Sri Lanka’s newly elected Government faces a formidable challenge as it prepares to present its full-year Budget for 2025 in Parliament tomorrow.
President Anura Kumara Dissanayake, who also serves as the Finance Minister, will unveil the National People’s Power (NPP) Government’s first full-year Budget. This Budget serves as the administration’s inaugural policy statement, setting the economic direction for the country amid severe financial constraints.
On one hand, President Dissanayake must fulfill key electoral promises made during the past two elections. On the other, he must operate within limited resources, navigating an economic recovery following an unprecedented sovereign debt default while adhering to strict conditions imposed by the International Monetary Fund (IMF) under its $3 billion bailout package.
Managing Budget for a bankrupt nation
Crafting a Budget for a bankrupt nation requires careful fiscal planning to avoid another sovereign debt default. The Government has set key targets, including raising tax revenue to around 15 percent of Gross Domestic Product (GDP) and capping primary Government expenditure at 13 percent of GDP to maintain fiscal prudence.
The 13 percent expenditure cap is a new requirement introduced under the Public Finance Management Act (PFMA), passed by former President Ranil Wickremesinghe’s Government in May last year. This means Government spending—excluding interest payments and debts—must remain within this limit, regardless of revenue levels. Any increase in Government spending requires higher GDP growth, emphasizing the need for economic expansion.
According to the Central Bank, Sri Lanka’s economy was estimated to have grown by around five percent last year. However, with constrained resources, the Government must prioritise spending to achieve both short-term relief and long-term economic stability.
Rural development and social protection
“This Budget is constrained, and we accept that,” said NPP legislator Lakmali Hemachandra in a recent TV show.
However, she said that the Government’s primary focus remains rural development, ensuring more funds flow into rural areas through targeted projects.
The second major priority is social protection. The Government aims to provide a robust safety net and economic empowerment for vulnerable communities.
“The economic crisis hit ordinary people the hardest. We want to help them recover while laying the foundation for industrialisation and economic reform,” Hemachandra said.
Though financial limitations restrict the extent of reforms, the Government is committed to initiating key policy changes within this Budget to establish a foundation for future development, she said.
Key Budget proposals
President Dissanayake has already announced several Budget proposals set to take effect in the new fiscal year, starting April 1, 2025. These include:
Doubling the withholding tax (WHT) to 10 percent.
Increasing the monthly taxable income threshold from Rs. 100,000 to Rs. 150,000.
Exempting locally produced dairy products from Value Added Tax (VAT).
Lifting tax exemptions on the export of services, which will be taxed at 15 percent.
This Budget is critical for Sri Lanka as it seeks to avoid another sovereign default.
The 2022 economic crisis led to severe shortages of essentials and widespread public unrest, culminating in the ouster of former President Gotabaya Rajapaksa.
Now, in 2025, the NPP Government is forced to strike a delicate balance between fulfilling electoral promises and adhering to IMF conditions.
Electoral promises vs IMF constraints
The NPP’s rise to power was based on a platform of economic recovery, social equity, and anti-corruption measures. Its promises include tax reforms, public sector wage increases, and greater investment in healthcare, education, and infrastructure.
A key electoral pledge was reducing the tax burden on lower- and middle-income earners by restructuring the tax system to ensure a more progressive framework.
Recognising the erosion of real wages due to past inflation, the Government has proposed salary increments for public sector employees to improve living standards and stimulate domestic consumption. Finance Ministry officials said that revenue for these wage hikes will be generated through higher taxes on imported vehicles.
The Budget also includes a significant increase in funding for healthcare and education. While the NPP in the past had originally aimed for six percent of GDP in education spending, Hemachandra said that the current Budget falls short of this target, but still represents a substantial increase in allocation.
IMF mandates and fiscal constraints
The IMF bailout program was crucial in stabilising Sri Lanka’s economy, but it comes with stringent conditions aimed at restoring fiscal discipline and ensuring debt sustainability. These conditions include, fiscal consolidation, higher taxes, restructuring of loss-making State-Owned Enterprises (SOEs), and debt restructuring.
The IMF requires Sri Lanka to achieve a primary surplus of 2.3 percent of GDP in 2025, necessitating strict expenditure control and increased revenue generation. This means while the Government seeks to reduce tax burdens for lower-income groups, any reductions must be offset by alternative revenue sources. The IMF has recommended new property and wealth taxes, though NPP officials have indicated these will not be rushed due to a lack of proper data.
The Government may delay SOE reforms for a year, giving it time to prove its ability to reduce fiscal burdens from loss-making SOEs. However, cost-recovery pricing mechanisms, particularly in the energy sector, have already been implemented despite public opposition. While the Government has expressed its eagerness to provide relief, it faces the formidable challenge of balancing public expectations with IMF stipulations.
Alternative revenue streams must be identified to offset tax relief measures. These could include expanding the tax base, improving compliance, and increasing taxes on luxury goods and high-income earners.
Challenges ahead
Although the Government has allocated Rs. 90 billion for public sector wage increases, improving State-sector efficiency remains a significant challenge. Any salary hikes should be accompanied by performance-based incentives and administrative reforms to ensure better service delivery.
The public has already begun voicing concerns about rising prices for essential goods such as rice and coconut, as well as sudden price hikes for new motor vehicles. However, lower interest rates, a stable exchange rate, and deflation have helped keep overall price levels in check. Maintaining macroeconomic stability will be crucial for the Government to deliver on its promises.
With little room for manoeuvering, this Budget will serve as a litmus test for the NPP Government’s ability to govern effectively while steering Sri Lanka towards sustainable economic recovery.
