As Sri Lanka’s economy stabilises under the new government, a looming El Niño threatens to reignite food inflation and test hard-won gains.

Sri Lanka, still navigating the fragile recovery from its 2022 economic meltdown, faces a new climate-driven challenge. Sri Lanka’s First Capital Research has warned that an emerging El Niño phase could drive food inflation into double digits late this year and persist through 2027, compounding pressures on households and policymakers.

Recovery Gains at Risk

The island nation has made notable strides since the crisis. Under President Anura Kumara Dissanayake (AKD) and the National People’s Power (NPP) government, which took power in late 2024, the economy has shown resilience. GDP growth rebounded strongly, inflation moderated significantly (even turning negative at points), and foreign reserves have strengthened. Debt restructuring has progressed substantially, with agreements reached with most creditors, placing public debt on a more sustainable path.

However, these gains remain vulnerable. The country’s agriculture sector, a cornerstone of food security and exports, is particularly exposed to climatic shifts. First Capital Research’s latest economic update highlights early indicators of an El Niño developing in 2026, expected to strengthen through late 2026 and peak into early 2027, mirroring the severe 2015-2016 event.

Lessons from 2015-2016

During the previous strong El Niño, Sri Lanka experienced significant disruptions. Paddy production plummeted by around 50 per cent from peak levels due to drought conditions. Headline inflation, as measured by the Colombo Consumer Price Index (CCPI), rose from about 2 per cent to 8 per cent over 24 months. Supply shocks prompted the Central Bank of Sri Lanka (CBSL) to hike policy rates by 100-125 basis points. Government spending also surged temporarily to support affected farmers and manage food security.

First Capital overlays this historical impact onto current baselines. In a severe scenario, food inflation could hit 10-12 per cent year-on-year (YoY), persisting for up to 24 months. Even in a moderate case, increases of 5-7% YoY lasting 12-18 months are projected. These risks arise from weakened agricultural exports, higher food imports to cover domestic shortfalls, and reduced hydropower output leading to greater reliance on imported thermal fuels – widening the trade deficit.

Banking sector impacts may lag, with non-performing loans (NPLs) potentially rising as farmers and agribusinesses struggle, echoing delays seen after 2016.

Broader Economic Context in 2026

Sri Lanka’s economy in mid-2026 shows mixed signals. Growth has stabilised around 4-5 per cent in recent periods, supported by tourism recovery, remittances, and fiscal consolidation under the IMF’s Extended Fund Facility (EFF). The government has maintained reform momentum, focusing on revenue enhancement, anti-corruption measures, and public sector efficiency.

Yet structural vulnerabilities persist. The country remains import-dependent for many essentials, and agriculture employs a significant portion of the workforce while contributing to exports like tea, rubber, and spices. Global forecasts indicate El Niño could disrupt monsoons and rainfall patterns across South Asia, threatening rice and other key crops.

Recent global analyses warn of potential simultaneous price shocks for major food commodities under a strong El Niño, exacerbating import costs for nations like Sri Lanka.

Government Preparedness and Policy Implications

The AKD administration has signalled awareness of climate risks. Efforts to bolster water management, power sector resilience, and food security are underway, including irrigation investments highlighted in recent budgets. However, balancing these with IMF commitments – such as cost-recovery pricing for energy – adds complexity, as higher electricity and fuel costs could further squeeze households already facing potential food price spikes.

Economists note that renewed inflation could constrain CBSL’s policy flexibility. With inflation targets around 5 per cent, upside risks from supply shocks might force tighter monetary policy, potentially slowing growth. Fiscal space is limited, as debt servicing remains a heavy burden despite restructuring.

Impacts on Households and Vulnerable Sectors

For ordinary Sri Lankans, the threat is immediate. Food constitutes a large share of household expenditure, and any sustained inflation would erode purchasing power, particularly for low-income families. Rural communities dependent on rain-fed agriculture face the brunt of droughts or erratic rainfall.

Small and medium enterprises (SMEs) in agribusiness, already recovering from past crises, could see rising NPLs and credit constraints. Tourism, a key growth driver, might also suffer indirect hits if broader economic instability or global commodity volatility affects visitor sentiment.

Mitigation Strategies and Long-Term Resilience

Experts recommend proactive measures: strengthening buffer stocks, diversifying crops, investing in climate-resilient agriculture (e.g., drought-resistant varieties), and enhancing early warning systems. Regional cooperation within South Asia could help manage shared risks.

On the policy front, the government may need to calibrate fiscal support carefully – targeted subsidies or cash transfers for the vulnerable – without derailing debt sustainability goals. The IMF and other partners could provide additional technical assistance or flexible financing for climate adaptation.

Longer-term, Sri Lanka must accelerate economic diversification, boost productivity, and integrate climate considerations into national planning. The Clean Sri Lanka initiative and digitalisation efforts offer platforms for building more resilient systems.

Navigating Uncertainty

As of late June 2026, the exact intensity of the El Niño remains uncertain, but probabilities of a moderate-to-strong event are high according to global climate models. Sri Lanka’s policymakers face a delicate balancing act: sustaining reform momentum and growth while shielding citizens from climate shocks.

The coming months will test the government’s ability to deliver on promises of a “new era.” Success in mitigating El Niño impacts could solidify public confidence; failure risks reversing hard-earned stability. For a nation that has endured political upheaval and economic default, building adaptive capacity is not just an economic imperative but a cornerstone of future resilience.