After nearly four decades of deficits, Sri Lanka posts a rare budget current account surplus, driven by surging tax revenues and tighter spending, but looming currency risks threaten to undo the gains.
Sri Lanka has recorded a surplus in the current account of its budget after 38 years in 2025, according to central bank data, as strong tax revenue growth combined with controlled government spending reshaped the country’s fiscal outlook.
The central bank maintained a firm stance on limiting expenditure by keeping inflation relatively low, although the inflation target was missed and the currency showed some depreciation toward the latter part of the year.
Tax revenues surged by 36 percent to 5,049 billion rupees in 2025, supported in part by the resumption of taxes on vehicle imports. These imports had previously been restricted due to foreign exchange shortages that emerged following inflationary rate cuts in 2020.
The blocking of highly taxed imports, particularly vehicles, has often reduced government revenue and weakened fiscal performance, especially when foreign exchange shortages are triggered by loose monetary policy decisions.
In 2025, current government spending declined by 2 percent to 5,232 billion rupees, reflecting tighter fiscal discipline.
As a result of rising revenues and reduced current expenditure, Sri Lanka reported a current account surplus in the budget of 217 billion rupees, marking the first such surplus since 1987.
Sri Lanka last achieved a current account surplus in 1987, making this development a significant milestone in the country’s economic recovery narrative.
Monetary depreciation and uncontrollable spending
In 2025, Sri Lanka’s interest costs were reported at 2,500 billion rupees, down from 2,690 billion in 2024 and below the budgeted 2,950 billion rupees, which helped reduce overall current expenditure.
Analysts note that a stronger monetary framework tends to lower interest rates, a pattern historically observed in systems such as gold and silver standards.
Sri Lanka’s nominal interest rates and inflation began rising sharply in the early 1980s following changes to global monetary rules, including the IMF’s Second Amendment, which allowed greater currency flexibility and depreciation.
This shift contributed to persistent inflation and made fiscal management increasingly difficult.
During that period, Sri Lanka’s Treasury was influenced by macroeconomic policies that prioritized inflationary approaches, often overlooking recommendations from global economic experts such as Singapore’s Goh Keng Swee, who had been invited to advise on monetary stability and reforms.
Before the era of currency depreciation and high inflation, many countries were able to maintain current account surpluses and even overall budget surpluses by simply controlling expenditure, a principle often referred to as the Golden Rule of Budgeting.
However, inflation has since driven up current spending, including wages and interest costs, making it harder for governments to maintain balanced budgets.
Most countries lost the ability to consistently achieve budget surpluses after the collapse of the gold standard.
The United States, for instance, briefly achieved budget surpluses in the late 1990s during a period of low inflation, but later returned to deficits following policy shifts that contributed to economic imbalances such as the housing bubble.
Some taxes finance capital spending for the first time in nearly 4 decades
In 2025, Sri Lanka’s capital expenditure rose to 998 billion rupees, up from 790 billion rupees in 2024, indicating a renewed focus on development spending.
The overall budget deficit declined sharply to 744.9 billion rupees in 2025, compared to 2,039 billion rupees the previous year, reflecting improved fiscal management.
With a current account surplus of 217 billion rupees, part of the capital expenditure was financed through tax revenue for the first time since 1987, marking a structural shift in budget financing.
In previous years, government spending often focused on short-term stimulus measures aimed at boosting growth, sometimes without sufficient evaluation of long-term returns or project priorities.
The current administration has indicated a shift toward prioritizing projects that generate sustainable economic benefits beyond immediate gains.
Debt to GDP down to 91-pct
In 2025, central government domestic debt rose to 18,675 billion rupees from 11,319 billion rupees, while foreign debt increased to 11,319 billion rupees from 10,429 billion rupees.
Despite this, the debt to GDP ratio declined to 91.6 percent from 96.1 percent, signaling relative improvement in debt sustainability, although additional liabilities remain within state-owned enterprises.
However, analysts warn that aggressive monetary depreciation in 2026 could reverse these gains.
The Sri Lankan rupee has already weakened to around 315 against the US dollar by March, raising concerns about external stability.
Currency depreciation increases the burden of foreign debt while reducing purchasing power, limiting consumption and constraining economic growth and tax revenue potential.
Critics argue that although exchange rates are often described as market-driven, monetary policy decisions play a dominant role in determining currency value, particularly in flexible exchange rate systems.
They further suggest that certain policy frameworks have allowed authorities to avoid accountability for currency depreciation and its social and economic consequences.
Exchange rates are largely shaped by monetary policy in clean floating regimes, making policy discipline critical for stability.
Inflation-driven depreciation, often justified as a defensive strategy, has been criticized for enabling economic instability and social unrest.
While policymakers face political consequences from rising living costs, monetary authorities have historically avoided similar accountability, critics note.
Sri Lanka’s currency has depreciated significantly over time, undermining economic stability and public confidence in fiscal and monetary policies.
Undermining Prudent Fiscal Policy with Monetary Depreciation
In 2018, policy actions such as currency swaps and rate adjustments contributed to further depreciation, even as energy prices rose under pricing mechanisms, adding strain to state enterprises.
In 2026, similar trends have continued, with monetary expansion and foreign exchange interventions weakening the rupee despite calls from leadership to maintain currency stability.
Depreciation continues to increase foreign debt burdens and sustain high nominal interest rates, limiting economic recovery.
Several East Asian and Gulf countries, including Qatar, the UAE, Oman and Saudi Arabia, have rejected inflationary monetary approaches and instead maintained currency stability, contributing to stronger economic performance.
Unlike these economies, countries with inflation-prone monetary systems often amplify external shocks through currency weakening.
Historically, some nations established more stable monetary systems to avoid such outcomes, emphasizing disciplined currency management.
In Sri Lanka, structural issues within monetary governance have also constrained the Treasury’s ability to access foreign currency, increasing reliance on external borrowing.
There have been growing calls for reforms to limit the discretionary powers of monetary authorities, especially as the responsibility for repaying international obligations increasingly falls on the Treasury.
Experts argue that stronger legal and institutional safeguards are needed to prevent future economic crises and ensure long-term fiscal and monetary stability.
SOURCE :- ECONOMYNEXT
