In Focus - Sri Lanka's 2025 Fiscal Story
February 2026
Sri Lanka ended 2025 with the strongest fiscal performance ever recorded, continuing on its positive fiscal trajectory post the crisis in 2022. The primary surplus recorded is more than double the IMF’s set target and the initial budget estimates. Overall budget deficit is at historic lows as well. Keeping in line with this relatively strong fiscal space, the country is on track to record GDP growth of around 5% for the year. While at Frontier we have been highlighting the likelihood of such a performance over and over again, we finally have the data to explore this in more detail.
Overall budget and primary balances record historic balances in 2025
In 2025, Sri Lanka recorded its lowest ever budget deficit in decades of around -2.2% of GDP. For an economy that has seen budget deficits of at least 5% even in a good fiscal year, and deficits even surpassing 10% of GDP in some years (2020–2022), this current performance is by far one of the best turnarounds any economy could have seen.
Adding to this is the primary balance of the budget, expected to be around 5.5% of GDP In 2025 - more than double the IMF’s and the initial budgeted estimate of 2.3% of GDP. This marks the third consecutive year of primary surpluses, a mark that the Sri Lankan government has never achieved before. All of this overperformance stems from varying factors including improved revenue collection and contained government expenditure.
Government revenue has been quite strong
Sri Lanka’s revenue overperformance has drawn considerable attention and has been talked about somewhat favorably in recent times and has even been commended by the IMF. From historic lows of around 8% of GDP a few years ago, the government has now been able to collect close to 17% of GDP in total revenue including grants in 2025.
Income taxes continued to grow beyond nominal GDP growth
The Budget for 2025 announced a widening of the tax-free threshold for income taxes, increasing it from LKR 100,000 to LKR 150,000. This was initially identified as a factor that could cause income tax collections for the year to fall, as some individuals would now be exempt from paying. However, despite this widening, income tax collections for both corporate and personal taxes rose and contributed positively during the year.
Indirect taxes on domestic goods have continued to improve along with growing economic activity
The overall pickup in economic activity, driven by higher private sector credit, also meant that in 2025 indirect tax collections started to pick up. Higher VAT rates, the lowering of the VAT threshold, and the removal of exemptions over the last couple of years have all contributed to this increase.
While revenue collections overperformed, government expenditure remained broadly contained
Overall, government expenditure in 2025, despite rising marginally in nominal terms fell as a percentage of GDP when compared to the previous year. This fall in government expenditure mainly comes from a reduction in recurrent spending, which was partly offset by a marginal rise in capital expenditure during the year.
Expenditure on salaries remained largely flat while transfer spending fell in 2025
The NPP government that came into power in late 2024 fulfilled part of its election promise by increasing public sector salaries in its very first budget, with implementation expected in several stages starting from 2025. As a result, while one would have expected salary-related expenditure to rise by a significant margin, as most public sector salary revisions usually do, it only rose marginally in nominal terms and potentially would have fallen as a percentage of GDP.
The fall in interest payments was a key driver in bringing overall expenditure down
As a result of improved fiscal performance in 2023 and 2024 the government’s deficit financing needs were much lower in 2025. Furthermore, the cash buffers built by the government as a result of primary surpluses meant that the government was able to pay down some of its outstanding debt, particularly short-term treasury bills.
Can this be sustained going forward?
Sri Lanka has now seen three consecutive years of primary surpluses and has consistently overperformed on set targets, with each year doing better than the previous one. The key question now remains whether Sri Lanka can sustain this fiscal overperformance going forward.
All in all, real story of 2025 is not merely that targets were exceeded, but fiscal measures taken post crisis has started to bear fruit and now look sustainable. Moving from crisis management to surplus generation in three years is no small feat for any economy. Whether this pace can be maintained remains to be seen, but for now, the numbers are cooperating, the Treasury is breathing easier, and a “fiscal surprise” no longer means that the deficit was larger than expected, but the opposite.
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