Strong revenue key as SL stays committed to debt reduction: Fitch

Sri Lanka’s latest budget reaffirms the government’s commitment to reducing debt as a share of GDP over the medium term, according to Fitch Ratings, which noted that strong revenue performance will remain vital for meeting fiscal goals.

The 2026 Budget, presented on November 7, sets a deficit target of 5.1% of GDP, slightly higher than the 4.5% expected in 2025. However, this is still a marked improvement from earlier projections. The 2025 deficit was originally forecast at 6.7% of GDP in last year’s budget, but the International Monetary Fund (IMF) later revised it down to 5.4% in March.

The government expects the primary balance—the fiscal balance before interest payments—to stay in surplus at 2.5% of GDP in 2026, compared to 3.8% in 2025, remaining above the 2.3% target under Sri Lanka’s IMF programme. Under its medium-term fiscal framework, the government aims to reduce the overall deficit to 3.8% of GDP by 2030.

Fitch noted that continuing to meet fiscal benchmarks under the IMF programme would strengthen Sri Lanka’s policy credibility and help maintain macroeconomic stability. The agency observed that while the 2026 deficit projection (5.1%) is slightly higher than its earlier expectation of 4.6%, the country’s stronger-than-expected fiscal performance in 2025 could help offset the impact.

According to the budget, revenue-to-GDP is expected to fall modestly to 15.4% in 2026 from 15.9% in 2025, though still slightly above Fitch’s projection of 15.3%. Fitch cautioned that any failure to maintain tax revenue growth in line with GDP could add pressure to Sri Lanka’s credit profile over time.

The government expects taxes from external trade to decline by 1.2% in 2026 following a one-time surge in vehicle imports this year. Meanwhile, goods and services tax revenue is forecast to grow by 3.5%, and income tax collections by 8%. Fitch described the goods and services tax projection as “conservative,” noting that nominal GDP is expected to rise by more than 7%, supported by new VAT registration thresholds and improved tax auditing processes.

Fitch also pointed out that the government’s strong fiscal results in 2025 were partly due to underspending, with public investment amounting to 3.2% of GDP—well below the 4% target. The agency warned that such shortfalls could weaken long-term growth potential, making future fiscal consolidation more difficult.

However, the latest budget includes several measures aimed at stimulating investment and economic growth. These include the expansion of Colombo’s international airport, a LKR 342 billion allocation (around 1% of estimated 2026 GDP) for road development, tax incentives for digital infrastructure, and new legislation to encourage public-private partnerships (PPPs) in infrastructure projects.

Despite these efforts, Fitch emphasized that Sri Lanka’s high public debt remains a significant challenge. The agency projects gross government debt to decline from 100.5% of GDP in 2024 to around 96% in 2027, still far above the 74% median for countries in the same ‘CCC’ rating category.

Fitch also warned that risks to the debt outlook could rise after 2027, when the IMF programme concludes and debt repayment obligations are set to increase, underscoring the need for sustained fiscal discipline and effective revenue management.