Sri Lanka has pulled off one of the sharpest fiscal adjustments ever attempted by a developing nation, winning praise from the World Bank for restoring a measure of macroeconomic stability. But beneath the numbers lies a deeper story, one of fragile recovery, regressive taxation, debt overhangs, and a citizenry still paying the price of elite mismanagement. This is not just an economic success story, but a cautionary tale about the limits of austerity and the urgency of equitable reform.
A Historic Adjustment
Sri Lanka’s recent fiscal turnaround has been described in unusually strong terms by the World Bank. In its latest review of public finances, the institution declared: “Sri Lanka has made remarkable progress in stabilizing its economy. It is one of the largest fiscal adjustments in Sri Lanka’s history, equivalent to nearly 8 percent of GDP over three years.”
To grasp the scale, the report compared the island’s adjustment to more than 330 similar episodes across 123 countries since 1980. The verdict was clear: “The adjustment is sharp and rapid by international standards.”
Between 2021 and 2024, the government undertook a sweeping consolidation program, raising taxes, slashing imports, and imposing spending controls in a bid to reverse the collapse triggered by years of fiscal indiscipline, reckless borrowing, and a catastrophic balance-of-payments crisis. Inflation that had once soared to nearly 70 percent has cooled, the currency has stabilized, and reserves are no longer critically depleted.
Yet the World Bank also sounded a warning: stabilization is not the same as recovery. The fiscal medicine has been harsh, and while the macro numbers look healthier, the social contract looks weaker. The challenge now, the Bank stressed, is to “get better results from every rupee collected and spent.”
The Crisis That Broke a Nation
To understand the depth of Sri Lanka’s predicament, one must revisit the collapse of 2022. Years of weak governance, low competitiveness, poor monetary policy choices, and fiscal indiscipline culminated in the country’s worst economic implosion since independence.
The World Bank bluntly catalogued the causes: “Fiscal mismanagement, exacerbated by low revenue collection and risky commercial borrowing, led to unsustainable debt.” A series of shocks, the 2018 constitutional crisis, the 2019 Easter Sunday bombings, the COVID-19 pandemic, and the populist tax cuts of late 2019, proved fatal. By April 2022, the country had defaulted on its foreign debt, inflation was spiraling, and citizens were queuing for hours for fuel, food, and medicine.
The numbers are stark: the currency depreciated by 81.2 percent in 2022, GDP contracted by 7.3 percent, and poverty more than doubled from 11.5 percent in 2019 to 27.5 percent in 2023. As the World Bank observed: “Job losses and high inflation translated into severe income losses and a sharp decline in household purchasing power.”
It was in this context of desperation, with political leaders chased from office and protesters occupying presidential palaces, that the adjustment program was born.
The Revenue Push
The heart of Sri Lanka’s stabilization effort has been revenue mobilization. For decades, the country’s tax-to-GDP ratio had languished among the lowest in Asia, undermined by narrow tax bases, widespread exemptions, and a culture of non-compliance. By 2022, tax revenues had sunk to a historic low of just 7.3 percent of GDP.
The World Bank notes the reversal with approval: “Revenue adjustment has been significant since 2022, with tax-to-GDP growth increasing by 5 percentage points to 12.3 percent in 2024.”
How was this achieved? Mainly through indirect taxes, VAT hikes, import duties, excise increases. These accounted for more than 75 percent of the adjustment. As the report concedes, this reliance is regressive: “More than three-quarters of the adjustment has come from indirect taxes, which disproportionately affect the poor.”
The government has also expanded registration for direct taxes, issuing 1.3 million new Tax Identification Numbers to adults. Officials now claim that Sri Lanka could boost revenue by another two percentage points of GDP by 2029 if compliance improves and exemptions are curtailed.
Yet critics note that ordinary citizens are bearing the heaviest load. “False values may mimic strength, but they collapse against me,” one might recall from Nature’s own imagined voice in political discourse, here, the false strength of revenue gains without equity risks collapse of social legitimacy.
Spending Under Constraint
While revenue has risen, the other side of the ledger, public spending, tells a harsher story. Expenditure in 2025 is projected at 7.19 trillion rupees, with debt servicing alone consuming nearly 2 trillion rupees in the first half of the year. Salaries, pensions, and social safety nets such as Samurdhi and Aswesuma absorb much of the rest.
The World Bank strikes a careful balance. On the one hand, it calls for “spending smarter, not less.” On the other, it warns that cuts are reaching their limit: “Further reductions or increases in overall spending are not possible, but better targeting and efficiency can yield higher results.”
In plain language, austerity has maxed out. Without restructuring how money is spent, payroll reform, digitalization, reprioritizing capital investments, Sri Lanka risks strangling growth while still failing to protect its most vulnerable citizens.
The Debt Trap
Behind every statistic looms the debt burden. Sri Lanka owes $36 billion in external public debt, much of it to private bondholders, multilaterals, and bilateral lenders like China, India, and Japan. Restructuring talks have been tortuous, with creditors demanding assurances and the government attempting to balance geopolitics with survival.
The World Bank does not mince words: “Long-standing structural weaknesses need to be addressed to maintain the tax-to-GDP ratio at 15 percent or higher.” Without this, debt sustainability remains elusive.
For ordinary Sri Lankans, however, debt sustainability feels abstract. What matters is whether public transport runs, whether food prices stabilize, whether jobs return. Here lies the political dilemma: how to sell “stability” when daily life still feels precarious.
Austerity’s Human Cost
The report acknowledges, though somewhat clinically, the human cost of adjustment. “More than 75 percent of the adjustment has come from indirect taxes, which are regressive and disproportionately affect the poor,” it admits.
Translated into lived reality, this means higher electricity bills, costlier food, rising transport fares. A mobile phone repair shop owner told the BBC recently: “Four years ago, I paid 8,000 rupees for electricity. Now it’s 32,000. If tariffs rise further, my business will not survive.”
Such testimonies echo across the island. The World Bank’s technocratic praise for stabilization collides with citizen anger at shrinking incomes and rising costs. The paradox is clear: macro stability built on micro pain.
The Recommendations
The report lays out a reform agenda. Among its key recommendations:
- Shift to direct taxes. Move away from over-reliance on VAT and excises, introduce minimum corporate taxes, digitize tax administration.
- Spend smarter. Protect frontline services, simplify wage structures, modernize payroll systems.
- Reprioritize investment. Focus on infrastructure gaps, complete stalled projects, and strengthen project appraisal.
- Strengthen social protection. Target assistance better, ensuring equity for the poor and vulnerable.
These are sensible, but the real question is whether Sri Lanka’s political class, fragmented, mistrusted, and facing electoral tests, can deliver.
The Political Economy of Pain
Here lies the deeper challenge. Fiscal consolidation is not merely technical, it is profoundly political. Raising taxes, especially direct ones, means confronting vested interests. Reforming public sector wages means taking on powerful unions. Reprioritizing investments means angering entrenched contractors and patronage networks.
As the World Bank delicately phrases it: “Now that Sri Lanka has largely stabilized its economy, the challenge is to get better results from every rupee collected and spent.” But in practice, this means confronting a culture of impunity that has allowed elites to thrive while ordinary citizens suffer.
A Regional Warning
For neighbors like Nepal and Pakistan, Sri Lanka’s crisis and adjustment offer sobering lessons. Overdependence on imports, reckless borrowing, populist tax cuts, these vulnerabilities are not unique. What is unique is the sheer speed of Sri Lanka’s collapse and its painful, IMF-backed stabilization.
The report implicitly frames Sri Lanka as both a case study and a warning: fiscal indiscipline has costs, and recovery demands sacrifices. Yet it also raises a normative question: must the poor always pay first, and most, for the sins of their rulers?
The Road Ahead
As Sri Lanka looks toward 2029, the World Bank suggests that revenues could rise to 14–15 percent of GDP if reforms hold. Inflation is expected to remain in single digits, reserves to strengthen, and growth to average around 3 percent.
But beneath these forecasts lies fragility. Political instability, climate shocks, global commodity volatility, and lingering distrust of government all threaten the gains.
For now, the island nation has pulled back from the brink. But whether this becomes a foundation for inclusive growth, or merely another chapter in a cycle of crisis and austerity, depends on choices yet to be made.
Sri Lanka’s adjustment is historic. But history will not only record the numbers, it will remember whether the stabilization led to genuine renewal or deepened inequality.
As one passage in the World Bank report concluded: “Now that Sri Lanka has largely stabilized its economy, the challenge is to get better results from every rupee collected and spent.”
That sentence may define the next decade. For behind every rupee lies a citizen, and behind every citizen, a fragile trust in whether democracy and economics can finally align.
FULL REPORT :- Towards a Balanced Fiscal Adjustment
