Despite the upsurge in fighting that has claimed over 3,300 lives since December, the economy was forecast to expand by over seven percent in 2006 and more than eight percent in the coming year, government officials said.
"We're going to see an expansion that has not been seen for nearly 30 years," deputy finance minister Ranjith Siyambalapitiya said.
Preliminary budget estimates placed before parliament projected defence spending would jump to 139.55 billion rupees (1.29 billion dollars) in the 12 months to December 2007 from an estimated 96.21 billion rupees in 2006.
The documents did not contain a 2007 deficit estimate.
But the strain of spending on the three-decade-old ethnic conflict which has killed over 60,000 people was apparent even before the flare-up in violence last December in defiance of a 2002 truce.
The 2006 deficit is projected at 9.1 percent of gross domestic product, up from 8.7 percent the previous year.
The ethnic conflict along with rising global oil prices has pushed inflation to a forecast average 12 percent for 2006 from 3.6 percent last year, the government said.
In October, inflation stood at 17.2 percent.
"It's difficult to see how the country can achieve high growth and keep inflation down at the same time unless there's an end in sight to the (ethnic) conflict," said Alistair Corera, director at Orion Fund management.
Military purchases of weapons and other equipment jumped nearly three-fold with the army, navy and the air force budgets leaping.
Sri Lanka's finance secretary P.B. Jayasundara said overall defence spending was about 4.5 percent of GDP.
Neighbouring India's defence spending represents about 2.5 percent of GDP.
Jayasundara said the budget to be presented in parliament by President Mahinda Rajapakse, who is also finance minister, would target infrastructure.
"We don't have adequate electricity and the quality of electricity available isn't good enough. We don't have roads. Our port capacity is not sufficient," he said.
He said the government hoped to borrow foreign funds to finance a coal power plant, expand the Colombo port and create a southern highway network.
He added 60 to 70 billion rupees (555 million to 648 million dollars) was expected from foreign concessionary loans to finance big-ticket projects next year.
The island nation imports all its oil and gas needs and is heavily dependent on textile exports and tourism, both of which have been hit by an upsurge in violence between Tamil rebels and the military since December.
Sri Lanka's rupee has fallen nearly five percent since the start of the year to around 108.07 against the dollar which the government has attributed to the high cost of oil imports.
Sri Lanka's central bank said the trade deficit during the first nine months of this year widened by 2.59 billion dollars or by 38.4 percent from the corresponding period in 2005.However money sent by Sri Lankans working abroad grew by 23 percent to 1.73 billion dollars and helped contain the current account deficit, the bank said.