Sri Lanka Grapples with Tax Hikes amid Fragile Economic Recovery

• 5opn1
• January 11, 2025
• Weekly Economic Review
• Weekly Economic Review
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Weekly Economic Review

Sri Lanka’s government, led by President Anura Kumara Dissanayake, finds itself under increasing scrutiny for a series of tax hikes that have strained public finances and failed to provide meaningful relief to citizens.

While the Central Bank of Sri Lanka (CBSL) touts improved macroeconomic stability and a 5% growth rate in 2024—the highest since 2017—these gains are overshadowed by the stark realities faced by the public.

Rising living costs, increased taxes, and limited social welfare measures paint a challenging picture for the island nation still recovering from its worst economic crisis in history.

The CBSL, during the launch of its Policy Agenda for 2025 and Beyond, emphasized the importance of sustained economic reforms to cement the progress achieved so far.

Governor Dr. Nandalal Weerasinghe highlighted that macroeconomic stability has been restored through decisive policies, enabling the country to pursue structural reforms and strengthen institutions.

Despite these claims, many Sri Lankans feel left behind, struggling to cope with escalating costs and limited government support.

Mixed Signals in Economic Indicators

The Central Bank’s data reveals some promising signs. The economy grew by 5% in 2024, reflecting improved fundamentals.

Tourism revenue surged by 53.2% to $3.17 billion, the highest since 2018, with 2.05 million arrivals marking a six-year high.

However, this success fell short of the government’s target of 2.3 million visitors, with visa policy changes and security concerns cited as major deterrents. Workers’ remittances also improved, reaching $613.8 million in December 2024 compared to $569.7 million in the same period in 2023.

Earnings from tourism and remittances contributed to bolstering Sri Lanka’s gross official reserves, provisionally estimated at $6.09 billion at the end of 2024.

Yet, the Sri Lankan rupee depreciated by 1% against the US dollar as of January 10, 2025, signaling continued vulnerabilities in external financing.

Government revenue and grants increased to Rs. 3,664.6 billion from January to November 2024, compared to Rs. 2,771.4 billion in the same period of 2023.

However, total expenditure and net lending also rose to Rs. 4,881.9 billion, highlighting the persistent budget deficit, which, although reduced to Rs. 1,217.3 billion, remains a concern. Net domestic financing dropped significantly to Rs. 889.5 billion in the same period, while net foreign financing increased to Rs. 327.8 billion, underscoring the country’s reliance on external funding.

Rising Public Discontent over Taxes

Amid these mixed economic signals, the government’s tax policies have sparked widespread discontent.

The 2025 Appropriation Bill set a borrowing limit of Rs. 4,400 billion while allocating Rs. 4,218 billion for current spending and Rs. 4,616 billion for capital expenditure.

Significant increases in excise duties on alcohol, cigarettes, mineral water, and plastics, announced on January 11, aim to raise additional revenue but have drawn sharp criticism for disproportionately affecting low-income households.

Alcohol taxes, for instance, have seen steep hikes. Excise on special arrack rose from Rs. 6,840 to Rs. 7,244 per proof liter, while taxes on coconut arrack increased from Rs. 7,320 to Rs. 7,752.

Beer with alcohol content above 5% now carries an excise of Rs. 6,015 per liter, up from Rs. 5,680. While the government argues these measures are necessary to boost revenue, critics highlight the regressive nature of such taxes and their potential to fuel illegal alcohol production.

The central bank’s deflationary policies, aimed at curbing inflation, have also come under scrutiny. Although inflation fell significantly in 2024, interventionist measures tied to the IMF-backed bailout have led to a 5-7% increase in the cost of living, further straining household budgets.

The government has committed to additional revenue generation in 2025 to fund salary hikes for state workers and expanded subsidies, but these measures risk exacerbating public dissatisfaction if not carefully managed.

Challenges in Agriculture and Food Security

The government’s approach to agriculture and food security has been another contentious issue. Despite President Dissanayake’s farming background, the administration has struggled to implement effective policies to support farmers while ensuring affordable prices for consumers.

Farmers continue to receive minimal compensation for their produce, while consumers face exorbitant costs for essentials like rice. The manipulation of rice prices by powerful interest groups remains unchecked, and quick fixes, such as increased imports, have failed to address the root causes of the problem.

Observers have urged the government to prioritize long-term solutions, such as strengthening domestic production and creating support structures for farmers.

The National People’s Power (NPP) coalition’s focus on resourcing the domestic agricultural sector has been widely applauded. However, critics argue that these efforts need to be scaled up and integrated into a broader strategy to achieve food security and economic independence.

Geopolitical Opportunities and Strategic Priorities

Sri Lanka’s strategic location in the Indian Ocean presents significant opportunities to strengthen its economy through astute diplomacy. As global powers like China, India, the US, and Japan vie for influence in the region, Sri Lanka could leverage its position to secure investments and build partnerships. President Dissanayake’s recent trips to India and China are seen as crucial steps in this direction, although concrete outcomes remain to be seen.

The next five years will be critical for the Dissanayake administration to lay the groundwork for economic independence and restore international credibility. However, achieving these goals will require balancing fiscal discipline with social welfare, a challenge that the government has yet to convincingly address.

Tourism: A Silver Lining

The tourism sector’s recovery offers a rare bright spot for Sri Lanka’s economy. Revenues rose to $3.17 billion in 2024, marking a significant improvement from $2.07 billion in 2023. This resurgence was driven by increased arrivals, which peaked at 2.05 million—the highest since 2018.

However, industry players blame the missed target of 2.3 million tourists on poor policy decisions, including abrupt changes to visa processes and lingering security concerns.

While tourism earnings have provided much-needed foreign exchange, experts caution against over-reliance on the sector. Diversifying the economy and investing in sustainable industries will be key to ensuring long-term stability.

The Road Ahead

As Sri Lanka enters 2025, the Dissanayake administration faces immense challenges in balancing fiscal reforms with public expectations. The government’s heavy reliance on tax hikes and external funding has raised questions about its ability to chart a sustainable economic path. Meanwhile, the opposition remains fragmented, offering little in terms of alternative strategies.

The upcoming 2025-26 budget will be a litmus test for the administration’s priorities and its commitment to addressing the pressing needs of its citizens. For now, Sri Lanka’s economic recovery remains fragile, with the twin goals of economic independence and public welfare hanging in the balance.