Beyond Budget Surpluses: Making Public Expenditure Work for Sri Lanka’s External Sector
“One of the great mistakes is to judge policies and programs by their intentions rather than their results.” — Milton Friedman
Author: Prof. Asoka.S.Seneviratne
Introduction: From economic stabilisation to external-sector strength
Sri Lanka has made considerable progress in restoring macroeconomic stability following its unprecedented economic crisis. Fiscal consolidation, improved revenue mobilisation, debt restructuring and the rebuilding of foreign exchange reserves have helped restore confidence in the economy. These achievements must be protected.
However, economic stabilisation is not the same as economic transformation. A country can improve its fiscal accounts while continuing to face structural weaknesses in its external sector. Sri Lanka’s challenge is particularly evident in the persistent gap between its foreign exchange earnings and its commitments to finance imports, service external obligations and meet other international payments.
This raises an important question for the 2027 Budget: How can public expenditure be transformed from an instrument primarily concerned with allocating financial resources into a strategic instrument for strengthening the country’s capacity to earn foreign exchange?
Recent discussion in the Daily FT, including the article 2027 Budget should strengthen external sector capacity, has rightly drawn attention to the relationship between fiscal policy and external-sector pressures. This discussion deserves to be taken further.
The issue is not whether Sri Lanka should increase or reduce Government expenditure. It is whether the composition, quality and expected economic returns of that expenditure are appropriate for the country’s development requirements.
The 2027 Budget should therefore mark a transition from expenditure discipline alone towards expenditure effectiveness, without compromising fiscal and debt sustainability.
The primary surplus is necessary, but not sufficient
Sri Lanka’s achievement of a primary surplus of 5.4% of GDP in 2025 demonstrated the progress made in fiscal consolidation. The IMF’s May 2026 review projected a primary surplus of 2.3% of GDP for 2027, reinforcing the importance of maintaining a credible fiscal anchor.
However, a primary surplus measures Government revenue less non-interest expenditure. It does not, by itself, establish whether the economy is generating sufficient foreign exchange to meet its external commitments.
Similarly, a Government budget surplus does not automatically produce a balance-of-payments surplus. The two accounts measure different economic relationships.
The external sector is influenced by merchandise exports and imports, tourism, other services, workers’ remittances, investment income and external financing. Consequently, fiscal performance must be assessed alongside the country’s capacity to generate and retain foreign exchange.
The policy implication is clear. Sri Lanka should maintain fiscal discipline, but it should not treat the achievement of a primary surplus as the ultimate objective of economic policy.
The more important question is whether the available fiscal resources are being used to strengthen the productive and foreign exchange-earning capacity of the economy.
Understanding the widening external-sector challenge
Sri Lanka’s external-sector position requires continuous attention.
According to the Central Bank’s August 2026 external-sector assessment, the cumulative merchandise trade deficit reached approximately US$7.2 billion during January–August 2026, compared with US$4.3 billion during the corresponding period of 2025. Tourism earnings declined by 10% over the same period, although workers’ remittances increased by 19.8% to approximately US$6.1 billion.
These developments demonstrate that individual sources of foreign exchange earnings can move in different directions, while import expenditure can increase substantially.
The IMF’s May 2026 projections also indicated a current account deficit of US$534 million for 2026 and US$115 million for 2027.
These projections should not be interpreted as an inevitable outcome. They should instead serve as an early warning that the country’s external-sector capacity needs strengthening.
Sri Lanka must pay attention to both sides of the equation: increasing foreign exchange earnings and reducing avoidable foreign exchange expenditure.
This does not mean indiscriminately restricting imports. Imports of machinery, technology, energy, intermediate goods and essential inputs are necessary for economic growth. The objective should be to ensure that foreign exchange is used productively and that the economy develops a stronger capacity to generate the resources needed to finance these commitments.
Making public expenditure an instrument of foreign exchange generation
Not all Government expenditure produces the same economic returns. Some expenditure increases immediate domestic consumption, while other expenditure creates productive assets, improves efficiency and generates future income.
The 2027 Budget should therefore distinguish between three complementary expenditure priorities.
First, strengthening domestic productive capacity.
Investment in agriculture, fisheries, manufacturing, renewable energy, transport and logistics can reduce production costs, improve productivity and lower avoidable import dependence.
For example, improving agricultural productivity through irrigation, technology, storage, research and better market access can reduce the need for selected food imports while improving rural incomes.
Similarly, developing renewable energy and improving energy efficiency can reduce exposure to imported fossil fuels, strengthen energy security and release foreign exchange for other productive uses.
However, import substitution should not become an excuse for protecting inefficient domestic production. Investments should be guided by productivity, quality, cost competitiveness and long-term economic viability.
Second, expanding foreign exchange-earning activities.
Sri Lanka needs a broader and more diversified export base.
Traditional merchandise exports, including apparel, tea, rubber and coconut products, remain important. However, greater attention should be given to value addition, product diversification, market development and integration into international production networks.
There are also substantial opportunities in tourism, information technology, business-process outsourcing, professional services, maritime services, logistics, education and specialised knowledge-based services.
Public expenditure should support the infrastructure, skills, research, digital connectivity and institutional arrangements required to develop these activities.
Third, investing in future sources of competitiveness.
Sri Lanka should not limit its ambitions to expanding existing industries. It should also identify emerging opportunities in artificial intelligence, digital services, advanced manufacturing, biotechnology, renewable-energy technologies and other knowledge-intensive activities.
This does not mean that the Government should attempt to manufacture every new technology domestically. Rather, it should facilitate partnerships between Sri Lankan entrepreneurs, universities, international investors and technology providers to identify commercially viable opportunities.
Public investment in research, technical education, innovation and industry partnerships can help position Sri Lanka in higher-value segments of international markets.
Connecting the BOI, EDB and National Business Facilitation initiatives
One of the most important requirements is to ensure that public expenditure supports a coordinated institutional system.
The Board of Investment (BOI), Export Development Board (EDB) and National Business Facilitation (NBF) initiatives should operate as complementary components of a broader economic development strategy.
The BOI should concentrate on attracting and facilitating quality domestic and foreign investment, particularly investment that expands productive capacity, introduces technology, develops export industries and creates employment.
The EDB should strengthen export development by helping businesses identify international markets, improve product standards, diversify their markets, develop brands and integrate into global value chains. It should also give greater attention to services exports and emerging sources of foreign exchange earnings.
The National Business Facilitation initiative should help remove the administrative obstacles that delay investment and business activity. Simplifying approvals, improving inter-agency coordination, digitising procedures and developing an effective National Single Window can reduce the time and cost of doing business.
These institutions should not operate as separate administrative entities pursuing disconnected objectives. They should function as a coordinated system, with clearly defined responsibilities and measurable outcomes.
The 2027 Budget should support this coordination through appropriate institutional funding, performance targets and accountability mechanisms.
The ultimate objective should be to convert investment proposals into actual investment, investment into productive activity, and productive activity into exports, employment and sustainable foreign exchange earnings.
Improving the quality of public investment
A major weakness in public expenditure management is the tendency to assess projects primarily through their financial allocations and physical completion rather than their wider economic returns.
The 2027 Budget provides an opportunity to strengthen project appraisal and monitoring.
Major public investment proposals should be evaluated not only by their construction costs and immediate outputs but also by their expected contribution to:
Additional foreign exchange earnings.
Savings of avoidable foreign exchange expenditure.
Export competitiveness and diversification.
Domestic value addition and productivity.
Employment and skills development.
Private-sector investment and technology transfer.
A project that requires substantial imported equipment may initially increase foreign exchange expenditure. However, if it subsequently generates export earnings, reduces energy imports or improves national productivity, its longer-term economic contribution may be substantial.
Conversely, a project with relatively low initial foreign exchange costs may produce limited economic returns if it does not address a genuine productive need.
The Government should therefore introduce an external-sector impact assessment for major public investment projects.
Such an assessment should identify the project’s foreign exchange requirements, expected earnings or savings, implementation period, risks and long-term economic returns.
It should also distinguish between short-term costs and longer-term benefits. This would enable policymakers to make better-informed decisions rather than judging investments solely by their immediate impact on the balance of payments.
Coordinating fiscal, monetary and trade policies
Public expenditure cannot strengthen the external sector in isolation.
An increase in Government expenditure can stimulate household consumption and business activity. If domestic productive capacity does not expand correspondingly, additional demand may be directed towards imported goods and services.
The situation can become more challenging if commercial bank credit expands rapidly and finances consumption and import-intensive activities rather than productive investment.
This is why fiscal policy must be appropriately coordinated with monetary, credit and trade policies.
The Central Bank should continue to safeguard price and financial stability, while allowing monetary and exchange-rate policies to respond to evolving economic conditions within its statutory mandate.
Commercial banks should be encouraged to strengthen lending to viable productive activities, including export-oriented businesses, SMEs, technology-based enterprises and industries capable of improving domestic value addition.
Trade policy should support competitive access to essential inputs, modern technology and international markets. Unnecessary administrative barriers and unpredictable policy changes can discourage investment and weaken export competitiveness.
The objective is not to control every import or direct every lending decision. It is to establish a policy environment in which fiscal resources, financial intermediation and international trade reinforce domestic production and sustainable foreign exchange generation.
Mobilising private investment and international partnerships
The Government cannot finance the entire transformation required by Sri Lanka’s economy through the national Budget.
Public resources are limited, and debt sustainability remains a critical consideration. Therefore, public expenditure should also be used strategically to mobilise private investment.
Well-designed public-private partnerships can support infrastructure, renewable energy, logistics, industrial development and other commercially viable activities.
However, such partnerships must be transparent, competitively structured and supported by appropriate risk-sharing arrangements. They should not create hidden fiscal liabilities or transfer unreasonable risks to the public.
Sri Lanka should also make more effective use of its international economic relationships.
Investment promotion, export market access, technology partnerships, development finance and participation in regional and global value chains should be treated as interconnected elements of economic strategy.
The objective should be to attract investment that contributes to production, exports, skills, technology and employment rather than investment measured merely by the amount of capital announced.
Establishing an external-sector-oriented expenditure framework
The preceding proposals require a practical mechanism for implementation.
I would therefore suggest that the Government consider introducing an External-Sector-Oriented Public Expenditure Framework as an integral part of its medium-term fiscal and development strategy.
Under this framework, major expenditure proposals would be assessed against their expected contributions to domestic productive capacity, export earnings, import efficiency, foreign exchange savings and private investment.
The Ministry of Finance should provide the overall fiscal framework and ensure consistency with debt sustainability and medium-term expenditure limits.
Relevant sectoral ministries should identify investment priorities and establish measurable performance indicators. The BOI, EDB and National Business Facilitation initiative should contribute to identifying investment opportunities, export potential and administrative constraints.
The Central Bank should provide independent analysis of external-sector developments and associated macroeconomic risks, consistent with its statutory responsibilities.
An annual public report could assess the outcomes of major expenditure programmes, identifying whether expected investments, exports, employment and foreign exchange benefits have materialised.
Importantly, this framework should complement, not replace, existing public financial management and investment appraisal arrangements. It should strengthen accountability by connecting budget allocations with measurable economic outcomes.
Summary
Sri Lanka’s economic recovery has restored a measure of fiscal stability, but its external-sector vulnerabilities remain a fundamental challenge. The 2027 Budget presents an opportunity to move beyond treating the primary surplus as the principal measure of fiscal success. While maintaining fiscal discipline and debt sustainability, public expenditure must increasingly be directed towards expanding productive capacity, strengthening export competitiveness, reducing avoidable import dependence and generating sustainable foreign exchange earnings. This requires a strategic approach to public investment, stronger coordination between economic institutions, and a measurable framework for assessing the external-sector consequences of Government spending. Ultimately, the success of the Budget should be judged not only by how much the Government saves, but also by how effectively it helps the country earn.
Conclusion: From fiscal discipline to economic transformation
Sri Lanka’s 2027 Budget is an opportunity to consolidate the achievements of economic stabilisation while addressing the structural weaknesses that contributed to the country’s external-sector vulnerability.
Maintaining a credible primary surplus, controlling public debt and strengthening revenue mobilisation remain essential. However, these objectives should not be pursued independently of the country’s productive and foreign exchange-earning capacity.
The fundamental challenge is to narrow the gap between what Sri Lanka earns in foreign exchange and what it must spend to sustain its economy and meet its international commitments.
This requires more than expenditure restraint. It requires better expenditure decisions, stronger productive investment, export diversification, import efficiency, private-sector participation and effective institutional coordination.
The BOI, EDB and National Business Facilitation initiatives can play complementary roles in translating these priorities into practical economic outcomes.
Ultimately, the success of the 2027 Budget should not be judged solely by the primary surplus it achieves or the amount of public expenditure it contains. It should also be judged by the productive capacity it creates, the foreign exchange it helps generate and save, the investment it mobilises and the employment and prosperity it delivers.
Sri Lanka needs a Budget that does not merely manage scarcity, but builds the country’s capacity to earn and save foreign exchange. That is the transition from economic stabilisation to sustainable economic transformation.
The writer served as the Special Advisor to the Office of the President of Namibia from 2006 to 2012 and was a Senior Consultant with the UNDP for 20 years. He was a Senior Economist with the Central Bank of Sri Lanka (1972-1993). He can be reached via asoka.seneviratne@gmail.com