Reduction in Govt spending could weaken Sri Lanka’s growth potential - Fitch Ratings

Shortfalls in implementing planned investment spending could weaken Sri Lankan economy’s growth potential, making longer-term fiscal consolidation more challenging, Fitch Ratings said.

Meanwhile, Fitch noted that the government’s 2026 budget proposals indicate that the authorities remain committed to reducing government debt/GDP over the medium term after beating the targets in the 2025 budget.

Fitch Ratings is also of the view that sustained strong revenue performance will remain key to meeting the government’s fiscal goals.

The budget, unveiled on 7 November, targets a deficit of 5.1% of GDP in 2026, wider than the 4.5% that the government expects in 2025. The original deficit target for 2025 in last year’s budget was 6.7% of GDP, but in March the International Monetary Fund (IMF) projected a lower figure of 5.4%.

The latest budget forecasts the primary balance before interest payments will remain in surplus at 2.5% of GDP in 2026, down from an expected 3.8% in 2025, but still above the 2.3% target under Sri Lanka’s IMF programme. The government aims to reduce the fiscal deficit to 3.8% of GDP by 2030 under its medium-term fiscal framework.

Fitch Ratings noted that continuing to meet the key fiscal markers laid out in the IMF programme would help the authorities to improve Sri Lanka’s policy-making record adding macroeconomic stability would also benefit.

The official budget deficit projection for 2026 is wider than the 4.6% of GDP that Fitch anticipated when it affirmed Sri Lanka’s rating at ‘CCC+’ in October 2025. However, the effect on Sri Lanka’s debt trajectory could be more than offset by the over-performance in 2025, where Fitch Ratings had expected a budget deficit of 5.4% and a primary surplus of 2.4%.

Fitch Ratings stressed that the outperformance in 2025 was partly driven by underspending, with the public investment/GDP ratio significantly below target, at 3.2% against the original goal of 4%.

It added “shortfalls in implementing planned investment spending could weaken the economy’s growth potential, making longer-term fiscal consolidation more challenging.”

However, Fitch stated that the latest budget highlights several measures that have the potential to lift investment and benefit growth including the resumption of an expansion of Bandaranaike International Airport (BIA), a Rs. 342 billion (1% of 2026 Fitch-estimated GDP) allocation towards road development, tax incentives for the construction of digital infrastructure and planned legislation to increase the use of public-private partnerships in infrastructure projects.