Global Economy

The global economy is entering a more fragmented and uncertain phase, shaped by rising protectionism, strategic competition, and renewed pressure on trade and supply chains. Growth has softened, and the outlook remains uneven as elevated interest rates, geopolitical risk, and high debt burdens continue to weigh on investment and confidence. While inflation has moderated from post-pandemic peaks, it remains above target in several major economies, limiting the pace and timing of policy normalisation. The result is a global environment that is less predictable and more exposed to shocks, with risk increasingly influencing economic decision-making.

Multilateral forecasts indicate a gradual deceleration in global growth over the medium term. The International Monetary Fund (IMF) projects global gross domestic product (GDP) growth at approximately 3.3% in 2025 and 2026, and notes that the medium-term outlook may settle around 3.1% the weakest trajectory in decades. The World Bank presents a more cautious assessment, forecasting global growth of around 2.3% in 2025, and warning that heightened trade tensions and policy uncertainty are pushing growth towards its slowest pace since 2008 outside recession periods.

Trade policy is increasingly shaping economic conditions. Higher tariffs and renewed restrictions on trade and technology flows are adding friction to supply chains, raising production costs, and complicating long-term investment decisions. These pressures coincide with ongoing conflicts and geopolitical tensions, contributing to volatility in energy markets and uncertainty across key global trade corridors.

REAL GDP GROWTH

Monetary conditions remain restrictive. Even where inflation has eased, it has proven persistent in several economies, reinforcing the risk of interest rates remaining elevated for longer. With public finances already constrained, high real interest rates are complicating efforts to rebuild fiscal buffers and are intensifying debt sustainability concerns. In this setting, the global economy enters 2026 with limited capacity to absorb additional shocks without affecting confidence, capital flows, or growth momentum.

Regional Outlook

Advanced economies are expected to expand at a subdued pace, with growth projected at around 1.6% in both 2025 and 2026. Structural pressures including ageing populations, labour supply constraints, and the lagged effects of earlier monetary tightening continue to weigh on output.

Emerging markets and developing economies are projected to grow more strongly, with the IMF estimating growth of approximately 4.2% in 2025. Improved policy credibility and moderating inflation support this outlook. However, these markets remain vulnerable to financial volatility, sovereign debt stress, and shifts in capital flows driven by global interest rate differentials.

South Asia is expected to remain the fastest-growing region, although at a moderated pace. Latin America and the Caribbean is forecast to register comparatively weaker growth. A persistent concern across developing regions is the decline in Foreign Direct Investment inflows, which can constrain long-term capital formation, productivity gains, and employment generation.

Sri Lankan Economy

Prior to Cyclone Ditwah, Sri Lanka’s recovery was strengthening. Progress under the IMF supported programme and improvements in policy credibility contributed to enhanced macroeconomic stability. Ratings upgrades by major agencies reflected this progress. However, the recovery remained uneven. Poverty levels were elevated, labour market conditions were fragile, and structural reform requirements remained significant.

Following substantial fiscal and monetary adjustment, macroeconomic stabilisation had been achieved to a considerable extent. Real GDP growth reached 5.0% in 2024, marking a strong rebound from the contraction experienced in 2022 and 2023. In 2025, early indicators suggested that economic momentum continued in the first half of the year.

Despite these gains, economic output remained below 2018 levels. Household incomes and welfare indicators had not fully recovered to pre-crisis conditions. This underlying fragility is relevant in assessing the impact of Cyclone Ditwah, as resilience across segments of the population remained constrained.

Long-term stability will depend on sustained structural reform. Key priorities include improving the performance of loss-making State-Owned Enterprises, reducing barriers to trade and investment, and strengthening the efficiency and targeting of public expenditure.

Impact of Cyclone Ditwah

Cyclone Ditwah inundated approximately 1.1 million hectares, representing close to one-fifth of Sri Lanka’s land area, and exposed an estimated 2.3 million people to flooding, according to geospatial analysis by the United Nations Development Programme (UNDP). It has been described as the country’s most severe flooding disaster in decades.

The World Bank’s Global Rapid Post-Disaster Damage Estimation assessed direct physical damages at approximately USD 4.1 Bn, equivalent to about 4% of Sri Lanka’s GDP. This estimate captures physical asset damage and excludes indirect losses such as income disruption, business interruption, supply chain effects, and the broader cost of reconstruction. The total economic impact is therefore expected to be significantly higher.

The shock is expected to intensify fiscal and external pressures. Relief, repair, and reconstruction spending will add to public expenditure at a time when fiscal space remains limited. Increased import demand for construction materials, fuel, and machinery may widen the trade deficit. The recovery path will depend materially on the balance between concessional funding and debt-financed reconstruction.

Food inflation may rise due to crop losses, damaged storage facilities, and disrupted logistics. Tourism earnings and productivity may be affected where infrastructure damage constrains mobility and business continuity. Social vulnerability may increase unless support is effectively targeted.

At the same time, reconstruction presents an opportunity. Climate-resilient infrastructure, improved land-use planning, and modernised drainage and energy systems can reduce future vulnerability. The structure and quality of reconstruction financing will determine whether the recovery strengthens long-term resilience or compounds fiscal strain.

Banking Sector Outlook

Sri Lanka’s financial sector demonstrated improved resilience during the first half of 2025 compared with the corresponding period in 2024. More favourable macroeconomic conditions and stabilisation progress supported improvements in credit conditions and balance sheet strength.

Private sector credit growth strengthened during H1 2025 as household and corporate debt servicing capacity improved. Although lending expanded, private sector credit-to-GDP remained below pre-crisis levels, indicating scope for further recovery as demand normalises.

Sector resilience improved across profitability, capital adequacy, efficiency, asset quality, and market risk indicators, as reflected in the Banking Soundness Index. Stage 3 loans remained elevated but continued on a declining trend.

Liquidity metrics, including the Rupee Liquidity Coverage Ratio and Net Stable Funding Ratio, remained above regulatory minimum thresholds, although both moderated slightly in line with credit expansion. Profitability strengthened during H1 2025, supported by improved net interest income, and total capital adequacy improved by end-Q2 2025.

The positive outlook prevailing through most of 2025 was subsequently affected by Cyclone Ditwah. The cyclone introduces uncertainty in asset quality, liquidity dynamics, and sector risk conditions going forward.

Impact of CYCLONE Ditwah on Banks

Sri Lankan banks have implemented multiple rounds of borrower concessions in recent years, including relief measures following the Easter Sunday attacks, the COVID-19 pandemic, and the subsequent economic crisis. Cyclone Ditwah adds further strain, requiring targeted relief while preserving systemic stability.

The Central Bank of Sri Lanka (CBSL) issued Circular No. 04 of 2025 dated 05 December 2025, directing licensed commercial banks to provide targeted debt relief and concessional lending for affected borrowers. Measures include temporary suspension of capital and interest repayments on a case-by-case basis, concessional credit facilities with interest rate caps, waiver of penal charges and certain fees until end-January 2026, and easing of credit access criteria in defined circumstances.

The primary channels through which Cyclone Ditwah may affect the banking sector are summarised below.

Summary of Ditwah’s Potential Impact on Banks

Area of impact	Likely effect on banks
Regulatory relief	Moratoriums, waived penalties, concessional lending
Asset quality	Potential rise in Stage 3 loans, restructuring and provisioning needs
Liquidity and funding	Higher credit demand, pressure on deposit growth, and liquidity buffers
Interest rates	Potential upward pressure due to funding requirements
Collateral values	Downward pressure from infrastructure and property damage
Climate risk	Greater integration of disaster risk in underwriting and portfolio management
Growth and confidence	Slower credit demand and weaker investor sentiment

The Ditwah shock reinforces the importance of integrating climate and disaster risk more explicitly into regulatory frameworks, credit appraisal models, and capital planning processes. It also underscores the expanding role of banks in financing resilience, supporting recovery, and enabling climate-smart investment.