Sri Lanka unfunded pension crisis has intensified after the government ended the final attempt to introduce a contributory pension scheme for public sector employees. The decision raises renewed concerns over fiscal sustainability amid an ageing population and mounting long-term liabilities.
Sri Lanka unfunded pension crisis worsens as contributory reform ends
Sri Lanka has effectively abandoned efforts to introduce a contributory pension system for state employees, extinguishing what economists viewed as a critical reform to contain the country’s growing unfunded pension obligations. The Cabinet of Ministers has approved changes that remove provisions aimed at altering pension conditions for public servants recruited after January 1, 2016, reinstating their eligibility for the existing non-contributory pension framework.
The move comes at a time when unfunded pension liabilities are increasingly viewed as a major fiscal risk. Estimates suggest that such obligations could add as much as 25 percent to Sri Lanka’s national debt over time, amplifying pressures already heightened by demographic shifts and weak revenue growth. With the population ageing rapidly, the long-term cost of maintaining an unfunded system continues to rise.
Under the revised position, appointment letters issued to public servants recruited after 2016, which previously indicated that pension entitlements would be subject to future policy decisions, will now be amended. Cabinet Spokesman Nalinda Jayatissa confirmed that while earlier letters referenced the possibility of a new pension scheme, no such system has been implemented. As a result, the 2026 budget proposes amendments to formalise pension conditions under the existing structure.
The decision effectively grants permanent pension rights to government employees recruited after 2016 under the same unfunded arrangement that applies to earlier cohorts. This system relies entirely on annual tax revenues to meet pension payments, rather than accumulated contributions or investment returns. Economists have long warned that this structure transfers the cost of today’s employment decisions to future taxpayers.
Sri Lanka’s unfunded pension crisis has been a recurring concern in fiscal policy debates for decades. During the sovereign default in 2022, pensions and public sector salaries together consumed nearly 80 percent of total tax revenues, leaving little fiscal space for essential services or debt servicing. Although subsequent tax increases reduced this ratio, the underlying structural imbalance remains unresolved.
Previous attempts to reform the system have faltered. Following a currency crisis in 2001, Sri Lanka explored introducing a funded pension model for state workers, similar to the Employees’ Provident Fund used in the private sector. However, political resistance and concerns over labour unrest stalled implementation. The failure to enact reform left the government exposed when fiscal conditions deteriorated two decades later.
The latest reversal has drawn criticism from analysts who argue that abandoning contributory reform deepens the Sri Lanka unfunded pension crisis at a time when fiscal discipline is essential. They contend that postponing reform increases the eventual adjustment cost, forcing future governments to choose between higher taxes, reduced benefits, or increased borrowing.
The cabinet decision also clarified obligations under the Widows and Orphans Pension Scheme and the Widowers and Orphans Pension Scheme. Public servants will continue to make prescribed contributions to these schemes, which provide survivor benefits. However, these arrangements do little to offset the much larger burden posed by the main pension system, which remains unfunded.
From a macroeconomic perspective, unfunded pensions represent a contingent liability that does not always appear in headline debt figures but has real implications for long-term stability. As pension payments grow, they can crowd out spending on infrastructure, health, and education, limiting economic growth potential and exacerbating intergenerational inequities.
Supporters of the decision argue that maintaining pension guarantees preserves job security and morale in the public sector, which remains one of the largest employers in the country. They caution that abrupt changes to pension rights could trigger labour disputes and social unrest, particularly during a fragile economic recovery.
Critics counter that gradual, well-communicated reform would be less disruptive than deferring action until fiscal pressures become unmanageable. They point to international experience showing that transitioning to contributory or partially funded systems can improve transparency and sustainability if implemented early and equitably.
As Sri Lanka seeks to consolidate its recovery from the 2022 default, the handling of pension reform will remain a central policy challenge. The latest cabinet decision underscores the political difficulty of addressing long-term fiscal risks, even as warning signs continue to accumulate.
Without credible reform, analysts warn that the Sri Lanka unfunded pension crisis could resurface as a major destabilising factor in future downturns, constraining policy choices and placing a heavier burden on taxpayers for decades to come.