Tax Windfall, Industry Risk: Sri Lanka’s Auto Sector Crossroads

Sri Lanka’s vehicle import surge delivered a short-term fiscal jackpot in 2025, but the policy choices that enabled it now threaten to destabilise the country’s emerging automobile manufacturing base. Analysis by Parliament’s Public Finance Committee (PFC) shows that nearly Rs. 600 billion of the roughly Rs. 1 trillion increase in total tax revenue last year stemmed from vehicle imports overshooting official targets by more than Rs. 200 billion. While the inflow eased budget pressures, the momentum is fading, and industry leaders warn the aftershocks could be severe.

The government’s decision to reopen vehicle imports and layer new taxes was designed to bolster revenues as pent-up demand returned. Yet the same move has exposed local assemblers to intensified competition without transitional protection. Over the past few years, Sri Lanka quietly built a domestic assembly ecosystem, with 17 operational plants producing motorcars, SUVs and electric three-wheelers, and a further 17 investors preparing to enter the market. The sector supports more than 15,000 direct and indirect jobs and has been positioned as a cornerstone of industrialisation.

That progress is now at risk. Imported vehicles enjoy powerful cost advantages global economies of scale, mature production processes and integrated supply chains allowing them to land at prices domestic assemblers struggle to match. Local assembly, by contrast, bears higher labour and input costs that are ultimately passed on to consumers. Without a tax regime that recognises value addition at home, industry executives argue that investment plans will stall and existing operations could downsize.

The debate is not limited to conventional vehicles. Sri Lanka is weighing pathways to cleaner mobility, including electric vehicles and the longer-term promise of hydrogen fuel cell vehicles (FCVs). FCVs offer fast refuelling and extended range, but global hydrogen infrastructure remains nascent and production costs are high. Developing such technology locally would require substantial policy backing, infrastructure investment and patient capital conditions that are difficult to meet if the domestic industry is weakened.

Ironically, the country’s auto component manufacturing segment is gaining traction. Sri Lankan firms have earned a reputation for quality, embedding themselves in regional supply chains. The ambition is to lift component exports from about US$800 million to US$2 billion within five years and generate an additional 45,000 jobs. This opportunity hinges on a stable automotive ecosystem at home.

As import-led revenues cool in 2026, policymakers face a trade-off: rely on volatile tax windfalls or recalibrate policy to protect local assembly while still meeting fiscal goals. The choices made now will determine whether Sri Lanka converts a temporary boom into durable industrial growthor watches it unwind.