A distant war, a direct shock: What the Middle East crisis means for Sri Lanka

In a country still recovering from a crisis, confidence itself is a financial variable. If businesses and households begin to believe that every external shock will be allowed to cascade unchecked through prices, transport, and incomes, they will defer spending, cut investment, shorten planning horizons, and hoard cash. That is how an external commodity shock becomes a domestic confidence shock. Preventing that outcome is as important as managing the fuel supply itself 

The war involving the United States, Israel, and Iran is not a remote geopolitical event for Sri Lanka. It is already a real economic shock. The Strait of Hormuz, through which roughly one-fifth of global crude and LNG normally moves, has been severely disrupted, and even after tentative ceasefire signalling this week, markets remain volatile because traders still do not know how durable any de-escalation might be. Brent crude was still trading around the $ 100 mark on 25 March after violent swings in recent days, and the conflict has all but halted much of the usual oil and LNG traffic through Hormuz.

For Sri Lanka, the first instinct is to compare this moment with 2022. That comparison is understandable, but it is incomplete. The symptoms may look familiar: higher fuel costs, inflation pressure, transport stress, queues, and anxiety. The difference is that the 2022 crisis was, in large part, a domestic balance-of-payments collapse whereas today’s shock is primarily external. That distinction matters because it means the policy response must be different. At the same time, we are not starting from the same point of macroeconomic fragility that we were in four years ago. Sri Lanka entered this episode with stronger foreign reserves, lower inflation, a recovering external sector, and a financial system that is significantly healthier than it was during the crisis years.

The Central Bank’s latest signals reinforce that view. It kept the overnight policy rate unchanged at 7.75%  this week (24 March), explicitly citing uncertainty from the Middle East conflict while also noting that inflation was only 1.6% in February and that reserves had risen to $7.3 billion by end-February 2026. According to the Department of Census and Statistics, Sri Lanka grew by 5% in 2025, and the authorities are still targeting 4–5% growth in 2026. This is not the profile of an economy in free fall. It is the profile of an economy in recovery that has now been hit by a major external price and supply shock.

The first-round shock is energy. The second-round shock is everything else

Energy is where the crisis enters first, but it will not remain there. Foreign media has described this as the most severe energy disruption yet seen, with Middle East supply losses reverberating through oil, gas, jet fuel, and fertiliser markets. For Sri Lanka, this means the problem is not only the direct cost of crude. It is also the knock-on effect on transport, logistics, power generation, food production, imported inputs, and household budgets. In response, Sri Lanka has drastically increased the prices at the pump, implemented fuel rationing and approved emergency spot purchases to manage the supply side issues.

This is precisely why the conversation should not stop at oil. When energy prices rise, almost every supply chain begins to reprice. Working capital requirements go up. Freight becomes more expensive. Insurance costs rise. Airlines rework routes and fuel planning. Importers pass through at least part of the increase. Exporters face slower demand and more expensive shipping. Even firms that do not import fuel directly get hit through input costs, transport costs, or the shrinking purchasing power of consumers. Jet-fuel-related disruptions have been recorded across Asia and the closure of key Middle Eastern hubs such as Dubai, Doha, and Abu Dhabi shows how quickly a regional conflict becomes an aviation and tourism problem for the rest of the world.

For Sri Lanka, that second-round effect is especially important because our economy is externally connected in very specific ways.

 A prolonged external shock can still damage bank balance sheets indirectly. The risk does not begin with banks; it begins with clients. This is where the banking system must act as a shock absorber rather than a passive observer. That means disciplined credit assessment, yes, but also intelligent restructuring, sector-specific monitoring, and fast operational responses for otherwise viable borrowers facing temporary stress

Sri Lanka’s vulnerability is not just on the import side

The obvious exposure is energy imports. But Sri Lanka is also exposed through remittances, tourism, trade routes, and labour-market linkages with the Gulf and wider Middle East. CBSL’s remittance bulletins show that Gulf countries remain central to Sri Lanka’s external earnings base: in the first quarter of 2025, the largest remittance sources were Kuwait, the UAE, and Saudi Arabia, and nearly 79% of migrant worker departures were to the Middle East. By the third quarter of 2025, the UAE and Kuwait remained among the top remittance sources. In other words, the Middle East is not peripheral to Sri Lanka’s financial flows; it is part of their core architecture.

Tourism is another transmission channel. Sri Lanka had begun 2026 strongly, with 277,327 arrivals in January and 279,328 in February, and 666,065 arrivals recorded by 18 March. That momentum matters because tourism has been one of the country’s most visible recovery engines. Any prolonged aviation disruption in the Gulf, any further rise in fares, or any deterioration in traveller sentiment will affect arrivals, occupancy, and hospitality cash flows. This is not theoretical; it is already visible in the broader regional aviation disruption being reported across Asia.

The external sector had also been improving before this conflict intensified. CBSL reported that Sri Lanka recorded an estimated external current account surplus of $ 1.7 billion in 2025, and that the external current account in January 2026 was stronger than in recent months and stronger than a year earlier. CBSL also noted stronger export earnings, remittances, and tourism income in the first two months of 2026. That is exactly why this war matters so much: it is hitting Sri Lanka at a moment when recovery channels are working.

The financial system is stronger, but it will now be tested in a different way

From a banking perspective, the right question is not whether Sri Lanka faces an immediate systemic financial crisis. On the evidence available today, it does not. CBSL’s Financial Stability Review summary and its latest financial-sector update both indicate stronger market liquidity, healthier institutions, improving key indicators, and continued credit expansion through 2025. That is an important starting point.

But a prolonged external shock can still damage bank balance sheets indirectly. The risk does not begin with banks; it begins with clients. Transport operators, tourism businesses, small manufacturers, traders, agriculture-linked firms, and households face margin compression when energy and freight costs jump faster than revenues. Some will need higher short-term working capital. Some will face repayment stress. Some viable firms will look weaker for a quarter or two simply because the shock is being transmitted through prices and logistics rather than through poor underlying business models. This is where the banking system must act as a shock absorber rather than a passive observer. That means disciplined credit assessment, yes, but also intelligent restructuring, sector-specific monitoring, and fast operational responses for otherwise viable borrowers facing temporary stress.

There is also a deeper point here. In a country still recovering from a crisis, confidence itself is a financial variable. If businesses and households begin to believe that every external shock will be allowed to cascade unchecked through prices, transport, and incomes, they will defer spending, cut investment, shorten planning horizons, and hoard cash. That is how an external commodity shock becomes a domestic confidence shock. Preventing that outcome is as important as managing the fuel supply itself.

Sri Lanka should treat this moment as a strategic warning. For too long, we have discussed resilience mainly in macroeconomic terms. True resilience is broader. It includes energy security, logistics redundancy, stronger domestic production in selected essentials, deeper capital buffers, better social protection delivery, and a banking system capable of smoothing external shocks rather than amplifying them. The lesson of this crisis is not only that the world is unstable. It is that small open economies must build shock absorbers before the next shock, not during it

Targeted relief matters

Sri Lanka’s recovery remains incomplete. The World Bank notes that food prices more than doubled between 2021 and 2024 and that many households have not recovered lost livelihoods. In that context, a sharp increase of energy costs on  vulnerable households without a targeted cushioning mechanism would be economically and socially costly.

The correct response is not a return to untargeted subsidies and macroeconomic indiscipline. Sri Lanka cannot afford that. The right course is targeted, temporary, data-based support: protecting the most exposed households, safeguarding essential transport and productive sectors, and ensuring that liquidity support reaches viable businesses that are strategically important to employment and foreign exchange generation. This is exactly what fiscal and policy buffers are for.

Sri Lanka is better prepared today than it was in 2022. That is the good news. The harder truth is that preparedness alone will not protect us if this war drags on. What matters now is whether we respond with precision, discipline, and speed

What Sri Lanka should do now

First, secure the energy bridge. The immediate task is to diversify supply where possible, accelerate procurement discipline, and manage demand without creating unnecessary panic. Second, protect the external-earnings engine: remittances, tourism, and key exports need constant monitoring because they are now exposed through the same regional corridor. Third, keep the financial system proactive. Banks should intensify surveillance of exposed sectors now, not after arrears rise. Fourth, communicate the factual situation clearly and in a timely manner.

Finally, Sri Lanka should treat this moment as a strategic warning. For too long, we have discussed resilience mainly in macroeconomic terms. True resilience is broader. It includes energy security, logistics redundancy, stronger domestic production in selected essentials, deeper capital buffers, better social protection delivery, and a banking system capable of smoothing external shocks rather than amplifying them. The lesson of this crisis is not only that the world is unstable. It is that small open economies must build shock absorbers before the next shock, not during it.

There is no doubt that Sri Lanka is better prepared today than it was in 2022. That is the good news. The harder truth is that preparedness alone will not protect us if this war drags on. What matters now is whether we respond with precision, discipline, and speed.

(The author is the CEO/General Manager of People’s Bank. He can be reached via [email protected])

References

Reuters (2026). Oil prices fluctuate as Middle East conflict disrupts Strait of Hormuz flows. https://www.reuters.com/business/energy/us-oil-prices-fall-prospect-middle-east-ceasefire-easing-supply-disruption-2026-03-24/

Reuters (2026). Energy markets react to Iran–US–Israel conflict; supply disruptions and price volatility. https://www.reuters.com/business/energy/iran-wars-energy-impact-forces-world-pay-up-cut-consumption-2026-03-21/

Reuters (2026). Sri Lanka tightens fuel rationing as supply squeeze deepens. https://www.reuters.com/business/energy/sri-lanka-tightens-fuel-rationing-supply-squeeze-deepens-2026-03-18/

Reuters (2026). Regional aviation disruptions linked to fuel shortages and Middle East tensions. https://www.reuters.com/world/asia-pacific/philippine-president-says-grounding-planes-due-fuel-shortage-distinct-2026-03-24/

Reuters (2026). Sri Lanka central bank holds policy rate amid Middle East uncertainty. https://www.reuters.com/world/asia-pacific/sri-lanka-central-bank-holds-policy-rate-unchanged-2026-03-25/

Central Bank of Sri Lanka (2026). Monetary Policy Review – March 2026. https://www.cbsl.gov.lk

Sri Lanka Tourism Development Authority (2026). Monthly Tourist Arrivals Reports 2026. https://www.sltda.gov.lk

World Bank (2025). Sri Lanka Development Update. https://www.worldbank.org/en/country/srilanka/publication/sri-lanka-development-update-2025