As Sri Lanka exits a prolonged economic crisis, fixed-income investments are emerging as a key component of long-term portfolio strategy. With interest rates stabilizing, inflation under control, and sovereign debt restructured, the fixed-income market is not only helping finance the government’s recovery agenda but also offering investors a way to manage risk and preserve capital in a low-growth, low-volatility environment.
“Fixed income will and should play a significant part in long-term portfolios,” says Gayan J. Karunaratne, Assistant General Manager and Head of Trading and Research Development at Wealthtrust Securities. “But it should be flexible to capture any movements in yields, as we are currently in a low-interest rate environment.”
Gayan J. Karunaratne, Assistant General Manager and Head of Trading and Research Development at Wealthtrust Securities
Sri Lanka’s economy grew by 5% in 2024 and will likely maintain momentum into 2025, supported by fiscal consolidation and improved credit conditions. “The economic outlook is very positive,” Karunaratne notes. “A lot of uncertainties have been reduced. The country has completed its sovereign debt restructuring, paving the way for a credit upgrade.” Tax revenue as a share of GDP could rise, reinforcing macroeconomic stability and creating a more predictable backdrop for long-term investing.
In this context, fixed-income yields could hold steady. “Yields are likely to remain range-bound in the coming year as market players attempt to weigh the true state of the economic policies,” Karunaratne explains. He sees potential for a term premium on longer maturities as credit growth resumes, prompting investors to reassess duration exposure.
Understanding how fixed-income assets generate returns is essential to positioning them within a long-term strategy. Most instruments, including government and corporate bonds, offer regular coupon payments and return the principal at maturity. Investors can also realize capital gains in the secondary market by purchasing bonds at a lower price and selling them at a higher price when interest rates fall. Since bond prices and interest rates move inversely, a decline in market rates makes existing higher-yielding bonds more valuable, driving their price.
Investors realize capital gains when bonds are sold at a higher price, while the coupon income offers stable cash flows during the holding period,” Karunaratne says. Investors rely more heavily on these coupon payments in low-interest environments for predictable returns. However, reinvestment risk and inflation remain constant concerns.
Inflation is significant because it erodes the actual value of future fixed payments. “Maintaining domestic price stability is the central objective,” Karunaratne notes, referring to the Central Bank’s current stance. When inflation rises, investors demand higher yields to offset the loss in purchasing power. Conversely, if inflation falls and interest rates follow, bond prices rise—enhancing total returns in fixed-income portfolios.
This means shifting from a defensive to a more balanced stance for investors. “Portfolios should not take on an above-normal interest rate risk,” he advises. A 70:30 allocation between short- and long-term instruments offers liquidity and flexibility while still capturing duration-based returns where warranted by the yield curve.
Evaluating fixed-income opportunities in the current environment demands close attention to inflation and other indicators. These include exchange rate movements, the average call money rate, credit expansion, fiscal deficits, and foreign participation in government securities. These factors feed into the broader outlook for yields, liquidity, and capital flows.
When weighing government versus corporate debt, the trade-off is between credit and liquidity risk. “Government securities account for low credit risk and high liquidity,” Karunaratne says. But timing matters. Investors need to understand where the economy sits in the interest rate and credit cycles before allocating to less liquid, higher-yielding instruments. Corporate bonds can offer higher yields but come with higher credit risk and limited secondary market liquidity.
Portfolio design, then, is less about static allocation and more about adjusting to the structure of the yield curve. “The investor should change his asset allocation or duration decision depending on yield curve positioning,” Karunaratne advises. He argues that long durations at current interest rate levels must offer sufficient compensation for future inflation expectations to justify inclusion in a long-term portfolio.
Beyond their role in individual portfolios, fixed-income instruments play a structural role in economic recovery. “A well-functioning fixed income and government securities market can contribute to the recovering Sri Lankan economy by facilitating capital formation and channelling savings into investment,” Karunaratne says. The high levels of domestic borrowing anticipated in 2025 will test the depth and liquidity of the bond market.
In a stabilizing but still uncertain macroeconomic landscape, fixed income offers investors a tool not just for return but also for resilience. As Sri Lanka rebuilds, bonds become a foundation for public finance and long-term capital strategy.