How Sri Lanka regains upper-middle-income status after enduring a three-year crisis

The World Bank's Development Data Group reclassified Sri Lanka to upper-middle-income status this week after real GDP grew by 5% in 2025, well above the Bank's own earlier projection of 3.5% for the year.

The country crossed the $4,496 GNI per capita threshold required for upper-middle-income status, only narrowly, according to the World Bank, but crossed it nonetheless just three years after a sovereign default that the institution itself once called the country's worst post-independence crisis.

Sri Lanka's upgrade to upper-middle-income status is the clearest evidence yet that its post-default reform programme worked and worked faster than most comparable recoveries.

Conventional stabilisation programme, consistent execution

Sri Lanka defaulted on its external debt in April 2022 halting payments on approximately $51 billion in foreign obligations. The unprecedented sovereign default was precipitated when several factors converged to cause an economic meltdown. 

There were policy missteps like the massive tax cuts that dried up revenue.  The chronic twin deficits– large fiscal and current account deficits, required excessive foreign commercial borrowing. The 2019 Easter Sunday attacks  and the Covid-19 pandemic devastated the tourism industry while surging global commodity prices strained the balance-of-payments. The island's foreign exchange reserve was depleted and the country was unable to pay for vital imports like fuel, gas and medicines.

What followed was a $3 billion IMF Extended Fund Facility, paired with fiscal consolidation and monetary tightening from the Central Bank of Sri Lanka. 

The government subsequently put in place tax reforms that widened the revenue base, energy pricing was rationalised to end loss-making subsidies, and public spending was reined in, the standard prescription for a crisis economy, but one Colombo stuck to through several difficult budget cycles rather than abandoning midway.

Prof Dr Mustafizur Rahman, Distinguished Fellow at the Centre for Policy Dialogue (CPD), said, on Sri Lanka's turnaround, "Sri Lanka undertook a series of fiscal and monetary measures, with the central bank and the government working in tandem to implement these policies consistently. That is what allowed them to turn the economy around." 

Debt restructuring supplied the breathing room that reform alone could not. A $17.5 billion agreement with private bondholders and China, alongside $4 billion in Indian assistance, allowed Sri Lanka to service its obligations without derailing the stabilisation effort. This combination of external support and domestic discipline is precisely what distinguishes recoveries that stick from those that reverse.

Tourism and remittances converted stability into growth

Macroeconomic discipline created the conditions; tourism and remittances supplied the growth. Tourist arrivals exceeded two million in 2024, a 38% increase over 2023, feeding directly into foreign exchange reserves that had been nearly exhausted during the crisis. Stronger worker remittances added a second, steadier stream of foreign currency, easing the external sector pressure that had driven the 2022 collapse in the first place. 

Together with a broad-based industrial rebound and growth in financial services, these inflows are what the World Bank credits for the 5% expansion in 2025.

A rare instance of policy continuity

Perhaps the least appreciated factor is continuity. Sri Lanka first reached upper-middle-income status in 2019, before losing it as reforms lapsed and the crisis took hold. This time, the stabilisation framework survived a change of government, with the National Peoples Power administration that took office in late 2024 largely maintaining the IMF-backed programme rather than reopening it. 

Dr Mustafiz said, "Their real strength lies in the fact that whatever decisions they take, they actually implement. That is good governance, institutional capacity, the ability to follow through on decisions, and consistent monitoring of whether implementation is actually happening on the ground. After the Rajapaksa era, re-establishing good governance was the task, and they have managed to do this remarkably well. That is precisely why they have been able to achieve both economic stability and recovery." 

The next external debt repayments fall due from mid-2027, and the country's capacity to generate foreign exchange through trade-led growth, rather than aid and remittances, will determine whether this upgrade proves durable.