MACROECONOMIC REVIEW

SRI LANKA’S ECONOMIC RECOVERY

There is a gap between the pace of import recovery and export growth 

Shiran Fernando wonders whether the recovery is uneven of if it’s too early to make predictions

The latest GDP data suggests that the next phase of economic growth will be more challenging – and the issue is no longer simply whether Sri Lanka is growing but what is driving that growth, how sustainable it is, and whether it is translating into stronger external earnings and productive investments.

Growth of 4.2 percent recorded in the second quarter of this year is instructive: while the economy continued to expand, growth moderated from five percent in the corresponding quarter of 2025 – and more importantly, the composition of growth reveals a more nuanced recovery. 

Industry expanded by 7.3 percent – driven significantly by construction and mining – while services grew by 2.7 percent. However, agriculture contracted by 2.3 percent. Construction expanded by 13.9 percent, and mining and quarrying by 17.4 percent while manufacturing grew by a more modest 3.2 percent. 

Within manufacturing, sectors linked to domestic construction and investment performed strongly, while textiles, apparel and leather contracted.

A prolonged closure of the Strait of Hormuz could test the resilience of the external sector

This distinction matters… 

Construction led growth is an important part of economic recovery – particularly after a prolonged period of underinvestment. But for Sri Lanka to sustain higher growth over the medium term, its recovery must increasingly be driven by exports, productivity, private investments and tradable services, rather than predominantly by domestic demand and import intensive activity.

EXPORT SECTOR Imports increased sharply in the second quarter with total expenditure rising by over 47 percent year on year and import volumes increasing by 20.5 percent. The volume of imported consumer goods alone increased by more than 44 percent. 

In contrast, export volumes grew by only 1.8 percent.

This doesn’t mean that imports are inherently negative. A recovering economy needs to import machinery, intermediate goods and consumer products. But the gap between the pace of import recovery and export growth highlights a key vulnerability: Sri Lanka can’t sustainably rebuild its economy if domestic demand recovers much faster than its foreign exchange earning capacity.

That makes the resilience of exports particularly important. 

During the first seven months of 2026, exports of goods and services increased by around 5.5 percent with rubber, coconut, spices, electrical and electronic products, and ICT-related services among the segments displaying resilience. However, apparel, tea and seafood have faced more difficult conditions.

Therefore, the policy response should be to broaden the export base and deepen market access. Strengthening the institutional capacity for negotiating FTAs, modernising the customs ordinance and accelerating trade facilitation – including a National Single Window – should remain central elements of the reform agenda.

The Purchasing Managers’ Indices also point to an economy that remains in expansion but with differing degrees of momentum across sectors. 

Manufacturing continued to expand in August though the pace moderated while services remained stronger. Construction has also continued to grow, supported by new orders and ongoing projects. 

These indicators reinforce the message from the GDP numbers: the economy is growing but the recovery is becoming increasingly uneven.

Agriculture is particularly important in this context. The contraction in agriculture during the second quarter reflects the vulnerability of production to weather conditions. 

However, the outlook for Maha 2026/27 is more encouraging with approximately 900,000 hectares expected to be cultivated with adequate seeds, fertiliser, agrochemicals and fuel. Rice stocks are also sufficient for current requirements.

Meanwhile, the principal agricultural uncertainty is now the weather. 

The issue is no longer simply whether Sri Lanka is growing but what is driving that growth, how sustainable it is, and whether it is translating into stronger external earnings and productive investments

Expected heavy rainfall could create localised flooding, delayed planting and crop protection challenges. A more targeted fertiliser subsidy, potentially through a QR linked system connecting the subsidy to actual fertiliser purchases, could also improve the effectiveness of public support and help protect productivity.

EXTERNAL SECTOR A prolonged conflict in the Middle East and the virtual closure of the Strait of Hormuz present a significant risk to Sri Lanka through higher energy prices, disrupted shipping, tapering forex from tourism and pressure on the balance of payments. 

The Central Bank of Sri Lanka has already reported that the external current account moved into deficit from April with the cumulative shortfall reaching US$ 387 million for the seven months from January to July, compared with a surplus in the corresponding period of 2025.

Therefore, a prolonged closure of the Strait of Hormuz could test the resilience of the external sector when Sri Lanka is seeking to rebuild reserves and resume external debt servicing. So the priority should be to strengthen foreign exchange earnings while managing import demand and energy vulnerability.

This is why the reform agenda can’t slow down simply because macroeconomic stability has been restored. The lesson from the latest growth data is that the composition of growth matters as much as the headline number.

Sri Lanka has achieved an important degree of macroeconomic stability. The next challenge is to ensure that stability becomes the platform for a more competitive, export oriented and investment driven economy. 

While the transition from crisis to stability was necessary, the shift from stability to sustainable growth will determine whether recent gains will translate into higher productivity, stronger incomes and a more resilient economy.