The flip side of achieving Primary Surplus

• Domestic savings, capital formation and the challenge of sustainable recovery

Following its sovereign default, Sri Lanka has taken a significant step towards restoring macroeconomic stability through the achievement of a primary budget surplus. Fiscal consolidation should be viewed not as an end in itself but as a means of strengthening the economy’s long-term capacity to generate investment, productivity, and growth. The next phase of Sri Lanka’s recovery will depend not on fiscal arithmetic alone but on rebuilding domestic savings, strengthening capital formation, improving competitiveness, and enhancing institutional capability.

Sri Lanka’s achievement of a positive primary budget surplus marks a significant milestone in its recovery from the unprecedented 2022 economic crisis. For the first time in many years, Government revenue has exceeded non-interest expenditure, signaling that the state can finance day-to-day operations without additional borrowing. Together with declining inflation and progress in debt restructuring, these developments have restored macroeconomic credibility. 

In the aftermath of the economic collapse, fiscal consolidation became an economic necessity to restore confidence among creditors and international financial institutions. Yet every major economic achievement involves trade-offs. The more important question is whether the policies that restored fiscal stability have also weakened some of the foundations of long-term economic growth.”

This distinction is fundamental: a primary surplus measures the Government’s fiscal position, not the nation’s capacity to generate future wealth. Macroeconomic stability is a prerequisite; however, it cannot independently yield enduring enhancements in productivity, investment, or living standards. Restoring fiscal discipline was merely the first stage; converting that stability into sustainable growth requires rebuilding the productive foundations of the economy. 

Looking beyond fiscal arithmetic 

Public discussion has understandably focused on improving fiscal indicators. However, successful development requires looking beyond the Government’s balance sheet.

Sri Lanka’s recovery should be viewed through two complementary balance sheets. The first is the Government’s, reflected in revenue, expenditure, deficits, and public debt. The second is the nation’s, comprising its financial, physical, human, technological, and institutional capital. While the first measures fiscal health, the second ultimately determines long-term prosperity.

Lasting prosperity will depend on rebuilding the nation’s productive capacity through higher domestic savings, stronger capital formation, enhanced competitiveness and more capable institutions

A Government may improve its fiscal position while the country’s productive capacity remains weak. If domestic savings decline, productive investment stagnates, and skilled people leave, fiscal improvement alone cannot sustain growth. The national conversation must move toward rebuilding the productive economy. 

The flip side of fiscal consolidation

 Sri Lanka’s fiscal adjustment program has concentrated on revenue mobilisation and expenditure restraint. At the same time, the process has coincided with a significant increase in the cost of living, higher utility tariffs, and reduced disposable incomes. While stronger revenue mobilisation has driven the primary surplus, a substantial proportion has come from indirect taxation, placing a heavy burden on consumption.

Fiscal policy should not merely restore budgetary balance. Its broader purpose should be to strengthen the economy’s capacity to generate future growth. Compared with successful Asian economies, Sri Lanka continues to depend heavily on indirect taxation while facing challenges in attracting investment and expanding exports. Revenue adequacy is essential, but the structure of revenue mobilisation must support entrepreneurship and the future expansion of the tax base itself.

The question, therefore, becomes:” Where will the capital required for Sri Lanka’s next phase of development come from?”

Domestic savings: The missing strategic variable

One consequence of fiscal adjustment has received remarkably little attention: the condition of domestic savings. For years, Sri Lanka relied on a combination of Government investment, domestic savings, and foreign capital. Today, each faces constraints: fiscal consolidation limits public capital expenditure, access to international capital markets remains constrained, and foreign direct investment falls short of regional peers. Savings finance investment; investment raises productivity; productivity strengthens competitiveness.

When external capital is limited and public investment is constrained, domestic savings assume strategic importance. They become the principal source for financing future investment and capital formation. As nations like Singapore, South Korea, and Vietnam have demonstrated, sustained transformation depends upon high levels of investment driven by a country’s capacity to generate its savings. 

The broken savings–investment cycle

The relationship between household savings and national development is profound. Higher household savings strengthen the financial system, expanding long-term investment finance for businesses to upgrade technology and skills. This improves productivity, expands exports, and raises incomes, creating a virtuous cycle. 

Conversely, when real disposable incomes decline over an extended period, households reduce savings. Lower savings weaken the domestic pool of investment capital, slowing capital formation and productivity growth. 

This is the flip side of fiscal stabilisation. In Sri Lanka, the middle class has historically been a principal source of savings and entrepreneurship. Prolonged financial pressure on this segment impacts future innovation and labour productivity. For vulnerable households, persistent reductions in income affect nutrition, education, and healthcare, with long-term implications for human capital.

 Capital formation and competitiveness

Capital formation is the bridge between stability and prosperity. Fiscal stability creates confidence; capital formation creates growth. Without adequate investment, productivity cannot rise, leaving enterprises struggling to compete internationally.

Sri Lanka’s structural challenges—insufficient domestic savings, modest foreign direct investment, and slow export diversification—long predate the 2022 crisis. Because fiscal space remains limited, the Government cannot finance the scale of investment required alone. The private sector must assume a larger role, supported by policies that encourage long-term productive investment over short-term commercial activity. 

Human capital and stronger institutions

Physical capital alone cannot transform an economy; investment in people is equally vital. Sri Lanka, known for its strong human development indicators, faces challenges due to skilled professionals migrating abroad and ongoing skills mismatches. These issues jeopardise the country’s historical advantages in human development. To bolster future competitiveness, it is essential to treat expenditures on education, research, and digital capabilities as strategic investments.

 Ultimately, sustainable development depends upon institutions capable of converting sound policies into measurable outcomes. Sri Lanka has rarely suffered from a shortage of policy ideas but rather a gap between formulation and implementation. Institutional capability—the practical ability of the state to design sound policies and maintain continuity across political cycles—is a critical competitive advantage that remains to be fully developed.

The Government should aim to transition towards growth by reducing tax reliance and fostering investment through structural reforms. Thus, the country’s Primary Budget Surplus should be viewed not as the culmination of economic recovery but as the starting point of a more demanding journey towards sustainable, inclusive and investment-led growth

 The Budget as a strategic instrument

Forthcoming national budgets assume significance extending well beyond annual fiscal arithmetic. Their success should be judged by whether they begin to strengthen the productive foundations of the economy. Their success should be judged by whether they strengthen the productive foundations of the economy through protecting productive public investment, encouraging domestic savings, stimulating private investment through policy certainty, and investing in education, technology, and human capital.

Fiscal discipline and economic development are complementary. Fiscal credibility creates confidence, which encourages investment, raises productivity, expands exports, and generates rising incomes—thereby reinforcing the fiscal position itself.

Conclusion

Sri Lanka has made significant progress since the 2022 crisis, with fiscal stabilisation laying an essential foundation for future growth. However, Sri Lanka’s goal for a primary surplus—mandated by the IMF Extended Fund Facility—largely relies on arduous indirect taxation, which stabilises debt but negatively impacts domestic consumption and savings, thereby jeopardising economic growth. The article highlights the limitations of financial engineering, the need for long-term fiscal policies, and the dangers of complacency within fragile economies. Concerns arise regarding the sustainability of tax-based revenue, with calls for reforms to modernise tax administration and enhance compliance without hindering growth. Lasting prosperity will depend on rebuilding the nation’s productive capacity through higher domestic savings, stronger capital formation, enhanced competitiveness and more capable institutions. 

The Government should aim to transition towards growth by reducing tax reliance and fostering investment through structural reforms. Thus, the country’s primary budget surplus should be viewed not as the culmination of economic recovery but as the starting point of a more demanding journey towards sustainable, inclusive and investment-led growth.

(The author is the former Chairman of the Finance Commission of Sri Lanka with expertise in financial management across various sectors. Having served as an investment banker and a Financial Management Specialist at the Commonwealth Secretariat, his career spans over five decades of dual-sector experience, focusing on institutional governance, fiscal policy, and structural reform in a comparative context)