MACROECONOMIC OUTLOOK
The World Bank released its South Asia Economic Update in April; it reaffirmed that the region was the fastest growing emerging market and developing economy (EMDE) in 2025, and that it had been expanding by a robust seven percent.
This performance exceeded earlier expectations that were driven primarily by stronger than anticipated domestic demand in India, alongside a notable recovery in Sri Lanka.
SOUTH ASIA’S GROWTH MOMENTUM
An uncertain global landscape is triggering economic headaches Shiran Fernando assesses the implications for Sri Lanka
However, as the region moved into 2026, the outlook became more nuanced.
Growth is projected to be moderate at 6.3 percent while reflecting mounting external pressures. These are most notably from global energy market disruptions and broader financial uncertainties in the wake of the Middle East conflict.
At the heart of South Asia’s recent resilience is domestic demand.
Consumption and investment have remained strong across several economies, and helped offset weaker external conditions. Yet, this growth model is increasingly being tested.
Persistently high energy prices linked in part to geopolitical tensions in the Middle East are expected to raise production costs, erode household purchasing power and widen current account deficits in energy importing economies across the region.
ENERGY MARKETS The outlook for energy markets remains highly uncertain. Baseline projections from the report suggest that oil prices will average around US$ 90 a barrel in 2026 but the scenarios range widely.
A swift resolution of geopolitical tensions could bring prices down while prolonged disruptions – particularly involving the Strait of Hormuz – could push prices beyond 110 dollars a barrel.
For South Asia, which is heavily dependent on imported energy, such shocks have significant macroeconomic implications.
Higher oil prices feed directly into inflation, and indirectly through transport, fertiliser and broader production costs. Even a 10 percent increase in oil prices could raise inflation by approximately 0.4 percent, tighten financial conditions and limit policy flexibility.
STRUCTURAL CHALLENGES Beyond energy, structural challenges are becoming more pronounced. Job creation across South Asia is slowing particularly as AI begins to disrupt labour intensive service sectors.
Longstanding disparities in subnational labour markets further complicate the employment landscape. Trade related measures – especially import restrictions – have reduced imports but haven’t boosted exports.
PERSISTENT TROUBLES Sri Lanka’s recovery is stabilising but challenges continue. In the regional context, the island’s economic trajectory reflects both recovery and constraint.
After expanding by five percent last year, matching its 2024 performance, the economy is expected to grow by only 3.6 percent this year and 3.8 percent in 2027.This marks a transition from the post-crisis rebound to a more sustainable but slower growth path.
The 2025 recovery was underpinned by strong domestic consumption that grew by 9.1 percent. It was also supported in part by workers’ remittances, which increased by more than 20 percent.
Inflation remained contained, and stabilised between 2.1 and 2.3 percent in late last year and early 2026. These developments signal improved macroeconomic stability following the unprecedented sovereign debt crisis.
Fiscal and financial sector indicators also show signs of strengthening. Sri Lanka’s debt-to-GDP ratio had declined from over 120 percent at its peak to around 93 percent by the third quarter of 2025 while the primary balance has continued to improve. The banking sector has regained stability with better liquidity conditions and rising profitability.
But the economy continues to grapple with the lingering effects of the crisis including reduced fiscal space, under-execution of public investment and a shortage of skilled labour.
These constraints are likely to limit the pace of expansion in the near term.
In November last year, Cyclone Ditwah caused extensive damage that’s estimated at US$ 3.3 billion (3% of GDP) and resulted in over 600 fatalities.
The disaster underscored Sri Lanka’s acute exposure to climate risks and required emergency financial assistance exceeding 200 million dollars from the IMF. Reconstruction activity is expected to support growth this year but it places additional pressure on constrained public finances.
Growth in Sri Lanka will be driven primarily by consumption and investment. The tourism industry remains a key upside – particularly as disruptions to Middle Eastern flight routes ease.
Continued progress on structural reforms, particularly those linked to fiscal consolidation, restructuring state-owned enterprises and an improvement in the investment climate will be critical to sustaining investor confidence – and indeed, unlocking private sector led growth.
Rising global energy prices could strain the fiscal and external accounts while any disruption to remittance flows from the Middle East, which is home to a large number of Sri Lankan migrant workers, could affect household incomes and consumption.
South Asia’s recent growth performance demonstrates its underlying dynamism but the path ahead is increasingly complex.
External risks from energy markets to global financial conditions are intersecting with domestic structural challenges including employment constraints and uneven reform implementation.
For Sri Lanka, the transition from stabilisation to sustained growth will require careful policy calibration.
Strengthening macroeconomic fundamentals has created a foundation but accelerating growth will depend on addressing structural bottlenecks, rebuilding resilience to climate shocks and maintaining reform momentum.
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