Sri Lanka’s sovereign credit rating has been upgraded by Fitch Ratings to ‘B-’ from ‘CCC+’, reflecting improvements in fiscal and external balances following macroeconomic stabilisation and structural reforms.

Fitch Ratings has upgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B-’ from ‘CCC+’, with a Stable Outlook, citing reduced external financing risks and greater resilience to economic shocks.

The ratings agency said the upgrade reflected the implementation of macro-stabilisation policies supported by structural reforms. These measures have contributed to a sharp improvement in fiscal and external balances and a modest rebuilding of foreign exchange reserves.

Fitch expects continued fiscal discipline and revenue mobilisation to support primary budget surpluses, helping place government debt on a declining path and reducing the risk of a renewed deterioration in external balances.

However, the agency cautioned that Sri Lanka’s credit profile remains constrained by high government debt and debt-servicing ratios compared with countries in the same rating category. Foreign exchange reserve buffers also remain modest, particularly in view of rising external debt-service obligations over the next five years.

Fiscal position strengthens

Fitch forecasts a primary budget surplus of 2.6% of GDP in 2026, compared with a record 5.4% in 2025. The surplus is expected to be supported by continued revenue growth, although the overall budget deficit is projected to widen to 4.1% of GDP from 2.3% in 2025.

The agency attributed the revenue improvement partly to tax reforms and a temporary increase in import duties resulting from pent-up demand for imported vehicles. These gains, however, are being partly offset by higher expenditure on reconstruction following Cyclone Ditwah and targeted energy support measures.

Fitch expects primary surpluses to remain above 2% of GDP over the next several years, supported by continued revenue mobilisation and expenditure restraint. Revenue collections are projected to remain just below 16% of GDP.

The agency also noted that the Public Financial Management Act of 2024 caps non-interest expenditure at 13% of GDP through 2031, although this ceiling has been exceeded in 2026 because of cyclone reconstruction spending. Fitch cautioned that the risk of fiscal slippage could increase as the 2029 elections approach.

Government debt is forecast to decline to 92.9% of GDP in 2026, from 96.7% in 2025, and continue falling towards the low-80% range over the following five years.

The interest-to-revenue ratio is also expected to improve to 41% in 2026 from 45.6% in 2025 and a peak of 76.3% in 2023. Nevertheless, Fitch noted that the ratio remains substantially above the ‘B’ median, leaving Sri Lanka with limited fiscal space.

External pressures remain

The improvement in Sri Lanka’s external position faces a fresh challenge from higher energy prices. Fitch expects the current account to move into a deficit of 1.2% of GDP in 2026, following three consecutive years of an average surplus of 1.5%.

The agency attributed the deterioration partly to the higher energy import bill and a temporary impact on tourism inflows arising from the US-Iran conflict. Rising worker remittances are helping offset these pressures.

Fitch expects the current account to return close to balance in 2027 as the energy shock eases, although it warned that Sri Lanka remains vulnerable because of its dependence on imported energy and fertiliser.

External financing conditions are expected to remain manageable in the near term, supported by financing from the IMF and other multilateral institutions. Fitch forecasts foreign exchange reserves to reach US$7.7 billion, equivalent to about 2.9 months of current external payments, by the end of 2026

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However, the agency said the pace of reserve accumulation has been dampened by the external shock and that risks remain tilted to the downside.

Debt servicing to become a key challenge

Fitch highlighted rising external debt repayments as a major medium-term vulnerability, particularly after 2028. The agency expects Sri Lanka to face continued exposure to external shocks and potential policy slippage.

The Government is considering a return to international bond markets in 2027, while the current IMF Extended Fund Facility is scheduled to end in March 2027. Fitch said a follow-on IMF programme remains possible and could provide both a policy anchor and a financing backstop.

Growth remains resilient

Despite recent shocks, Fitch expects Sri Lanka’s economy to continue expanding, although growth is projected to moderate to 4.1% in 2026, from an average of 5% over the previous two years.

Medium-term growth is forecast at slightly above 4%. Fitch identified attracting foreign direct investment, expanding exports and revitalising state-owned enterprises as continuing challenges, while noting that sustained reform momentum could improve the growth outlook.

Inflation, meanwhile, is expected to average 6.3% in 2026, compared with deflation of 0.5% in 2025, reflecting higher global energy prices and El Niño-related pressures.

Fitch said the Central Bank raised its policy rate by 100 basis points in May to 8.75% to address inflation risks and support the exchange rate, but does not expect further rate increases. It forecasts inflation to ease to below the Central Bank’s 5% target by 2027.

The upgrade nevertheless leaves Sri Lanka firmly in a rebuilding phase. Fitch identified continued fiscal discipline, stronger revenue mobilisation, a sustained reduction in the debt burden and further accumulation of foreign exchange reserves as key factors that could support future improvements in the sovereign rating.