Sri Lanka targets lower debt ratio with new budget: Fitch

Sri Lanka’s latest budget signals a continued commitment to fiscal consolidation, with authorities aiming to reduce government debt relative to the gross domestic product (GDP) after outperforming targets set for 2025, according to Fitch Ratings. Strong and sustained revenue performance remains central to achieving these goals.

The recently presented budget projected a fiscal deficit of 5.1 per cent of GDP in 2026—higher than the 4.5 per cent expected in 2025 but well below the originally budgeted 6.7 per cent for 2025. The IMF later revised the 2025 deficit projection to 5.4 per cent. The primary surplus is estimated at 2.5 per cent of GDP in 2026, down from 3.8 per cent expected in 2025 but still above the 2.3 per cent target under Sri Lanka’s IMF programme. The government aims to narrow the deficit to 3.8 per cent of GDP by 2030.

Fitch noted that while the 2026 deficit estimate is wider than its own forecast of 4.6 per cent, the effect on debt dynamics could be mitigated by the stronger-than-expected 2025 performance, when the agency anticipated a 5.4 per cent deficit and a 2.4 per cent primary surplus. Staying aligned with IMF fiscal benchmarks would strengthen policymaking credibility and reinforce macroeconomic stability.

Sri Lanka’s new budget reinforces its focus on fiscal consolidation, targeting a 5.1 per cent deficit in 2026 and maintaining a primary surplus above IMF requirement.
Fitch said stronger-than-expected 2025 results may offset a wider 2026 gap.
Revenue/GDP is set to ease slightly.
Growth-supportive measures continue, but high debt and post-2027 obligations remain key concerns.

Government revenue/GDP is expected to ease to 15.4 per cent in 2026 from 15.9 per cent in 2025, still slightly above Fitch’s 2026 projection. A failure to keep tax revenue growth broadly in line with GDP growth could add pressure to Sri Lanka’s credit profile.

The budget assumes a 1.2 per cent fall in trade taxes after this year’s surge in vehicle imports, while goods and services taxes are projected to rise 3.5 per cent and income taxes 8 per cent. Fitch described the goods and services tax estimate as conservative, given expected nominal GDP growth of over 7 per cent and new tax-enhancing measures such as a lower VAT registration threshold and strengthened auditing.

Unexpectedly strong import growth could further boost revenue but also strain external balances. The 2025 fiscal overperformance was partly driven by underspending, with public investment reaching only 3.2 per cent of GDP compared with the planned 4 per cent. Persistent shortfalls in capital spending could hinder long-term growth and complicate fiscal consolidation.

Even so, the budget outlines several growth-supportive initiatives, including the revival of Colombo airport’s expansion, a LKR 342 billion (~$1.13 billion) allocation for road development, tax incentives for digital infrastructure, and planned legislation to expand public-private partnerships in infrastructure.

Fitch expects gross general government debt/GDP to decline from 100.5 per cent in 2024 to around 96 per cent in 2027—still well above the median 74 per cent for ‘CCC’ rated sovereigns. The end of the IMF programme in 2027 and higher debt-servicing obligations from 2028 pose additional medium-term risks.

Fibre2Fashion News Desk (SG)