Sri Lanka faces a broad range of economic risks from any further escalation of the Middle East conflict, with the Asian Development Bank (ADB) warning that the fallout could simultaneously increase import costs while putting pressure on exports, remittances, tourism, foreign reserves and the government’s fiscal position.
In its Asian Development Outlook September 2026, the ADB said risks to Sri Lanka’s economic outlook remain tilted to the downside, with geopolitical developments in the Middle East presenting a particularly wide-ranging challenge for an economy that is still rebuilding its external buffers.
“The escalation of the Middle East conflict could raise the fuel, freight, fertiliser, food and subsidy costs and weigh on the exports, remittances, tourism and reserves,” the ADB cautioned.
The warning points to a potential double impact on Sri Lanka, with higher energy, shipping and food-related costs potentially feeding into the domestic economy at a time when key sources of foreign exchange could also weaken.
Sri Lanka’s external position has already deteriorated during 2026. The current account recorded a deficit of US$387 million during the first seven months of the year, compared with a surplus of US$1.7 billion during the corresponding period of 2025.
The merchandise trade deficit widened by 69 percent to US$6.5 billion as imports increased by 25.8 percent, while exports grew by only 4.4 percent. Total goods and services exports rose 2.2 percent to US$12.3 billion, but this was insufficient to offset the higher import bill and the narrower services surplus.
Foreign reserves have also come under pressure, with gross official reserves declining from US$6.8 billion at the end of 2025 to US$6.6 billion by the end of July, equivalent to around 3.2 months of imports.
The rupee depreciated 7.8 percent against the US dollar by the end of July before recovering later in August, narrowing its year-to-date depreciation to 5.5 percent.
Against this backdrop, the ADB stressed that rebuilding reserves and sustaining investor confidence remain priorities, particularly while Sri Lanka continues to carry a high public debt burden.
The Middle East conflict is particularly relevant to Sri Lanka because of the country’s dependence on imported energy and its economic links with Gulf economies through labour migration, aviation and tourism.
According to the ADB, geopolitical pressures on global energy markets have extended beyond crude oil, with disruptions also affecting refined petroleum products and major shipping routes. Diesel and gasoline refining margins have increased sharply, while higher security and insurance costs have contributed to elevated freight rates.
As a result, a decline in international crude oil prices alone may not immediately translate into lower costs for economies dependent on energy imports. Refined-product prices could remain elevated even if crude prices ease, maintaining pressure on transportation, industrial and agricultural costs.
Across Asia and the Pacific, economies have sought to diversify their crude oil supplies away from the Middle East. However, the region remains dependent on Gulf oil and vulnerable to disruptions along major international shipping routes.
Tourism represents another channel through which the Middle East conflict is affecting the region.
“The conflict’s impact on tourism in the region has been more evident than on the remittance flows so far,” the ADB said, citing airspace closures, flight rerouting, longer travel times, higher airfares and elevated jet fuel costs.
The impact has been particularly significant for South Asia because of the region’s reliance on Gulf airlines and major transit hubs. In Sri Lanka, tourist arrivals declined by 1.8 percent year-on-year during the first seven months of 2026, while tourism earnings fell by 11.5 percent amid lower spending per visitor.
Remittances, however, have so far provided an important buffer. Worker remittance inflows increased by 21.4 percent year-on-year during January to July, making them the main counterweight to the deterioration in the external account.
The ADB nevertheless warned that remittance flows could face greater risks if employment opportunities in the Middle East weaken or worker repatriation increases. Regionally, remittances from the Middle East have remained resilient so far despite the conflict.
Sri Lanka is also facing another emerging challenge in the form of a strong El Niño. The ADB said the phenomenon is already affecting crops and threatening hydropower generation in Sri Lanka. Across the region, El Niño is expected to strengthen towards the end of 2026 and continue into 2027, potentially adding further pressure to food and energy prices.
Despite these risks, the ADB maintained its GDP growth forecast for Sri Lanka at 4 percent for both 2026 and 2027. Inflation is projected at 6 percent for 2026 and 5.2 percent for 2027.
The combination of geopolitical and weather-related risks, however, leaves Sri Lanka with less room for external slippage as it seeks to rebuild its reserves and strengthen its economic recovery.
Sri Lanka’s tourism target of attracting three million visitors in 2026 also appears increasingly difficult to achieve, according to the ADB, following weaker tourist arrivals and a sharper decline in tourism earnings.
“With only 1.5 million arrivals by end-August, the three million target for 2026 appears distant,” the ADB said in its September 2026 outlook.
The decline in earnings is particularly significant because tourism is expected to play an important role in strengthening Sri Lanka’s foreign exchange position following the economic crisis. The 11.5 percent decline in tourism earnings during the first seven months was substantially larger than the 1.8 percent fall in arrivals, indicating lower spending per visitor.
The weaker tourism performance comes as Sri Lanka’s current account has moved into deficit. The US$387 million deficit recorded during the first seven months compares with a US$1.7 billion surplus during the same period of 2025, increasing the importance of tourism and other foreign exchange-generating services.
While tourism has weakened, worker remittances have continued to perform strongly. The 21.4 percent year-on-year increase during January-July has provided an important buffer for the external account.
The ADB noted that Sri Lanka’s tourism sector is operating in a more difficult external environment, particularly amid continued instability in the Middle East. Airspace closures and flight rerouting have increased travel times and airfares, while higher jet fuel costs and weaker outbound travel from Gulf economies have added to the pressure.
The ADB also noted that the decline in tourist arrivals in April was the steepest recorded in South Asia, a region particularly dependent on Gulf carriers and transit hubs.
For Sri Lanka, the lender warned that any further escalation of the Middle East conflict could place additional pressure on tourism at the same time as exports and remittances, while also affecting foreign exchange reserves.
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