Sri Lanka’s economy is bouncing back in 2025, powered by remittances, tourism, and a boost in private credit. But the Asian Development Bank warns that looming U.S. tariffs, persistent debt burdens, and global uncertainties could derail the fragile recovery as early as 2026.
Sri Lanka is experiencing renewed optimism in 2025 as the economy shows signs of stability after years of crisis. According to the Asian Development Outlook September 2025 report by the Asian Development Bank (ADB), the nation’s GDP is expected to expand by 3.9% this year, supported by robust remittance inflows, growing tourism numbers, and stronger domestic demand. Industrial activity and private credit growth are contributing to the recovery, while inflation remains relatively subdued. Yet, analysts caution that the country’s resilience will face serious tests in 2026, when external shocks and debt risks could trigger another slowdown.
The ADB report notes that economic activity has strengthened significantly in the first half of 2025. The economy grew 4.8% compared to the same period in 2024, while industrial production increased 5.1% year-on-year, nearly reaching pre-crisis levels. Lending conditions also improved, with private sector credit surging 19.6% by July, supported by increased vehicle imports, low interest rates, and optimism in construction and services. These developments have restored a sense of confidence among businesses and households alike.
Inflation has also played a supportive role. Headline inflation fell by 1.7% in the first eight months of 2025, largely due to lower energy and transport costs. Food inflation stabilized at 1.5%, while non-food prices decreased by 3.2%. Energy tariff adjustments in June pushed prices upward, yet inflation is forecast to average just 0.5% for the year before rising to 4.5% in 2026. In response, the Central Bank cut its key policy rate by 25 basis points in May to 7.75%, where it has since held steady, citing manageable inflation risks and the importance of sustaining growth momentum.
The external sector has also shown renewed strength. The current account surplus expanded by more than 30% in the first half of 2025, as remittances rose sharply by 19.3% and tourism earnings climbed 8.4%, surpassing pre-pandemic levels. However, imports grew even faster at 12.4%, led by vehicle purchases, compared with a 5.7% increase in exports. Gross official reserves stood at $6.2 billion by August, covering 3.7 months of imports, although the rupee weakened by 3.3% against the U.S. dollar since the start of the year.
Still, the country’s heavy debt burden continues to cast a long shadow. Public debt is expected to remain around 109% of GDP through 2025 and 2026. While the government has made progress under the International Monetary Fund’s Extended Fund Facility, with $1.74 billion already disbursed, the path forward requires strict fiscal discipline. Debt restructuring agreements have been reached with major creditors, including France, India, Japan, Saudi Arabia, and the United Kingdom. Completion of this restructuring is targeted by the end of 2025, but sustaining stability will depend on rigorous reforms and careful management of public finances.
The outlook for 2026 is far less certain. Economic growth is forecast to slow to 3.3% as the United States moves to impose 20% tariffs on Sri Lankan exports such as garments and rubber. Together, these sectors accounted for nearly a quarter of export earnings in 2024. Such tariffs would weaken export competitiveness, potentially causing job losses in key industries and reducing household consumption.
In addition to trade pressures, Sri Lanka faces external risks from global volatility. Instability in the Middle East could disrupt vital remittance inflows, while fluctuations in global energy prices and climate-related shocks could further destabilize the agricultural sector. These risks, combined with the existing debt overhang, may expose the economy to renewed stress just as it regains momentum.
Sri Lanka’s fragile growth path is also tied to the government’s ability to balance competing priorities. On one hand, officials must continue encouraging remittances, tourism, and domestic investment. On the other, they must ensure fiscal responsibility under the IMF program while navigating global challenges beyond their control. Success in completing debt restructuring and maintaining credibility with international lenders will be crucial in determining whether the island can avoid another downturn.
The ADB stresses that while Sri Lanka’s economic recovery in 2025 is encouraging, it is not yet secure. The nation’s experience highlights how vulnerable small, debt-ridden economies are to external shocks. Policymakers face a narrow window to strengthen resilience, diversify exports, and reinforce financial stability before the next wave of risks arrives.
As 2025 draws to a close, the message is clear: Sri Lanka’s recovery is real but fragile. The country stands at a crossroads, and decisions taken now will determine whether the gains of this year can be sustained or whether 2026 will mark yet another painful setback.
