According to the latest official data, the Sri Lankan economy grew by 4.7 percent during the first half of 2026. Although many analysts hail this as an indication of a stable economic recovery, some argue that economic recovery is hardly felt by ordinary citizens. A recent survey shows that only 25 percent of households in the country earn enough to cover their living expenses suggesting that cost of living has reached to a very high level amid inflation reaching above 8 percent. Hence, there appears to be a clear disconnect between the official economic growth numbers and what ordinary citizens experience.

Flawed Fiscal Policy

When we analyze the 2026 first half GDP data (as shown below), we can observe that the economy expanded by an overall 11.2 percent in nominal terms. However the increase in real economic activities or Gross Value Addition (“GVA”) was a much lower 8.6 percent. In between the growth of GDP and GVA was a massive 34.6 percent increase in (net) consumption taxes.  

 

Gross Domestic Product – Nominal

Rs, millions

 

1H 2025

1H 2026

Change

Gross Value Addition  ("GVA")

14,099,898

15,308,547

8.6%

Taxes less Subsidies* (“T&S”)

1,567,894

2,110,281

34.6%

GDP

15,667,792

17,418,828

11.2%

T&S as percentage of GDP

10%

12%

 

*Subsides are a very small figure and hence not shown as separate line item.

 

As seen above, consumption taxes amount to 12 percent of GDP. This means that the government takes (on average) a 12 rupee cut on every 100 rupee worth of economy in the country (production of goods and services). This cut is in addition to income taxes individuals and businesses pay (which are not accounted for in GDP). This tax directly impacts the cost of everything that is sold in the country resulting in slowing down consumer demand and pushing up prices. Therefore, we can clearly argue that government fiscal policy is the main reason behind the widening gap between GDP growth on paper and what people experience.    

Indirect or consumption taxes totaling 12 percent amid slower expansion of GVA points to a major “economic shock” rather than an “economic transformation”. This “shock” is clearly evident when we compare GVA and GDP trends over a longer period of time.

Growth in Nominal GVA

Growth in Nominal Taxes less Subsidies (T&S)

Growth in Nominal GDP

Gap between GDP Growth and GVA Growth *

T&S as share of GDP

2011

16%

-11%

13%

-3%

8%

2012

21%

3%

20%

-1%

7%

2013

11%

8%

11%

0%

7%

2014

8%

9%

8%

0%

7%

2015

6%

27%

7%

1%

8%

2016

10%

22%

11%

1%

9%

2017

12%

17%

12%

0%

9%

2018

7%

1%

7%

-1%

9%

2019

5%

-7%

4%

-1%

8%

2020

1%

-28%

-2%

-2%

6%

2021

13%

7%

13%

0%

5%

2022

38%

19%

37%

-1%

5%

2023

13%

52%

14%

2%

6%

2024

6%

52%

9%

3%

9%

2025

5%

46%

9%

3%

12%

*GDP Growth less GVA Growth

 

As shown above, the gap between GDP growth and GVA growth have expanded sharply since 2023 driven by contractionary fiscal policies. As seen above, it is possible to have a negative gap suggesting expansionary fiscal policies prevailed during such periods.

Danger of Economic Stagflation

Sri Lanka’s high indirect taxes are probably among the highest in the world. Shown below are few other countries for comparison purposes:

 

Country

Consumption taxes as percentage of GDP (approx.)

Sri Lanka

12.1*

India

5.6

Vietnam

6.7

Bangladesh

4.7

Malaysia

3.2

Singapore

3.1

UK

10.5

Australia

7.3

OECD countries (avg)

10.8

*1H 2026

 

 

Short and medium term outcomes of high indirect taxes or contractionary fiscal policies include rise in prices (inflation) and decline in demand (economic activity).

Prolonged high indirect tax regimes could lead to economic stagflation leading to deterioration of export competitiveness. Sri Lanka is already seeing signs of higher inflation together with expected slowdown in overall GDP growth during next two years. But the worst impact is going to be gradual shrinking of the middle class and increase in poverty.

(The writer is an Investment, Strategy and Policy Advisory professional in Sri Lanka. He has a master’s degree in economics (Colombo), an undergraduate degree in business (Wisconsin, USA), and CFA charter (USA). The views expressed are personal. He can be reached at indika.h@jupitercapitalpartners.com    © 2026, Indika Hettiarachchi)