In a report released in 2025, the World Bank estimated that Sri Lanka’s poverty levels had risen to more than twice those of 2019. At the same time, the World Bank’s assessment indicates that Sri Lanka’s economic growth has resumed, with GDP growth projected at about 4.6% in 2025 and about 3.5% in 2026 forecast.

However, the World Bank warns that this recovery remains incomplete, particularly for ordinary households facing rising living costs and reduced welfare. In fact, while overall economic growth is progressing, the living conditions of many people are deteriorating. The current situation, in which economic growth and poverty are unfolding simultaneously, reflects deep-seated contradictions in the country and represents one of Sri Lanka’s most difficult economic challenges. Multiple factors deeply rooted in Sri Lanka’s history lie behind this.

This article explores Sri Lanka’s current economic situation and the historical factors that have shaped the fragile economic structure behind it.

View from Maradana Station in Colombo, Sri Lanka’s largest city (Photo: Nazly Ahmed / Flickr [CC BY-NC-SA 2.0])

From a kingdom of wealth to imperial rule

From antiquity to the present day, the island has experienced a dynamic economic history. As early as 2,500 years ago, it was a key maritime trading hub connecting merchants from Rome, Greece, Arabia, and China. From around 300 BCE to around 1200 CE, large-scale cultivation of rice, grains, and spices developed alongside advanced irrigation systems. In addition to grains and other crops, gemstones and elephants from the island became major exports up to the 10th century.  

A coherent political organization based in the northern part of the island played a key role in this development. From around 300 BCE, early Sinhala kingdoms such as Anuradhapura oversaw irrigation and agricultural planning, while in the south, small political communities maintained semi-autonomy while trading and paying tribute to the north. As a result, the island emerged as an important agricultural center in South Asia.

However, in the late 10th century, repeated invasions by powerful South Indian dynasties destabilized this long-established order. These invasions also changed the island’s ethnic composition and contributed to unstable politics on the island. While much of the island was controlled by Sinhalese groups, over time Tamils from South India migrated to the island.

Furthermore, in 1214 the administrative center was abruptly relocated, causing a major shift in the island’s agriculture-centered economy. This was due to an invasion by a South Indian kingdom and the migration of many Sinhalese from the north to the south of the island. As a result, the centuries-old administrative base that managed the irrigation system collapsed. With the breakdown of administration, the irrigation system fell into disrepair and agricultural production declined. This led to an economic decline across wide swaths of the island from the 13th to the 15th centuries.

Thereafter, much of the island’s economy was dominated by three colonial powers. Specifically, Portugal from 1505 to 1658, the Netherlands from 1658 to 1796, and Britain from 1796 to 1948 each ruled Ceylon. Settlers from Portugal and the Netherlands established bases in Ceylon and controlled coastal trade and spice exports. For example, under Dutch rule, Ceylon was a global source of cinnamon, a rare and expensive spice used in medicines and foods. Portugal and the Netherlands sought to dominate the island’s trade in order to monopolize the production and export of cinnamon and other goods and secure the resulting rents.

The island was formally ceded from the Dutch to the British in 1802. Under British rule, two significant changes were brought to agriculture. The first was the establishment of coffee plantations, and the second was the introduction of tea cultivation in the 1860s after the coffee industry collapsed due to crop disease. Both changes were driven by European demand and export opportunities rather than local consumption.

This agricultural shift involved large-scale land clearing and an influx of labor, mainly Tamil Hindus who migrated from South India. The British exploited the indentured labor system (※1), extracting wealth from this system by maximizing profits from export crops while minimizing expenditures. As a result, by 1901 tea alone accounted for 54.7% of Britain’s total foreign-exchange earnings. While the wealth generated from Ceylon’s resources flowed to Britain, wages for workers were extremely low and working conditions were harsh.

This exploitative strategy expanded in the 1880s to rubber and coconut plantations. Rubber and coconut plantations developed mainly for Western consumers. In the case of rubber, demand in Western markets began to surge due to the expansion of industrialization and the spread of bicycles and automobiles, which required large amounts of rubber for tires and machine parts. Plantation owners profited greatly from this, often at the expense of local labor and the economy.

The island’s inhabitants eventually launched a peaceful movement seeking political independence. In 1948, Ceylon achieved independence from British rule, marking the beginning of self-government. The country’s name was later changed from Ceylon to Sri Lanka.

Tea leaves harvested in Sri Lanka (Photo: Knut-Erik Helle / Flickr [CC BY-NC 2.0])

Economic struggles after independence

From independence through the 1960s, Sri Lanka’s economy was shaped by the colonial-era plantation economy. Dependence on exports of tea, rubber, and coconuts continued to dominate the economy, and in particular, tea and rubber plantations remained under the ownership of settlers from Britain and British capital even after independence.

From the 1960s, especially into the 1970s, the newly independent government strengthened state control over the economy, nationalizing many private industries and foreign-owned plantations and expanding the public sector. The government’s goal was to promote greater economic equity and local land ownership by limiting the concentration of land in the hands of a few, reducing the outflow of wealth to foreign firms, and redistributing land to landless peasants.

Under the 1972 Land Reform Law and its 1975 amendment, large agricultural estates, including major tea, rubber, and coconut plantations, were vested in state agencies such as the State Plantation Corporation of Sri Lanka and the Janatha Estates Development Board. Most of this land was transferred to state management, and only about 12% of the remainder was eventually distributed to landless peasants.

Many residents living in rural Sri Lanka were already landless or owned only very small plots due to the colonial plantation system. Moreover, employment in state-run entities often involved low wages, precarious employment, and limited decision-making power. As a result, farmers working in these places were unable to attain the autonomy or economic stability that land ownership would have provided. Consequently, while Sri Lanka’s land reform reduced foreign ownership of capital, it did little to improve rural livelihoods or address inequality.

State entities also suffered from inefficiency, low productivity, and underinvestment, and the economic gains realized were limited. For example, replanting of tea fields and modernization of machinery lagged, and competitiveness against countries such as Kenya and India declined.

As a result, state management proved inefficient, and the plantation sector’s contribution to the economy declined. Moreover, as productivity in agriculture and other sectors slowed, export earnings from plantation crops could no longer cover payments for essential imports such as machinery, raw materials, and consumer goods.

Rural Sri Lanka and tea plantations (Photo: Nigel Hoult / Flickr [CC BY 2.0])

To address these problems, the government introduced import-substitution policies (※2) to expand domestic production and reduce dependence on foreign imports. At the same time, it promoted state-led industrialization, with the government playing a central role in developing and managing key industries. However, the lack of a strong industrial base and adequate finance and technology to sustain such trade restrictions and heavy government involvement made it difficult for domestic producers to compete with cheaper imports or meet domestic demand.

According to a World Bank analysis in 1973, the strict import restrictions and restrictive trade regime of the early 1970s left Sri Lanka’s economy extremely vulnerable to external shocks. This was mainly because industries found it difficult to procure essential imports such as machinery, fuel, and raw materials. Therefore, global price increases or supply disruptions could immediately disrupt production and raise costs.

Armed conflict and its impact on economic vulnerability

 The decisive blow to fragile post-independence economic self-sufficiency came with the armed conflict that erupted in 1983. This armed conflict was rooted in political grievances stemming from longstanding divisions between ethnic groups. Under British colonial rule, the divide between the majority Sinhalese and the minority Tamils, who mainly lived from the north to the east of the island, became pronounced. For example, Tamils were often favored for civil service positions and in education, which after independence bred resentment among the Sinhalese.

After independence, successive governments led by the Sinhalese introduced policies that many Tamils considered unfair. The 1956 law establishing the official language made Sinhala the sole official language. This reduced employment opportunities in government jobs and education for Tamil speakers. Subsequently in the 1970s, the university “standardization” policy (※3) further restricted access to higher education for Tamils. These measures exacerbated the sense of political and economic marginalization among the Tamil minority.

As peaceful efforts to achieve Tamil autonomy failed, inter-communal violence increased, including anti-Tamil riots in 1977 and 1983. In response, some Tamils joined armed groups. This movement culminated in the late 1970s with the formation of the Liberation Tigers of Tamil Eelam (LTTE). The LTTE sought to establish an independent Tamil state called Tamil Eelam. Clashes between the LTTE and the Sri Lankan government escalated into full-fledged armed conflict in 1983. That year, anti-Tamil violence triggered widespread reprisals, leading to further recruitment for the LTTE.

An LTTE vehicle in Kilinochchi in northern Sri Lanka (Photo: Author / Wikimedia Commons [CC BY-SA 3.0])

The military confrontation between the LTTE and government forces continued for over two decades, devastating the economies of the north and east, diverting resources to military spending, and undermining investor confidence and the development of tourism. All of this contributed to the weakening of Sri Lanka’s economy.  

After the armed conflict ended in 2009, Mahinda Rajapaksa, who had been elected president in 2005, became a central figure in the country’s postwar recovery. His administration focused on rebuilding infrastructure, improving security, and attracting investment to war-affected areas. While these efforts helped stabilize the country, economic growth remained uneven, with development concentrated in certain regions and political power becoming increasingly centralized—drawing criticism.

Rajapaksa administrations and mounting debt

The island nation experienced its strongest economic growth immediately after the end of the decades-long armed conflict. GDP growth reached 8.3% in 2011, the highest rate in about 60 years. From 2010 to 2015, GDP grew at an annual pace of about 6.4%. Postwar growth was driven largely by large-scale infrastructure development and tourism projects.

However, as significant macroeconomic weaknesses began to emerge, this growth soon slowed. One cause lay in the structural weaknesses of fiscal management. A series of fiscal and governance decisions under the Rajapaksa presidency (2005–2015) are cited as having contributed to the weakening of Sri Lanka’s economy. This mainly included long-standing tax cuts and exemptions granted to corporations and high-income earners, which are believed to have eroded the tax base. A 2023 Supreme Court ruling found Rajapaksa and others responsible for major political failures and mismanagement of the economy under that administration. The ruling focused on the legal responsibility of leaders for inappropriate policy choices and governance decisions. In addition, there was a growing reliance on high-risk commercial borrowing and large-scale infrastructure projects with low economic returns.

Commercial borrowing also became an important factor in Sri Lanka’s economy. Much of Sri Lanka’s external financing has been undertaken through loans from multilateral and bilateral lenders. The main bilateral lenders are China, Japan, India, and France, and major multilateral lenders include the Asian Development Bank (ADB) and the International Monetary Fund (IMF).

Rajapaksa meeting with IMF directors in New York in 2014 (Photo: Mahinda Rajapaksa / Flickr [CC BY-NC 2.0])

Before 2007, loans Sri Lanka received from China were mainly low-interest, long-maturity “soft loans.” These funds were used for large-scale infrastructure projects including the Hambantota Port and Mattala Rajapaksa International Airport. Such projects have often been cited as cases of “debt-trap diplomacy” (※4). The term has been used by some analysts to describe infrastructure projects financed by China. However, this interpretation is contested, with some arguing that Sri Lanka’s debt crisis was driven primarily by domestic fiscal vulnerabilities and broader external borrowing, rather than a deliberate strategy by the Chinese government.

In reality, Sri Lanka’s debt crisis was shaped by a broader combination of factors. By the end of 2022, about one-fifth of Sri Lanka’s public external debt was owed to Chinese lenders. This includes both official lending from China’s policy banks and commercial lending such as loans to state-owned enterprises.

To overcome a severe economic crisis, from 2007 to 2019 Sri Lanka increased commercial borrowing at higher interest rates and with shorter maturities from private international investors and bondholders such as BlackRock, HSBC, JPMorgan Chase, and Allianz. As a result, it soon faced heavy repayment pressures.

Mounting crises and the fall of the Rajapaksa administration

Since 2019, Sri Lanka’s economy has been further weakened by a series of largely unrelated events. One factor was the 2019 coordinated terrorist attacks known as the Easter bombings. On April 21, suicide bombings targeted churches and luxury hotels across Sri Lanka. The attack, attributed to extremists of the Islamic State (IS), killed 321 people and injured hundreds, severely undermining tourism and investor confidence in Sri Lanka.

Following this event, the COVID-19 pandemic struck in 2020. The collapse of international tourism and disruptions to trade, supply chains, and domestic commerce further squeezed the economy and reduced government revenues.

A third factor was policy missteps. In Sri Lankan politics, after President Mahinda Rajapaksa resigned in 2019, his brother Gotabaya Rajapaksa was elected president. Under his leadership, a new policy direction emphasized national security, economic reforms, and agricultural policy.

In 2021, the government suddenly banned chemical fertilizers, aiming for a rapid transition to 100% organic agriculture. Officially justified as a measure to improve public health and protect the environment and the economy, it was widely criticized for being implemented without a phased transition period, among other issues. It was also viewed as politically motivated, reflecting the president’s ambition to position himself as a global leader in environmental sustainability. Following the ban, agricultural businesses lost income, food prices soared, and production fell.

As a result, shortages of essential goods such as food, fuel, and medicines occurred alongside hyperinflation, triggering mass protests. Initially a peaceful movement, the four-month-long protests (the 2022 Aragalaya movement) ultimately culminated in the storming and occupation of the presidential residence. During the protests, cases of human rights violations, including allegations against state security forces, were reported. Ultimately, the movement led to the resignation of President Gotabaya Rajapaksa in 2022.

Protesters occupying the presidential residence in July 2022 (Photo: Valmedia / Shutterstock)

Austerity and public backlash

Amid this economic downturn and severe repayment pressures, Sri Lanka suspended debt repayments in 2022 and defaulted. As a result, the country began a debt restructuring plan with the involvement of the IMF and the World Bank.

Ranil Wickremesinghe, who became acting president following the Aragalaya movement, adopted tougher measures in 2022 to steer Sri Lanka toward economic recovery. By raising interest rates, constraining money supply, and stabilizing the currency, the inflation rate fell from about 70% at the end of 2022 to 1.7% by mid-2024 according to reports. His economic stabilization policies also included broadening revenue sources and restructuring existing commercial loans. These measures were conditions set by the IMF when Sri Lanka agreed in 2023 to a large Extended Fund Facility (EFF) (※5) worth about US$3 billion.

In line with conditions attached to debt restructuring, fiscal reforms emphasized consolidation and limited the government’s flexibility to expand public spending. Furthermore, reforms to strengthen the central bank’s independence in line with IMF requirements limited political interference in monetary policy and imposed stricter macroeconomic discipline.

Beyond price stability and debt restructuring, the economic program implemented under Wickremesinghe entailed significant austerity measures. These directly affected living standards and household finances. Specifically, they included substantial tax hikes and a broader tax base—raising the value-added tax rate, increasing corporate and income tax rates, and instituting mandatory withholding taxes. While intended to increase government revenue, these measures also increased burdens on consumers and businesses.

The government also reduced subsidies for fuel and electricity and raised public tariffs to cover costs. This made these services more expensive for households and businesses. This is a common requirement by the IMF when restructuring loans to reduce fiscal deficits. Cuts to government investment, public-sector wage freezes, and the scaling back of some state activities restricted public spending, further tightening demand in the economy.

Although Sri Lanka’s macroeconomic indicators such as GDP growth and low inflation have improved under the IMF-supported program, the benefits of this growth have not reached most of the population. While reforms such as higher utility rates, increased taxes, and subsidy cuts contributed to economic stabilization, they also raised the cost of essential goods and services and squeezed household incomes. As a result, poverty has deepened and public dissatisfaction is mounting.

Under widespread public discontent and political pressure, when Wickremesinghe held national elections in 2024, Anura Kumara Dissanayake took power in his place. Dissanayake is a leftist politician and the leader of the Janatha Vimukthi Peramuna (JVP) and the broader National People’s Power (NPP) alliance. While the party is rooted in Marxist political thought, it has increasingly positioned itself as a mainstream alternative to Sri Lanka’s traditional elite. His campaign appealed to voters dissatisfied with the political system and austerity, calling for anti-corruption, political reform, and economic transformation. During a period of recovery from the economic crisis, he pledged to fight corruption, protect ordinary citizens from hardship, and promote fairer governance.

Dissanayake heading to the opening of Parliament in November 2024 (Photo: Ruwan Walpola / Shutterstock)

Debt, growth, and the future

Under the Dissanayake administration, Sri Lanka is experiencing economic growth. However, some argue that this growth stems from the previous IMF-supported, stringent reform program, and that in practice the uneven implementation of policies and vacillating politics have undercut the larger recovery that had been expected. Moreover, the review of IMF conditions still lacks flexibility, generating further austerity. 

More concerning is that economic growth measured by GDP does not necessarily translate into broad-based recovery for ordinary citizens, especially in an environment characterized by austerity. Many households have yet to regain lost livelihoods, the labor market’s recovery is sluggish, food prices remain high, and malnutrition persists, particularly among the economically vulnerable. The reported numerical growth obscures the harsh realities most people actually face, and poverty levels in Sri Lanka remain high.

Austerity has continued under the Dissanayake administration. In November 2025, Dissanayake submitted the 2026 budget to Parliament. This budget also clearly aligned with IMF conditions and reflected strict measures similar to those under the Wickremesinghe administration. Specifically, it included significant cuts to public spending, expansion of indirect taxes, reductions in welfare benefits, higher import duties on certain items, and a push for the privatization of state assets.

By the end of 2025, the government and analysts predicted that Sri Lanka’s debt would fall to about 96% of total GDP (around 130% in 2022). While a lower debt-to-GDP ratio can indicate improved debt sustainability, the ratio of debt service to revenue reflects the government’s immediate fiscal constraints. In 2025, about 60% of government revenue was expected to go to interest payments on debt. Similar trends were observed in previous years: in 2023, about 80% of government revenue, and in 2024, 57%, were allocated to debt servicing.

As a result, less than half of government revenue in 2025 was left for public services, constraining spending in key sectors. According to Sri Lanka’s 2025 budget, the residual government revenue after debt service was allocated to public services, with about12％ of total revenue to health, 6.4％ to education, 5％ to agriculture, and 11％ to transport and urban development. Looking ahead, the 2026 budget suggests that high debt service obligations will continue, severely constraining efforts to reduce poverty and improve public welfare.

The current president appears to be following a similar path to former President Wickremesinghe, and the 2026 budget reflects this. It is clear that the austerity policies being implemented are heavily influenced by the conditions set by the IMF. Although the current administration won the election on a platform of left-wing alternatives, in practice it has largely continued the previous administration’s macroeconomic policies. Living standards for the poor and middle class are worse than they were a decade ago, and public dissatisfaction remains high. The core question that remains is what will actually bring about the sustainable future that Sri Lankans have been seeking.

A view of Colombo, Sri Lanka’s largest city (Photo: Just a Brazilian man from Brazil / Wikimedia Commons [CC BY 2.0])

※1  Indentured labor is a system in which workers agree, under a formal contract, to provide labor to others for a specified period. It is typically undertaken in exchange for payment of transportation to the worksite, housing, food, wages, or debt repayment. Working conditions were often harsh and exploitative.

※2  The import-substitution policy here refers to import-substitution industrialization (ISI). This is a government development strategy that seeks to promote domestic production and reduce dependence on foreign imports through trade restrictions such as import controls, tariffs, and licensing requirements. In Sri Lanka, ISI policies were particularly prominent from the 1960s to the early 1970s, involving extensive state intervention and foreign exchange controls. Aimed at saving foreign currency and nurturing domestic industries, these policies were constrained by limited capital, technology, and industrial capacity, resulting in inefficiencies and shortages.

※3  Introduced in the early 1970s, Sri Lanka’s university “standardization” policy adjusted university admission criteria by applying different cut-off scores to students based on language of instruction and district. Officially justified as a measure to promote regional equity, the policy disproportionately reduced the admission of Tamil students to highly competitive faculties such as medicine and engineering. This policy became a major source of resentment among the Tamil minority.

※4  This term refers to a diplomatic strategy in which a creditor country intentionally extends large loans on terms that are difficult for the borrower to repay, and then gains political or strategic advantages from the debtor when repayment problems arise.

※5  The EFF is an IMF lending framework designed to support countries facing medium- to long-term balance-of-payments problems stemming from structural weaknesses. EFF programs usually involve multi-year financial support conditioned on structural reforms, fiscal consolidation, and monetary policy adjustments aimed at restoring macroeconomic stability and debt sustainability.

Writer: Mohammad Istiaq Jawad

Translation: Seita Morimoto

Graphics: Yumi Ariyoshi

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