The group said its observers and those from UNICEF had documented more than 200 cases of child recruitment by the Karuna rebel group in Sri Lanka's eastern districts.
Karuna was formerly a splinter group of the Tamil Tigers fighting for an independent Tamil state but it broke away and is a government ally, the report said.
"The Karuna group is abducting children in broad daylight in areas firmly under government control," said Brad Adams, Asia director at Human Rights Watch. "The government is fully aware of the abductions but allows them to happen because it's eager for an ally against the Tamil Tigers."
The rights group also alleged the Karuna group has abducted and forcibly recruited hundreds of young men between ages 18 and 30, mostly from poor families.
"After years of condemning child recruitment by the Tamil Tigers, the government is now complicit in the same crimes," said Jo Becker, child rights advocate at Human Rights Watch. "The government's collusion on child abductions by the Karuna group highlights its hypocrisy."