Budget 2026: Comfort without compass
View(s):On the revenue side, Sri Lanka adopted an East Asian–style taxation system, which produced relatively low tax yields for the government. On the expenditure side, however, it embraced Western-style high spending.
This mismatch has proven disastrous. A nation that generates limited tax revenue must necessarily maintain restrained spending habits. Conversely, a government that sustains high levels of expenditure must ensure a correspondingly robust revenue base.
President Anura Kumara Dissanayake presenting Budget 2026 last week.
Sri Lanka’s failure to align these two sides of its fiscal equation has been a central driver of its economic instability.
Comfortable footing
Sri Lanka has, however, pursued a Western-style spending pattern while relying on an East Asian-style taxation system. This imbalance fuelled a mounting debt burden and ultimately drove the nation into a severe economic crisis.
Over the past three years, with support from the IMF’s Extended Fund Facility (EFF), Sri Lanka has embarked on a course correction aimed at fiscal consolidation—bringing taxation and expenditure into alignment.
This context is crucial in understanding the significance of Budget 2026, presented in Parliament last week. The country has made notable strides in consolidating its finances, though not without imposing considerable hardship on its people.
Rarely in its history has Sri Lanka enjoyed such a degree of financial stability when preparing an annual budget. This year, it had that privilege. The pressing question now is how best to use this stable footing: should the nation simply pause to celebrate, or should it seize the opportunity to lay a stronger foundation for the future?
Increased revenue
Before proceeding, let me clarify what I mean by “comfortable footing.” I am referring specifically to the government’s financial position, not that of the people—a distinction I must emphasise and address later.
To appreciate this position, we must examine tax revenue and expenditure. The simplest way is to compare the actual budgetary outcome for the current year with the original estimates presented earlier this year in Budget Speech 2025.
In essence, this reflects the anticipated results of Sri Lanka’s fiscal consolidation efforts over the past three years, guided in part by the IMF programme. Yet this is not the full picture. To truly understand the sources of this financial progress, we must look deeper into the underlying dynamics.
VAT and import duties
Sri Lanka’s usual experience has been that actual fiscal outcomes fall short of original estimates. This time—perhaps for the first time—the actual budgetary outcome has exceeded expectations.
In 2025, tax revenue was Rs. 135 billion higher than the original estimate of Rs. 4,950 billion. This increase was driven by both direct and indirect tax collections. Improved tax administration, stronger compliance, and a broader tax base appear to have played a decisive role—key elements of the IMF stabilisation programme.
Moreover, indirect tax revenue benefited from faster growth in VAT and import duties. The surge in demand for motor vehicles, following a five-year import ban, proved particularly striking, as many observers have noted.
Reduced spending
Government expenditure in 2025 recorded a remarkable decline of Rs. 642 billion compared to its original estimate. The largest contributions to this reduction came from two areas: interest payments and public investment.
Interest payments, initially projected at Rs. 2,950 billion, fell to Rs. 2,650 billion—a decline of Rs. 300 billion. This reflects, on one hand, the government’s reduced borrowing needs under the IMF stabilisation programme. On the other hand, the Central Bank Act of 2023 abolished the long-standing practice of direct lending to the government, which had previously been a major source of financing expenditure. Meanwhile, foreign borrowing remained constrained due to the debt default and ongoing economic crisis.
Public investment, estimated at Rs. 1,315 billion, was curtailed to Rs. 1,033 billion—a reduction of Rs. 282 billion. Whether this outcome should be celebrated or criticised is debatable. While lower capital spending eased fiscal pressures, widespread concerns persist about delays in fund disbursement and project implementation, which appear to have contributed to the underutilisation of allocated funds.
Spending lavishly
The outcome has been that the government was able to prepare Budget 2026 from a position of relative comfort, allowing for more generous spending without an immediate focus on tax revenue. As a result, the budget introduced a mix of spending proposals, with notable increases in recurrent expenditure—particularly salaries, wages, subsidies, and transfers. There was also greater scope for enhanced allocations toward public investment.
While the budget broadly aligns with the IMF’s fiscal consolidation programme, it is less clear whether its long-term vision, mission, and commitments are fully consistent with that framework.
The government’s approach to state-owned enterprises (SOEs) remains inconsistent. On one hand, budgetary allocations continue to cover accumulated losses and bank debts, effectively placing the burden on taxpayers. On the other hand, the government has signaled intentions to restructure or liquidate certain SOEs. Yet, the prevailing tendency appears to favour reinforcing state ownership, under the assumption that performance will improve with new leadership.
Another troubling precedent is the use of taxpayer funds to subsidise private sector wages. I am not yet convinced about what would be the justification for not extending it in the future from the plantation to other sectors. Since the time that private businesses became a government business, including nationalisation, they have become an entrenched political problem—one that taxpayers have been forced to shoulder. Decades later, the burden remains, and we continue to carry it.
Precedents established during periods of fiscal comfort are often difficult to reverse during times of strain. This reflects a long-standing pattern of public fund mismanagement in Sri Lanka—a habit that has persisted for decades.
Wishful thinking
It is commendable that the Budget 2026 anticipates accelerating the rate of growth to 7 per cent in the medium term – apparently, nullifying all growth forecasts by the World Bank, IMF and ADB. The IMF in its EFF programme did say that Sri Lanka needs to “unlock its growth potential” but did not specify how to do it, leaving it in the hands of policy makers.
We have long argued that Sri Lanka must transition from short-term stabilisation to medium-term transformative growth. Stabilisation itself depends on sustained economic expansion; without growth, it cannot endure. Moreover, growth has the power to lift 6–8 million people out of poverty by generating incomes and creating jobs.
Equally important, growth can ease the heavy tax burden currently borne by citizens. And only through robust, sustained growth can Sri Lanka aspire to reach high-income status within the next 20–25 years.
The challenge, however, is that higher growth momentum cannot be achieved through budgetary support for selected sectors alone. It requires deep structural reforms— reforms that foster a more conducive business environment and greater integration into global markets. The Budget Speech, however, makes little reference to the broader reforms that are required to achieve higher growth.
Missed the mark
Not everything appears promising. One critical area where Sri Lanka has fallen short—yet is fundamental to sustaining higher economic growth—is export expansion.
A higher growth trajectory cannot be achieved without robust export performance, and export growth itself depends on stronger inflows of foreign direct investment (FDI). At present, the country continues to rely on tourism earnings and worker remittances to ease foreign exchange shortages. What is needed, however, is the creation of a more conducive business environment that can drive export competitiveness and attract long-term investment.
Among the IMF macroeconomic targets Sri Lanka has missed, the official foreign reserve position stands out as the most significant. Reserves remain at around US$6 billion, below the expected $7 billion for this year and the $9 billion projected for next year. By the end of the decade, reserves should ideally surpass $15 billion, yet progress toward this goal has been disappointingly slow. It is an important proxy to understand the speed of export growth, which the country has to work on.
(The writer is Emeritus Professor at the University of Colombo and Executive Director of the Centre for Poverty Analysis (CEPA) and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
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