Sri Lanka’s economy has shown solid signs of recovery in 2025, but the rebound remains partial, with output still below pre-crisis levels and poverty rates significantly elevated, according to the World Bank’s latest Sri Lanka Development Update titled Better Spending for All. The report projects growth of 4.6% in 2025, supported by steady industrial and service sector activity, but warns that the recovery must be reinforced through fiscal prudence, private sector investment, and structural reforms.

The World Bank notes that while the country has made measurable progress since its 2022 economic collapse, the gains are uneven. Inflation remains subdued, and foreign inflows have stabilised, but high food prices, weak job creation, and persistent poverty continue to pose challenges. Poverty rates, though declining, are now double the levels seen in 2019. Many families have yet to recover lost livelihoods, and nearly 10% of the population lives just above the poverty line.

According to the report, Sri Lanka’s economic output remains below its 2018 level, highlighting the fragility of the recovery. Malnutrition, particularly among vulnerable communities, remains a serious concern, even as headline indicators suggest macroeconomic stabilisation.

Uneven recovery amid fiscal constraints

The World Bank estimates that Sri Lanka’s economy will grow by 4.6% in 2025 before moderating to 3.5% in 2026, with the current account expected to stay in surplus, buoyed by services exports and remittances. However, reserve accumulation has slowed as external debt servicing resumes. Public revenues have strengthened, but capital spending has been weak, resulting in a narrower fiscal deficit.

The Bank’s analysis finds that while inflation has stabilised and credit growth has picked up, overall demand remains subdued, with private consumption and investment leading the modest rebound. The monetary easing cycle has reduced lending rates, boosting private sector credit growth to nearly 20% year-on-year by mid-2025. Still, the report warns that sustained recovery will depend on the government’s ability to maintain macroeconomic stability and deepen structural reforms.

Medium-term growth prospects are expected to hover around 3%, with consumption-led growth and limited contributions from investment and exports. Without substantial policy action, the World Bank cautions, Sri Lanka’s growth could stagnate below potential, undermining poverty reduction efforts.

Reforms needed to sustain growth

To consolidate recovery, the World Bank calls for reforms to boost private sector participation, reduce barriers to trade and investment, and modernise tax and regulatory systems. The report stresses that private capital — rather than public expenditure — must drive future growth, given Sri Lanka’s limited fiscal space.

It recommends policies that make it easier for businesses to invest, hire, and expand by addressing inefficiencies in land, labour, and capital markets. The Bank highlights that easing these constraints could unlock new investment, attract foreign capital inflows, and generate employment.

Revitalising private sector-led job creation is a key priority, particularly as Sri Lanka’s labour market remains sluggish. Real wages and participation rates are still below 2019 levels, underscoring the need for more dynamic employment policies. The report adds that higher growth that raises household incomes is critical for sustained poverty reduction and improved resilience to economic shocks.

Fiscal reforms are also essential. The World Bank urges Sri Lanka to broaden its tax base, strengthen tax administration through digital systems, and improve taxpayer engagement to enhance compliance. Shifting from indirect to direct taxation, it says, would make revenue mobilisation more equitable and sustainable.

Public spending efficiency under scrutiny

A major theme of the Better Spending for All report is the need to optimise existing public spending. More than 80% of Sri Lanka’s expenditure goes to public sector wages, welfare benefits, and interest payments, leaving little fiscal room for productive investments in infrastructure, health, and education.

At an average of 19.7% of GDP, the country’s overall spending remains below regional and lower-middle-income benchmarks. The World Bank emphasises that rather than expanding expenditure, Sri Lanka must improve how existing funds are allocated and managed.

Key recommendations include reforms to manage the public wage bill more effectively. Although Sri Lanka’s wage bill, at 5% of GDP, appears modest by international standards, the public sector employs nearly 15% of the national workforce — much higher than in comparable economies. This has resulted in low average pay and challenges in retaining skilled staff.

Real wages in the public sector have fallen sharply — by about one-third between 2020 and 2023 — while compensation structures have become fragmented due to widespread ad hoc allowances. The Bank suggests rationalising pay structures, introducing a national compensation commission, and modernising payroll management systems to improve efficiency and transparency.

Revamping capital investment

On public investment, the World Bank notes that Sri Lanka’s capital expenditure remains limited at just 3.4% of GDP and is often poorly prioritised. Project implementation has been slow, with less than 80% of planned capital spending executed in recent years.

The report identifies major inefficiencies in project appraisal, approval, and monitoring systems, which have constrained infrastructure delivery. The World Bank recommends focusing resources on near-complete projects, redirecting funds from stalled initiatives, and establishing unique project identifiers to track progress across ministries.

Maintenance spending on infrastructure has also been inadequate, leading to higher long-term costs. Increasing allocations for regular upkeep and adopting a more rigorous project selection process are seen as crucial steps for improving investment efficiency.

Outlook and risks

While Sri Lanka’s near-term growth outlook is broadly positive, the World Bank warns of significant downside risks, including global uncertainty, tightening external financing conditions, and domestic policy slippages. Sustaining recovery will require consistent policymaking and political commitment to reform.

The Sri Lanka Development Update complements the World Bank’s South Asia Development Update (October 2025 edition), which highlights regional growth of 6.6% this year but warns of a slowdown ahead. It notes that reforms promoting trade openness, technology adoption, and job creation will be critical for maintaining momentum across South Asia.

For Sri Lanka, the World Bank concludes that the immediate priority is not higher spending but better spending—making every rupee count by improving efficiency, transparency, and accountability.