Analysis | How Sri Lanka Landed in a Crisis and What It Means


Comment

Months of protests in Sri Lanka over soaring inflation, shortages of food and fuel and lengthy power cuts have toppled the government in the South Asian nation and led to its first sovereign debt default since gaining independence from Britain in 1948. The political turmoil — and sporadic outbreaks of violence — were complicating efforts to manage the island’s foreign exchange crisis and secure more funds to keep its tourism-reliant economy running, having already been hit hard by the Covid-19 pandemic.

1. How did the crisis start?

In late 2019, newly elected President Gotabaya Rajapaksa carried out populist tax cuts, reducing revenues just months before the pandemic devastated the economy, with international flights grounded and successive lockdowns ordered. Remittances from overseas Sri Lankan workers dried up as well as many lost their jobs. Even though Sri Lanka has received credit lines from neighbors like India, it was unable to regularly pay for imports of fuel and essential foods. Making matters worse was Rajapaksa’s pivot in 2021 to organic farming with a ban on chemical fertilizers that triggered farmer protests and saw production of critical tea and rice crops decline.

2. What pushed it into default? 

With foreign-exchange earnings plunging, Sri Lanka struggled to manage its external debt, which had grown in part due to loans from China to fund ambitious infrastructure projects. Policy makers flagged to creditors that Sri Lanka wouldn’t be able to make payments until its debt was restructured, and it was therefore in pre-emptive default, central bank Governor Nandalal Weerasinghe said May 19. A group representing Sri Lanka’s creditors was set up to conduct restructuring talks.

3. What’s happening to the economy? 

The $81 billion economy is close to bankruptcy, with Russia’s invasion of Ukraine raising global prices for oil and other commodities. Sri Lanka’s growth is slow and inflation is at multiyear highs; Consumer prices rose 54.6% in June from a year earlier, with transport surging 128% from the previous month and food 80% amid acute shortages. Sri Lanka abruptly restricted fuel supplies in late June and encouraged people to stay home. The authorities have raised interest rates, devalued the currency and curbed non-essential imports. But with a meager $2 billion in foreign exchange reserves — and $7 billion in debt payments due this year — restoring the country’s economic health is an uphill battle.

4. How has the government responded?

After months of refusing to resign, the president fled the country with his wife on July 13. Prime Minister Ranil Wickremesinghe, in his capacity as acting president, imposed a state of emergency after protesters stormed some government buildings. Rajapaksa tendered his resignation the next day in Singapore, and lawmakers voted Wickremesinghe in as president a week later. However, he’s also deeply unpopular among the protesters. The emergency rule gives the army and police powers to detain and arrest people. The new president has blamed “fascist” elements for escalating tensions.

5. Is there any chance of a bailout?

The political uncertainty raises more questions about discussions with the International Monetary Fund on a rescue plan. Then-Finance Minister Ali Sabry told parliament in May that any IMF program would take as long as six months to start. He also said it may take two years for the country to emerge from the crisis. The Rajapaksa government had been deeply reluctant to ask for IMF help since it can involve unpopular austerity measures. It also has been seeking aid from India.

6. What’s the bigger picture?

The country, off India’s southern tip, has struggled with conflict since gaining independence. Civil war between the Sinhalese-dominated government and the separatist Liberation Tigers of Tamil Elam went on for decades and killed 100,000 people. The war ended in 2009 with a government victory — and allegations of human rights violations on both sides. There was a lull in violence until the 2019 Easter Sunday suicide bombing attacks, which killed more than 200 people and which the government blamed on a little-known Islamic group. Rajapaksa, a former military officer whom many voters view as a hero of the civil war, was elected president months later. Sri Lanka has also become a battleground in which China and India compete for influence. Rajapaksa and his family members in government shifted the country closer to Beijing.  

More stories like this are available on bloomberg.com



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