Implications on Sri Lanka’s balance sheet from rising tensions in the Middle East
Financial Analyst- Lanka Rating Agency
Rising tensions in the Middle East are threatening Sri Lanka’s fragile post-crisis recovery. As global oil prices climb and geopolitical risks grow, the island faces renewed external pressure. Higher fuel costs, disrupted remittances, and rising shipping expenses could undermine recent economic gains. With the region home to many Sri Lankan migrant workers and serving as a key trade partner, the conflict’s ripple effects are significant.
Sri Lanka is currently navigating a tumultuous economic landscape, compounded by escalating tensions between Iran and Israel. As the nation engages the IMF for its debt restructuring under a well-protected austerity framework, its reliance on key sectors such as merchandise and services, foreign remittances, and tourism has come under threat.
This precarious situation underscores the vulnerabilities in the country’s economic framework, particularly as external factors impact key income and expenditure line items in its national income statement.
Understanding these dynamics is crucial for assessing the potential implications for Sri Lanka’s recovery and overall economic health. This analysis takes a national balance approach to evaluating the impact on Sri Lankas economy.
Overview of key fuel expenditure
Middle East tensions caused crude oil prices to surge 7.55% in one day, while LNG declined 0.60%. Rising energy prices increase transportation, manufacturing, and household costs, threatening Sri Lanka’s economic stability and worsening its balance sheet and external financial position.
The following table outlines the recent price increases for key fuel types critical to sustaining Sri Lanka’s energy needs.
In addition, the following table highlights the current usages and the outcomes of crucial expenditure line items affecting the national income statement which has a material impact on both income and expenditure.
Petroleum
In 2024, total fuel imports comprise of 23.11% of Sri Lanka’s import bill, totaling nearly USD ~4.3 billion. Of this USD ~4.04 billion comes from petroleum which includes both refined petroleum and crude oil which accounts for 21.5% of the total imports.
In the event, costs rise by 10% annually, spending may reach USD 4.44 billion by 2025. This will have a notable impact on the total imports, where the USD 404 million increase will account for 2.14% of total import expenditure.
Energy
In 2024, total crude oil imports amounted to USD ~864 million. From this thermal energy accounted for roughly 20% of the energy generation and coal accounted for approximately 30% of it.
In the event of a price revision in thermal energy of 10%, it will have a large impact on the input costs of corporates, as this accounts for a large share of the entire energy generation in the country.
Logistics/ transportation
The total logistics expenditure of USD 2.8 billion includes both the outgoing and incoming value for logistics consisting of both for sea transport and air transport. Any cost increase in freight will have a material impact on the costs of almost all business sectors across the country, especially for companies directly involved in logistics & transport, manufacturing and tourism.
While the Baltic Exchange Dry Index (BDI) which represents freight cost surged 9.55% in a single day amid the Iran-Irael conflict, signaling major disruptions in global shipping markets.
Covering key routes for dry bulk commodities like coal, iron ore, and grains, this spike raises freight costs, which will push Brent crude, gasoline, and LNG prices higher, intensifying energy inflation and market uncertainty.
The following chart shows the rapid increase in the index in June 2025 because of the increase in tensions between Iran and Israel.
Further, there is a risk of Iran blocking the Strait of Hormuz, a vital chokepoint through which about 20-25% of the world’s oil which is around 17 -21 million barrels per day passes; it will severely disrupt global oil and gas shipments from major producers like Saudi Arabia, UAE, Iraq, and Qatar. This would cause sharp spikes in global energy prices, trigger inflation, and disrupt supply chains worldwide. Such a blockade would escalate regional tensions, risk military conflict and further destabilize global logistics and energy markets.
Implications for national income statement
The national income statement items include the main income and expenditure line items of a country. This section consists of the main line items including exports of goods, services, primary income and secondary income.
Implications for total national expenditure
Impact on input costs:
There will be a rise in global raw material costs which will increase because of the rising tensions in the middle east. The overall input costs for manufacturing companies, including raw material costs, will increase rapidly and this can drive the total operational costs upwards. The most vulnerable industries here include logistics, manufacturing, agriculture, shipping, chemical and food & beverage.
Staff costs:
Rising input and logistics costs limit companies’ ability to raise employee remuneration, often leading to layoffs and downsizing, especially in manufacturing. Meanwhile, households face declining real income due to higher bills and prices. High inflation is unlikely to be offset by wage increases amid low corporate profitability.
Finance/interest costs:
In the event of any contractionary monetary policies adopted by the central bank, such as raising interest rates to control external driven inflation can slow economic activity in an economy that is already below its potential. Higher interest rates increase borrowing costs for companies already grappling with low profitability and would discourage any new capital formation given that the net present value (NPV) of cashflows will be negatively impacted. As a result, businesses may pass these increased costs onto consumers through higher prices. This leads to cost-push inflation, which could compound the inflation outlook.
Implications for total national income
Impact on exports of goods:
Merchandise exporters generated USD 12.77 billion or 47.5% of national income of USD 26.8 billion in 2024. Rising logistics and energy costs will have significant impact on Sri Lanka’s exports of products, especially in energy-intensive manufacturing sectors.
Higher energy costs boost production expenses, squeeze profit margins, reduce export competitiveness, and ultimately may result in loss of global market share which may have longer term implications to the national income statement. Such a slowdown in industrial/manufacturing exports would impact on the topline of the national economy, i.e revenue, thereby slowing economic growth.
Impact on export services:
In 2024, services contributed USD 6.9 billion or 25.7% of Sri Lanka’s national income, with tourism accounting for 45.85% of this sector. Rising domestic transport and energy costs threaten tourism by increasing accommodation and travel expenses. With tourists staying an average of 8.42 nights could be under threat if the cost of staying rises.
Impact on primary and secondary income:
Primary income and secondary income in the national income statement contribute to USD 7.195 billion, which accounts for 26.75% of the total national income. From this 91.39% accounts for worker remittances.
Worker remittances brought in a net inflow of roughly USD 6.4 billion in 2024. Approximately 42% of remittances come from middle eastern countries including Kuwait, Saudi Arabia, Qatar, Iran, Iraq, Israel and the UAE. Tensions in Iran-Israel will affect the locals who are employed in the middle east in the event there is a layoff of labor force, due to the contraction in demand of those countries, which could impact the cashflows coming into the economy.
Risk assessment of key income variables
The following table shows the magnitude of risk from key income variables.
Export sector – high risk:
If export competitiveness declines due to cost pressures and external shocks, hypothetically if merchandise exports fall by around 10% in 2025, this will result in a loss of about USD 1.28 billion (10% of USD 12.77 billion). This decline would reduce total national income by approximately 4.75%, impacting the economy’s ability to service external debt commitments.
Tourism and services – medium risk:
The services sector, especially tourism, remains vulnerable due to rising transport and energy costs. Higher domestic travel and accommodation expenses increase the overall cost for tourists and providers. A 5% decline in tourism revenue which will be about USD 155 million could lower national income by 0.62%, highlighting its economic significance.
Primary and secondary income – low risk:
Worker remittances are vulnerable due to dependence on the stability of Sri Lanka and host countries, especially in the Middle East. Prolonged conflict in the region could disrupt cash flows from overseas workers, severely impacting Sri Lanka’s foreign currency inflows and national balance of payments.
It is important to highlight that if a 10% reduction takes place on the remittances coming from the middle east, it will account for roughly 0.9% of the total national income.
Implications on the national balance sheet
Impact on foreign reserves and debt servicing
IMF data shows the US dollar’s share of global reserves fell from 71% in 1999 to 59% in 2020, prompting Asian selloffs of US Treasuries and reducing demand and liquidity. Sri Lanka’s USD 6.28 billion foreign reserves are mainly in Treasuries, posing risks as declining Treasury values threaten debt servicing. With foreign debt at USD 36.7 billion (36.46% of national debt) as of January 2025, and fluctuating reserves around USD 6.28 billion in early 2025, Sri Lanka faces increased fiscal vulnerability amid rising global energy costs and import expenses, challenging its economic stability and ability to finance imports and external debt.
Increase in currency outflow risk will cause the exchange rate to depreciate resulting in increases in domestic costs and raises the local currency value of foreign debt, complicating Sri Lanka’s debt servicing obligations.
