World Bank Lifts Sri Lanka’s Growth Forecast; Says Recovery Running on Credit

Four years after the crisis, sri lanka’s economy has finally made up the lost ground. How fast it grows from here, the world bank says, depends on reform. The bank’s latest sri  lanka development update, from recovery to transformation, released in colombo on 6 october, raises this year’s growth forecast to 4.4%, From 3.6% In april. On current policies, it expects growth to ease to 4.2% In 2027 and 4.0% In 2028.

The forecast matters because the recovery is uneven. The public finances have strengthened: the Bank expects a primary surplus, meaning revenue above spending before interest on debt is counted, of 3.9% of GDP this year, keeping public debt on a gradual decline. Households are another matter. Inflation has climbed to 8%, and poverty, at 16.9% in 2025, remains above its pre-crisis level of 11.5%. “Sri Lanka’s economic recovery continues. It is real, and many households are still waiting to feel it,” said Jakob Engel, a senior country economist for Sri Lanka at the World Bank and a lead author of the report, at its launch.

Engel set out what the forecast assumes, why the World Bank expects inflation to ease sooner than the central bank does, and why it has singled out agribusiness as a route to faster growth. What follows draws on his presentation and responses to reporters’ questions at the report’s launch.

You forecast 4.4% economic growth in 2026. What would it take for Sri Lanka to grow faster?

Jakob Engel: Without new reforms, we expect growth to settle at around 4% a year. A serious push on structural reforms, meaning changes to the basic rules governing labour markets, trade, and investment, could lift that to 5% or 6%.

Our forecast is a baseline, which means it assumes current conditions continue. It assumes no major new reform effort, but also no retreat from the government’s announced fiscal and trade policy changes. On that basis, growth eases from 4.4% this year to 4.2% in 2027 and 4.0% in 2028. That is what we see as realistic under current policies.

The reason lies in what is driving growth today. Investment, measured as gross capital formation (spending on infrastructure, buildings, and machinery), rose 25.5% in the first half of the year, with household consumption the second driver.

Faster growth has to come from private investment, exports, and productivity, meaning the amount each worker produces.

Both are being financed by private credit, bank lending to households and businesses, which is growing at about 25% a year. Much of today’s growth is running on borrowed money, and that is one reason price pressures are spreading across the economy.

Exports and government spending are not driving growth. GDP, the total value of what the economy produces, has only just returned to its pre-crisis level, and industry is still below where it was in 2018.

Faster growth has to come from private investment, exports, and productivity, meaning the amount each worker produces. That rests on three things. The first is a predictable business environment: stable prices, clear rules for investment and competition, and an end to anti-export bias, the policies that make selling at home more rewarding than selling abroad. The second is foundational infrastructure, together with rebuilt fiscal and external buffers, the government savings and foreign-currency reserves that cushion the economy against the next shock. The third is private finance directed into priority sectors such as agribusiness.

Inflation has climbed from 2.2% in March to 8%, well above the central bank’s own 5% target. The central bank expects inflation to stay in the high single digits into early 2027. Why does the World Bank suggest inflation will decline faster?

Engel: We assume inflation is at, or very close to, its peak. The month-on-month figures point that way. From here we expect inflation to move towards the central bank’s 5% target relatively soon and stay in single digits.

Our 5.7% inflation forecast for 2026 is an average for the year, not a year-end figure. We already have nine months of data, and prices are now running 8% above a year ago. So even a rapid decline would make it hard for the full-year figure to get down to the 5% target. After that, we see inflation easing to 5.3% in 2027 and reaching 5% in 2028.

The rise has been driven primarily by energy and transport costs, after the Middle East conflict pushed up oil, gas, and fertiliser prices worldwide, and transport in particular has become much more significant in recent months. We are also seeing rising food prices, driven in part by a weaker rupee, by higher transport costs being passed through into food
prices, and by more expensive fertiliser. Core inflation, which strips out volatile food and energy prices to show underlying pressure, is also rising. Together with rapid growth in bank lending to households and businesses, that suggests price pressure is becoming broad-based, spreading beyond fuel and food into the wider economy.

As a small open economy, one that trades heavily with the world and cannot influence global prices, Sri Lanka remains exposed to outside shocks. But in this recent shock the central bank has shown strong determination to step in if inflation expectations, meaning what households and businesses believe prices will do, start to drift upward.

You point to the central bank’s determination. The rupee weakened about 8% against the dollar by June before partly recovering. Has the central bank done enough?

Engel: It has pulled several levers, and they have partly worked. In May the central bank raised its policy rate, the benchmark rate that sets the cost of borrowing across the economy. It also tightened its macro-financial measures, the rules governing lending and foreign-currency flows, including requiring exporters to convert their foreign earnings into rupees more quickly, and it extended an additional import charge on motor vehicles. Those actions have gone some way to countering the pressure on the rupee and the fall in reserves, but reserves are still lower than they were several months ago. The pressure came quickly. When the Middle East conflict broke out, official reserves, the foreign currency the central bank holds to pay for imports and service foreign debt, fell rapidly, and the exchange rate came under strain at the same time. A weaker rupee makes every imported good more expensive, which is one reason it has fed into food prices.

Sri Lanka’s IMF programme ends in March 2027. In 2022,Sri Lanka’s access to the World Bank’s concessional loans was linked to having one. Will that still hold?

Engel: No. Our funding decisions are made independently of whether an IMF programme is in place. That includes budget support, money paid directly into the government’s budget in return for agreed reforms. We already have a budget support series under way: our Board approved the first operation in June, and the second is being prepared. We expect that to continue, provided economic conditions allow. An IMF programme is a strong signal of a sound macroeconomic framework, but we make our own assessment.

“Unpredictable policy discourages investment, and the low incomes it leaves behind create pressure for the same protection.”

Beyond growth and inflation, where does the forecast leave public finances, external accounts, and household poverty by 2028?

Engel: We expect the government to keep running a high primary surplus. We see it at 3.9% of GDP this year and close to 3.5% in 2027 and 2028. Surpluses of that size keep central government debt on a downward path, from 87% of GDP in 2026 to 77.2% in 2028.

Externally, we expect a small current account deficit to remain, of between 0.3% and 0.5% of GDP each year, after a surplus of 1.6% in 2025. The current account is the balance of a country’s trade, services, and income flows with the rest of the world, remittances included, so a deficit means more foreign currency is leaving than arriving. It is partly driven by continued instability in energy markets.

Poverty, measured at the $4.20-aday line used for lower-middle-income countries, moves towards 14% by 2028, from 16.9% in 2025. That is still above the 11.5% recorded before the crisis.