The budget is also needed for the IMF’s seventh review, which could unlock about $345 million. Investors will watch whether relief measures undermine fiscal sustainability or support a stable return to bond markets.

An IMF bailout programme is emergency financial support for a country facing severe economic or balance-of-payments problems. The money is released in stages, usually after the country meets agreed policy targets. These conditions help restore confidence, control public finances, protect reserves, and make future borrowing more sustainable. The IMF programme therefore combines financing with economic reform.

Sri Lanka’s programme was worth $2.9 billion and followed the 2022 crisis, when the country defaulted and struggled to import essentials. The article links the programme to fiscal discipline, stronger external balances, reforms, and reserve rebuilding. It also says the budget must safeguard fiscal and debt sustainability. The seventh review could release about $345 million.

The programme is nearing completion after four years, with Sri Lanka expected to exit it in March. The article does not provide a complete list of required measures. It shows the broad objective clearly: move from crisis stabilisation toward growth without undoing the financial improvements achieved under the programme.

Sri Lanka’s financial position has improved substantially since the 2022 collapse. The economy has grown for 12 consecutive quarters, suggesting that the contraction and disruption of the crisis have been followed by sustained expansion. Foreign-exchange reserves, which had been dangerously depleted, reached $6.9 billion by the end of October. These reserves strengthen the country’s ability to pay for imports and reassure investors.

Public finances have also turned around. Sri Lanka recorded a primary surplus of 5.4 per cent of GDP in 2025. A primary surplus means government revenue exceeded spending before interest payments. That result reflects the fiscal discipline associated with the recovery. Fitch cited stronger fiscal and external balances, reforms, and rebuilt reserves when upgrading Sri Lanka to B-minus from CCC-plus.

The improvement is real but incomplete. The World Bank expects growth to slow to 4.4 per cent this year and 4.2 per cent in 2027. Poverty was still estimated at 16.9 per cent in 2025, above pre-crisis levels, while debt and debt-service burdens remain high.

Subsidies reduce the immediate price burden on households, especially when energy costs surge. But they also require the government to spend more or collect less revenue. If subsidies are broad, expensive, or prolonged, they can weaken the fiscal balance. That would threaten the discipline that helped Sri Lanka rebuild reserves, produce a primary surplus, and improve its credit rating.

The government has already introduced fuel and electricity subsidies, cash assistance, and support for farmers and fishermen. These measures come as Colombo inflation reached 8.3 per cent in October. The key mechanism is simple: every rupee spent on subsidies may reduce money available for debt repayment, public investment, or reserves. Financing the gap through borrowing increases public debt.

The danger is especially serious because debt-service burdens remain high. Fitch upgraded Sri Lanka but still warned about debt risks. Former central bank Deputy Governor W.A. Wijewardena estimated new borrowing could cost 11 to 12 per cent. At those rates, subsidies without firm limits could push the country toward its old debt trap.

In 2022, Sri Lanka ran out of the foreign exchange needed to pay for vital imports. The country struggled to bring in fuel, food, and medicines, while also defaulting on its foreign debt. These were not only financial problems. They quickly became daily hardships, with people facing shortages and a breakdown in confidence in the government’s economic management.

The crisis created the conditions for mass street protests. Demonstrators blamed the leadership for the collapse and demanded political change. The protests became so large that people stormed President Gotabaya Rajapaksa’s official residence. He fled the country and resigned, bringing an abrupt end to a presidency dominated by his powerful family.

The political upheaval showed how economic failure can destabilise a government. Sri Lanka has since rebuilt reserves and recorded 12 consecutive quarters of growth, but the recovery remains incomplete. Poverty stayed above pre-crisis levels, and the next budget must prevent a return to shortages while protecting households from new energy-price pressures.

Public investment can help restart an economy after a crisis, but it cannot carry growth forever when debt and interest burdens are already high. Debt-driven expansion leaves the government responsible for repayment and can limit spending on essential services. Sri Lanka therefore needs growth that creates income, jobs, exports, and foreign exchange without continually expanding public debt.

The World Bank’s Jakob Engel called for a shift toward private-sector investment, exports, and productivity. Private companies can add investment beyond the public budget. Export growth can bring in foreign exchange, which Sri Lanka needs to pay for imports and service external debt. Higher productivity lets workers and businesses produce more value from existing resources, improving competitiveness and incomes.

The need is urgent because the World Bank calls the recovery incomplete and uneven. It expects growth of 4.2 per cent in 2027, while poverty remains above pre-crisis levels. A more private and productive model could make growth more durable after the IMF programme ends, but the budget must create space for it without weakening fiscal discipline.

A fiscal deficit occurs when a government spends more than it receives in revenue and grants during a period. Public debt is the accumulated amount the government owes after borrowing to cover past deficits and other needs. Debt-service costs are the interest and principal payments required to keep that debt current. These costs compete with spending on investment, services, and household support.

Sri Lanka’s 2027 targets illustrate the balance. The government aims for revenue and grants of 15.5 per cent of GDP, a 2.6 per cent primary surplus, and an overall deficit of 4.5 per cent. The primary balance excludes interest payments, so a primary surplus does not mean the country has no deficit. Interest can still keep the overall budget negative.

A debt trap develops when new borrowing is needed mainly to pay old debt and interest. High rates make each refinancing more expensive, increasing future deficits and borrowing needs. Sri Lanka has already warned that 11 to 12 per cent borrowing costs would be unaffordable. That is why fiscal discipline and cheaper growth matter after the IMF programme.