CBSL flags economy-wide risks despite stronger buffers as Sri Lanka navigates a complex recovery phase, with renewed global shocks threatening macroeconomic stability despite recent gains in reserves and fiscal performance.
CBSL flags economy-wide risks despite stronger buffers amid global shocks
The Central Bank of Sri Lanka (CBSL), in its Annual Economic Review 2025, has cautioned that escalating geopolitical tensions—particularly in the Middle East—pose significant downside risks to the country’s economic outlook. While Sri Lanka has made measurable progress in rebuilding macroeconomic buffers since 2023, the central bank warns that these gains remain vulnerable to external disruptions affecting energy prices, trade flows, and foreign exchange inflows.
A primary concern highlighted in the report is Sri Lanka’s heavy dependence on imported energy, particularly from Gulf countries. Rising global oil and gas prices linked to geopolitical instability could sharply increase the fuel import bill, thereby widening the trade deficit and exerting upward pressure on inflation. The CBSL noted that inflation is now expected to accelerate towards its 5% target at a faster pace than previously projected, driven largely by energy-related price adjustments. This trend underscores broader Sri Lanka inflation risks, which remain tilted to the upside amid uncertainty in global commodity markets.
Remittance inflows—one of Sri Lanka’s most critical sources of foreign exchange—also face heightened vulnerability. Approximately 45% of remittances originate from Gulf economies, making them susceptible to labour market disruptions caused by regional instability. Any slowdown in migration or employment opportunities in these markets could reduce inflows, increase exchange rate volatility, and weaken external sector stability. These external sector challenges are further compounded by risks to exports and tourism, both of which are sensitive to global economic conditions and logistical disruptions.
The CBSL flags economy-wide risks despite stronger buffers in the context of trade dynamics as well. The merchandise trade deficit is projected to widen in 2026, primarily due to higher import expenditure driven by elevated fuel prices and increased demand for intermediate and investment goods. Although vehicle imports are expected to moderate following a surge in 2025, overall import growth is likely to outpace export earnings. Export sectors such as tea and apparel could also face indirect impacts from higher freight and insurance costs, as well as reduced demand in key markets.
Tourism, another vital contributor to foreign exchange earnings, remains indirectly exposed to geopolitical developments. While direct tourist arrivals from the Middle East are limited, over 30% of total arrivals rely on transit routes operated by Middle Eastern airlines. Any disruption to these routes—whether due to airspace restrictions or shifts in travel patterns—could adversely affect Sri Lanka’s tourism sector.
Despite these risks, the CBSL maintains that the external sector will remain broadly sustainable, supported by continued inflows from remittances, services exports, and financial assistance under the International Monetary Fund (IMF) Extended Fund Facility program. Gross official reserves, which strengthened through 2025 and early 2026, are expected to remain at adequate levels, providing a buffer against short-term external shocks. The central bank reiterated its commitment to maintaining a flexible exchange rate regime to absorb volatility.
On the fiscal front, however, pressures are mounting. The Government’s approval of a Rs. 500 billion supplementary estimate for post-disaster recovery following Cyclone Ditwah is expected to strain near-term fiscal balances. Additionally, higher energy costs could necessitate subsidies, further complicating fiscal consolidation efforts. While Sri Lanka aims to achieve a primary surplus and reduce its budget deficit in the coming years, these targets remain contingent on stable macroeconomic conditions and disciplined policy execution.
Monetary policy is expected to remain data-driven, with the CBSL prepared to respond to emerging inflationary pressures. Credit growth is projected to continue in line with economic recovery, although it may moderate later in 2026 due to global uncertainty. The financial system itself remains resilient, supported by improved asset quality, strong capital buffers, and adequate liquidity, though risks to credit quality persist.
The CBSL emphasised that sustaining the current recovery trajectory will depend heavily on continued structural reforms and the successful completion of the IMF program. These measures are seen as essential for maintaining investor confidence, enhancing economic resilience, and ensuring long-term growth.
In conclusion, while Sri Lanka has made notable progress in stabilising its economy, the CBSL flags economy-wide risks despite stronger buffers as a reminder that the recovery remains fragile. External shocks, particularly those linked to geopolitical tensions, continue to pose significant challenges, underscoring the need for prudent policy management and sustained reform momentum.