SRI LANKA'S REFORM DRIVE FACES TARIFF RISKS

Sri Lanka’s fragile fiscal recovery could stall if pending U.S. tariffs erode tax revenue and unsettle investors.

- By Prof. M. Udara Peiris

Trade uncertainty may delay tax hikes, stall subsidy reforms, and disrupt bond offeringswidening deficits and prompting higher risk premiums from lenders. Sri Lanka, still rebuilding its credit after default, now faces this predicament as even relatively favourable tariff terms could trim up to 162 million dollars from annual revenue, or around 25 % of the near term ISB payments. Most of this loss stems from tax exemptions on U.S. imports, not from reduced export tax revenue.

The challenge underscores a key lesson: the best way to steady the budget and reassure investors is to advance fiscal, trade, and economic reforms.

Based on projected tax losses due to reduced export volumes, Sri Lanka could face annual revenue losses ranging from USD 60 to 78 million in the case of a 20% drop in exports, and USD 131 to 172 million if exports decline by 30%

Directly in the Line of fire

On April 2nd, the U.S. imposed a 44% duty on nearly all Sri Lankan exports, then suspended it two days later pending a court review. In 2024, Sri Lanka exported $2.9 billion to the U.S.—23% of total exports. Apparel and rubber products make up 75% of this, contributing 64% and 11% respectively.

To determine the effect on government revenue, there are two avenues by which revenues would decrease:

1. The reduction in tax revenue through domestic value-added.

2. The reduction in tax revenue if the import tariff is set at zero on US goods.

According to Publicfinance.lk, a 44% tariff on Sri Lankan exports to the United States would likely reduce exports by 20% for apparel and 28% for rubber-based products. Based on these numbers, I analyse the reduction in tax revenue through domestic value-added under a 20% or 30% reduction in exports from the current level and then identify the revenue loss under each scenario.