Fitch Ratings has expressed optimism about Sri Lanka’s latest budget, highlighting the government’s commitment to increasing fiscal revenues as a share of GDP.
If successful, this approach could address a long-standing weakness in the country’s credit profile.
The budget, unveiled on 17th of February is the first under President Anura Kumara Dissanayake’s administration and provides greater clarity on the government’s medium-term fiscal and economic reform plans.
Fitch noted that most of the budget measures align with assumptions made in its December 2024 assessment when Sri Lanka’s credit rating was upgraded to ‘CCC+’ from ‘RD’ (Restricted Default).
The government aims to raise revenue-to-GDP to 15.1% in 2025, surpassing Fitch’s earlier expectations of reaching this level by 2026.
Key revenue measures include a 36.5% increase from taxes on external trade and a 13.1% increase from income taxes.
However, achieving these targets depends on the smooth liberalization of import restrictions, particularly on vehicles. A slowdown in this process could pose risks to external stability and foreign exchange reserves.
Despite revenue growth, Sri Lanka’s fiscal outlook remains challenging.
The budget projects a deficit reduction to 6.7% of GDP in 2025, driven by higher public spending, including a 61% increase in capital expenditure, a 12% rise in salaries and wages, and an 11% increase in subsidies. If capital expenditure implementation faces delays, the deficit could be smaller than expected, but Fitch warns that keeping public investment at 2024’s low levels (2.7% of GDP) could hinder long-term growth.
The budget’s fiscal consolidation pace is slower than outlined in Sri Lanka’s four-year, $3 billion Extended Fund Facility (EFF) agreement with the IMF. While the government expects to meet its primary surplus target of 2.3% of GDP in 2025, interest payments (8.9% of GDP) are significantly higher than IMF projections. Fitch assumes this divergence will not prompt the IMF to suspend EFF disbursements but warns that slow fiscal consolidation and limited debt reduction could weaken Sri Lanka’s credit profile and its ability to respond to future economic shocks.
