Sri Lanka’s fragile debt recovery is once again under strain as economic growth shows signs of losing momentum, raising serious questions about the country’s ability to manage both internal and external debt obligations beyond 2026. Despite achieving short-term macroeconomic stability through harsh fiscal consolidation, analysts warn that without deeper structural reforms and stronger foreign investment, the current trajectory risks trapping the economy in a low-growth, high-debt cycle.
According to First Capital Holdings PLC, GDP growth is expected to slow to 3–4% in 2026 and 2027, down from an estimated 4-5% in 2025. This deceleration reflects weakening consumer demand, rising interest rates, limited reform progress, and the economic fallout from Cyclone Ditwah. While fiscal discipline has stabilised inflation and the currency, growth at these levels is insufficient to meaningfully reduce Sri Lanka’s debt-to-GDP ratio.
Sri Lanka’s public debt burden already among the highest in emerging markets remains vulnerable to even modest economic shocks. Analysts caution that the exceptional trade surplus recorded last year, which supported foreign reserve accumulation and external debt servicing, is unlikely to be repeated. As imports rise due to post-cyclone reconstruction and easing vehicle import restrictions, the trade balance is expected to swing back into deficit, increasing pressure on reserves, interest rates, and the exchange rate.
External debt servicing capacity remains a central concern. Foreign reserves are projected to rise only marginally to around $7.25 billion in 2026 and $7.5 billion in 2027, constrained by higher imports, ongoing debt repayments, and a depreciating rupee. With the currency expected to weaken by about 5% in 2026, the local-currency cost of servicing foreign debt will rise, further straining fiscal space.
Domestically, higher interest rates are adding to the government’s internal debt burden. The Average Weighted Prime Lending Rate is expected to climb to 10-11% in the second half of 2026, pushing up Treasury yields and increasing debt-servicing costs. This dynamic risks crowding out private investment at a time when growth needs to accelerate.
First Capital warns that growth below 5% will keep debt ratios elevated above IMF projections through 2028. Only a sustained acceleration in growth driven by SOE restructuring, tariff reform, digitalisation, and faster land and trade reformscan place debt on a declining path. Without these changes, Sri Lanka faces the danger of stabilising today only to stumble into another debt crisis tomorrow.
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