Sri Lanka’s recovery over the past year reads like a narrow escape rendered into a cautious, albeit unfinished success story. After the calamitous months of 2022, when foreign-exchange reserves and fuel imports evaporated and the country teetered on the brink of sovereign default, the island has staged a visible turnaround.

But the recovery remains fragile, uneven and is to some extent still dependent on external lifelines and domestic reforms.

The clearest headline is growth. After contracting sharply during the crisis, the economy expanded robustly in 2024, with GDP growth estimated at around 5%, according to the IMF and Sri Lanka’s Department of Census and Statistics (IMF Country Report No. 24/87) at the time - a figure that surprised many international forecasters and reflected a rebound in services and agriculture.

That recovery has continued into 2025: domestic demand has revived, manufacturing output has climbed, and tourism arrivals exceeded 2mn in the first eight months of the year, according to Reuters a month ago – in the process bringing much-needed foreign currency back to the island.

Authorities in Colombo have also succeeded in meeting key IMF programme conditions, and unlocking successive tranche disbursements under the $2.9bn Extended Fund Facility (EFF) approved in 2023. Those funds, alongside stronger remittance inflows which rose to $6.4bn in 2024, up 12% year on year, according to Central Bank of Sri Lanka (CBSL) data, have helped rebuild official foreign-exchange buffers and stabilise the rupee after years of volatility.

“We are now in a position of relative stability,” Central Bank Governor Nandalal Weerasinghe told Reuters, adding that “discipline and structural reforms” were key to avoiding backsliding.

Yet beneath the surface, macroeconomic stability remains a work in progress. Both the IMF and the World Bank’s Sri Lanka Development Update of June 2025, stress that near-term gains rest on continued fiscal consolidation and structural reform rather than a one-off rebound.

As such, the World Bank cautions that, while inflation has turned positive again and consumer demand is firming, financing pressures persist. The government in Colombo faces steep short-term refinancing needs, and public debt remains above 100% of GDP even after restructuring. The Bank warned that “growth without sustained fiscal repair would be precarious,” noting that one in four Sri Lankans remains vulnerable to poverty.

The banking sector tells a similar story of cautious improvement. The Central Bank’s Financial Stability Review 2025 highlights that profitability, capital adequacy and liquidity ratios have strengthened from crisis lows, aided by lower provisioning and improved net interest margins.

Market liquidity also improved during the first half of 2025, while non-performing loans (NPLs), which peaked at 13% in 2023, have fallen to below 9%, helped by restructuring and recovery. The CBSL’s Banking Soundness Index shows a more stable system than at any time since 2021.

But vulnerabilities remain. Local banks’ exposure to government securities, which account for nearly 40% of total assets, leaves them highly sensitive to fiscal risks. Lending growth, particularly to small and medium enterprises, remains subdued. The IMF’s second review of August 2025, urged Colombo to strengthen banking supervision and diversify capital markets to reduce systemic risk. “The scars of 2022 haven’t fully healed,” one senior banker reportedly told Reuters. “The sector is stronger, but still wary.”

Foreign-exchange reserves – a key aspect of the economy for an import-dependent island - have recovered from near-zero levels in 2022 to roughly $5bn by mid-2025, according to CBSL monthly balance reports. This rebound reflects IMF disbursements, improved remittances, and resumed access to international capital markets following debt restructuring with China, India and Paris Club creditors. The improvement has reduced the acute risk of import stoppages that once led to nationwide fuel queues and the much-hated rolling blackouts.

However, reserves remain modest relative to import requirements, covering just over three months of imports, according to IMF data, and any deterioration in the balance of payments could again prove destabilising. Fiscal consolidation, particularly through improved tax collection, remains vital. The government’s goal of raising tax revenue to 15% of GDP by 2026 (from 9.1% in 2023) will be crucial to maintaining debt sustainability, according to the Finance Ministry’s 2025 Budget Statement.

To this end, the energy sector encapsulates both the progress and fragility of the recovery. The Ministry of Power and Energy in Sri Lanka reported that total electricity generation reached approximately 17,364 GWh in 2024, with renewables - primarily hydro and solar - accounting for nearly 48%. The Ceylon Electricity Board’s (CEB) Long-Term Generation Expansion Plan (2024–2043) outlines a shift towards renewables, with 70% of generation expected to come from non-fossil sources by 2030.

Yet the grid’s weaknesses were exposed again in early 2025 when a nationwide blackout plunged the island into darkness for nearly 48 hours, Reuters reported at the time. The outage underscored the urgent need to modernise transmission systems and improve grid resilience. The government has since pledged a $200mn grid modernisation plan, partly financed by the Asian Development Bank, but implementation has lagged.

Another issue is that for ordinary Sri Lankans, the recovery’s texture remains uneven. Inflation, which had soared above 70% in 2022, has now stabilised at around 4–5%, according to CBSL’s September 2025 inflation report. Food and fuel prices have moderated, and the Central Bank has cautiously reduced policy rates from 11% to 9% to spur consumption. Yet fiscal consolidation has come with painful trade-offs. Increases in VAT (to 18%) and cuts to fuel and electricity subsidies have disproportionately affected lower-income households. The World Bank estimates that national poverty, while improving, remains above the 25% mark, underscoring the recovery’s social fragility.

The government of President Anura Kumara Dissanayake faces a delicate balancing act: maintaining fiscal discipline without igniting social unrest ahead of elections expected in 2026. Investor confidence has strengthened with Fitch Ratings signalling potential upgrades if reform momentum continues, but the risk of populist policy reversals looms large.

So where does Sri Lanka go from here? The optimistic path is clear: maintain IMF-backed fiscal discipline, broaden the tax base, accelerate investment in renewable energy and digital infrastructure, and strengthen social safety nets to ensure inclusive growth. But the darker scenario of reform fatigue, renewed external shocks, or pre-election spending unravelling much of what has been rebuilt, is an ever present danger.