Economic crisis in Sri Lanka

Sri Lanka recently imposed a 36-hour curfew across the country, in addition to a state of emergency declared by President Gotabaya Rajapaksa. This is to avert further turmoil after demonstrators took to the streets, blaming the government for an economic crisis that has left the import-dependent country with insufficient funds to purchase food and fuel.

What is happening in Sri Lanka?

• Due to a significant lack of foreign currency, Rajapaksa’s government has been unable to pay for basic imports such as fuel, resulting in devastating power outages lasting up to 13 hours in Sri Lanka (a nation with 22 million population).
• The country was left with only $2.31 billion (as of February) in its reserves but faces debt repayments of around $4 billion in 2022, including a $1 billion international sovereign bond (ISB) maturing in July.
• At $12.55 billion, ISBs account for the majority of Sri Lanka’s foreign debt, with the Asian Development Bank, Japan and China among the other key lenders.
• Ordinary Sri Lankans are also experiencing shortages and rising inflation as a result of the country’s sharp devaluation of its currency in preparation for talks with the International Monetary Fund (IMF) over a loan programme.
• This fuelled outrage against the Sri Lankan President’s handling of the island nation’s increasing economic crisis.

What brought Sri Lanka here?

• Economic mismanagement by successive governments: This created and sustained a twin deficit – a budget shortfall alongside a current account deficit. Twin deficits indicate that a country’s national expenditure exceeds its national income, implying that the country’s production of tradable products and services is insufficient.
• Populist policies of the current government: The current crisis was accelerated by deep tax cuts by the government (given to meet its election campaign promise) that were enacted months before the COVID-19 pandemic.
• Impact of Covid-19: With the country’s vital tourism economy and remittances from foreign workers decimated by the pandemic, credit rating agencies proceeded to downgrade Sri Lanka, virtually shutting it out of international capital markets. As a result, Sri Lanka’s debt management programme (dependent on access to those markets) was derailed and the country’s foreign exchange reserves fell by about 70% in two years.
• Other policies: The present government’s proposal to ban all chemical fertilisers in 2021, which was later reversed, significantly impacted the country’s farm economy, causing a reduction in the important rice production.