ECONOMYNEXT – As Sri Lanka prepares to unveil its 2026 budget on Friday this week, President Anura Kumara Dissanayake faces perhaps the most defining moment of his one-year old administration.
The budget will be more than a fiscal plan.
It will be a test of political credibility for a government that came to power promising a clean break from the corruption, inefficiency, and economic mismanagement that plunged the country into its worst financial crisis in 2022.
In Sri Lanka, budgets are not viewed as a means of democratic control, where the state is restrained from imposing arbitrary spending and tax shocks on the public, but as an instrument that will deliver hidden taxes; tax changes that discourages long term investments, in particular that long gestation and recovery periods are key victims.
Good budgets that do not de-stabilize the business and economic environment and provide stability and continuity will be criticized by the opposition for lacking originality or imagination.
In 2026 monetary authorities ahve promised a return of high 5 percent, inflation, signalling that the temporary relief people have had the central bank missing its inflation target may end and public discontent over cost of living, may re-emerge, and the pressure on families in marginal income brackets may start again.
The Central Bank, under the 2023 Monetary Law Act, is now independent, suggesting that it is free of democratic control through excessively ‘flexibility’ and ‘discretion’.
The 5 percent or higher inflation could also de-stabilize budgets themselves, making it difficult to meet deficit targets.
Another challenge the democratic governments in Sri Lanka and elsewhere faced after the IMF’s Second Amendment to its articles in 1978, is preserving the external value of the currency of the note-issuing bank.
In the 1980s, as the currency depreciated, Sri Lanka’s budgets deteriorated and supplementary estimates replaced the democratic control of state spending.
Meanwhile pressure to deliver relief to families who themselves have been hit by inflation intensified and capital projects went over budget.
The 2026 budget must strike a delicate balance in maintaining fiscal discipline to satisfy the International Monetary Fund (IMF), while delivering programs and also reliefs to people who have been hit by past inflation.
AKD’s Promises
Since taking office in late 2024, President Dissanayake has built his economic message around discipline, transparency, and equity.
He pledged to create an “efficient people’s economy” that prioritizes production, fair taxation, and an end to wasteful state expenditure.
In multiple speeches, he emphasized that Sri Lanka’s crisis was “not merely financial but moral” which is seen as a direct attack on decades of corrupt patronage networks.
His government’s early months have been marked by a push to clean up state-owned enterprises (SOEs), strengthen the Commission to Investigate Allegations of Bribery or Corruption (CIABOC), and restructure institutions like the Ceylon Electricity Board (CEB) and SriLankan Airlines.
Economically, Dissanayake promised to turn fiscal reform into social justice, such as protecting the poor through targeted subsidies and efficient welfare schemes such as Aswesuma.
He also vowed to rebuild domestic production capacity, encourage youth entrepreneurship, and reduce dependence on imports, particularly in agriculture and manufacturing. Yet, these promises now face the sobering reality of tight fiscal space and IMF conditionalities.
Challenges
Sri Lanka’s tax hikes are delivering more revenue to the state, and the pressure to increase spending rather than use the fiscal gains to reduce debt overhang – especially to face future shocks including international ones – is the key challenge.
There are calls to increase capital spending, not to fill infrastructure gaps, but to to boost growth and the construction sector, despite the experience of the past with ill-conceived projects.
There is however a public investment committee to be set up under the Fiscal Management Law, which is expected to vet projects on their merits, notwithstanding the pressure to increase capital spending for the sake of spending from anti-austerity activists.
Parkinson’s Law
In Sri Lanka as in any country, the tendency is for spending to keep pace with revenue.
Over the past two decades, with stimulus becoming a buzzword in the West, pressure to run deficits has intensified with the beliefs by anti-austerity macro-economists that state spending increases welfare, though this country’s past experience shows otherwise.
Already state recruitment to the public sector is being ramped up, using up taxes paid by people under the International Monetary Fund’s ‘revenue based fiscal consolidation’ plan.
RELATE : Sri Lanka to hire 60,000 state workers as people pay more taxes after default
In 1955, the Economist newspaper in London published an essay written by one Northcote C Parkinson.
One of the key ideas in the article was that ‘work expands to fill the time available’ especially in terms of government bureaucracy.
Another idea now known as the Parkinson’s Second Law, described in detail by the same author is that ‘expenditure rises to meet income’.
“This is a matter of everyday expense,” Parkinson explained. “On the day we receive an increase in salary, the more inexperienced among us will plan how the money is to be spent… Those with more experience in life will save themselves the trouble.
“There is no surplus. There never has been. There never will be. Additional earnings cannot be allocated because they are quietly absorbed. We are no wealthier at the end of the month. We may actually be poorer. That surplus may exist in theory; it never exists in fact.
“When we turn from private income to public revenue we find that the basic principle applies; but here there is a difference. For, while the amount of the individual’s income is limited and is known, the amount of the Government’s income is elastic and vague.”
The government can borrow, and the government can also tax. In an external sovereign default, taxes are tolerated and the ability to borrow, especially from abroad reduces.
In the West, downgrades are coming, showing that the macro-economic doctrine that stimulus and monetary loosening can bring sustainable growth is false now as it was in the 1960s and 1970s.
Credit Rating
Despite progress in restructuring external obligations and a modest credit rating upgrade by S&P Global Ratings to CCC+, Sri Lanka’s debt-to-GDP ratio remains near 100 percent, while interest payments still consume nearly half of total government revenues.
The government’s primary surplus target, a key IMF benchmark, has been exceeded amid low inflation.
The only restraint is a 13 percent ceiling on primary expenses in a fiscal management law.
Any deviation from the fiscal path risks derailing the next IMF review and future funding disbursements.
There is pressure from macro-economists and others to show ‘growth’ very quickly.
That is another danger.
Instant growth, expected through targeting potential output of increase in state spending including capital, has tended to de-stabilize the nation in the past.
Additional growth will come from restoring freedoms to the people to engage in economic activities.
To grade freely without import controls and high taxes, to use their land as they fit, without the government blocking them with various rules.
Sri Lanka’s locational advantage is also under-utilized by restrictions on shipping, warehousing, freight forwarding, import tariffs themselves and also discriminatory electricity pricing on services which is discouraging data warehousing among other global services.
Sri Lanka’s future direction will depend on how vested interests are tackled in restoring lost economic freedoms of the people.
Political Realities
After two years of tax hikes, price adjustments, and austerity, households are still struggling. Not all sectors have got wage hikes.
Unlike taxes, which can be targeted somewhat, monetary debasement (inflation and depreciation) strikes everyone through higher food and energy prices.
In 2026, wage earners in marginal income brackets including plantation workers, are threatened with a five percent inflation target.
Trade unions, university students, and professionals have begun voicing frustration, warning that “recovery on paper” has not translated into improved livelihoods.
Sri Lanka may not face major elections until 2029. This means, the government has the space to take tough decisions to maintain fiscal prudence. There has been pressure mounting from opposition parties to hold the Provincial Council elections next year.
But the new government is still in the process of proving its credibility.
So, it is unlikely that the government tempting for political giveaways as such populism risks reversing hard-won macroeconomic gains.
Meanwhile, external uncertainties loom large. Slower global growth, fluctuating oil prices, and trade shifts following U.S. tariff realignments under Donald Trump’s policy revival could affect export competitiveness and foreign earnings.
Balancing IMF
Sri Lanka’s 2026 budget will also serve as the fifth IMF review checkpoint under the 3 billion dollar Extended Fund Facility (EFF).
The government has largely complied with IMF targets so far including raising revenues, reforming SOEs, and building reserves, but it now faces a tougher test: demonstrating social legitimacy for reform.
The IMF’s focus remains on broadening the tax base, is under pressure to implement an unpopular wealth tax on housing, and reducing quasi-fiscal losses from state utilities.
In the case of the Ceylon Electricity Board attempts to have cost reflective tariffs has hit some roadblocks by the electricity regulator shooting down price hikes.
To maintain the EFF, the government will likely reaffirm its commitment to fiscal transparency, data-driven budgeting, and digital tax administration.
Finance ministry insiders suggest Colombo could negotiate “reform pacing”, a strategy to meet fiscal targets over a longer horizon while cushioning the poor. Such negotiations will require deft diplomacy, balancing the Fund’s expectations with domestic realities.
People’s Expectations: Relief, Jobs, and Honesty
Public expectations for the 2026 budget are clear: relief and opportunity. After years of economic contraction and tax shocks, people want to feel the recovery in their daily lives.
Civil servants expect cost-of-living adjustments, while small businesses hope for access to affordable credit. Farmers demand continued fertilizer subsidies and better market access, while professionals are pushing for tax rationalization and improved infrastructure.
For many, however, the key expectation is credibility.
Voters want to see a government that keeps its promises and spends wisely.
The perception that revenue gains are being absorbed by inefficient SOEs or bloated administrative expenses could trigger backlash.
In Colombo’s urban neighborhoods, optimism is cautious. People do not expect major changes, but some sense of credible and rational budget.
Meanwhile, the younger generation, which is hit hardest by job insecurity and emigration pressures, wants investment in technology, skills, and innovation, not just traditional agriculture or public-sector hiring.
The Dissanayake administration, which rose to power on the promise of people-centric governance, must now deliver on the ground or risk alienating its core base of frustrated youth and working-class voters.
Fragile Gains and Hidden Risks
Despite improved macroeconomic indicators, Sri Lanka’s recovery remains fragile and uneven. Several downside risks could undermine the 2026 outlook.
Debt service pressures in one of them. With interest payments still absorbing over 50% of revenue, any shortfall in tax collection or external financing could reignite liquidity stress.
The 2025 tax revenues have got a lift from vehicle taxes. Vehicle taxes have traditionally been a key revenue earner, while it has also driven the finance and insurance sectors and also revenue through petrol taxes.
This year electric vehicles are making gains, which the CEB faces challenges in cost-reflective prices with the regulator.
But if there are no monetary shocks, the economy will grow and steady revenues will come from value added and other taxes as long as spending can be kept in check.
Delayed restructuring finalization could also become a risk in 2026. Unresolved negotiations over SriLankan Airlines’ bonds and potential creditor holdouts could dampen investor confidence.
Global headwinds could risk the country’s economy at any time and Sri Lanka has no control over them. A slowdown in U.S. or European demand could hit Sri Lanka’s garment exports and rising oil prices could inflate the import bill and weaken the current account.
Reform fatigue is another risk Dissanayake’s government is facing.
Additionally, climate vulnerability remains an under-addressed threat. Droughts and floods continue to damage agriculture and infrastructure, highlighting the urgent need for climate adaptation investment, something not yet fully integrated into budget planning.
There are several Asian Development Bank backed programs addressing the challenges.
President Anura Kumara Dissanayake’s political credibility depends on whether his government can show that economic discipline and social justice can coexist.
A budget that merely pleases the IMF but leaves the people behind risks fuelling cynicism.
But a populist budget that breaks fiscal rules could jeopardize the hard-won stability that took years to rebuild.
In many ways, this budget is about trust, from creditors, from international partners, and most importantly, from Sri Lankans who have sacrificed much for recovery.
If the 2026 budget can blend fiscal prudence with compassion, and reform with results, it could mark the beginning of a truly new chapter for Sri Lanka’s economy, one not just defined by survival, but by renewal. (Colombo/November 06/2025)
Continue Reading
