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Explained: the economic crisis in Sri Lanka

Sri Lanka is currently experiencing an economic and political crisis of massive proportions, recently culminating in debt default. The country also has almost no foreign exchange reserves, reducing the ability to buy imports and increasing domestic prices for goods.

There are several reasons for this crisis and the economic turmoil has led to mass protests and violence across the country. This visual provides an overview of some of the elements that have led to the current situation in Sri Lanka.

A timeline of events

Sri Lanka’s ongoing problems have bubbled up after years of economic mismanagement. Here’s a quick timeline looking at just some of the recent factors.

2009

In 2009, a decades-long civil war in the country ended and the government focused on domestic production. However, pressure on local production and sales, rather than on exports, increased dependence on foreign goods.

2019

Unsolicited income tax cuts were made in 2019, leading to significant losses in government revenues, draining an already cash-strapped country.

2020

The COVID-19 pandemic hit the world, causing border closures worldwide and suffocating one of Sri Lanka’s most lucrative industries. Prior to the pandemic, in 2018, tourism contributed nearly 5% to the country’s GDP and generated more than 388,000 jobs. By 2020, the share of tourism in GDP had fallen to 0.8%with more than 40,000 jobs lost until then.

2021

Recently, the government of Sri Lanka introduced a ban on foreign-made chemical fertilizers. The ban was intended to curb the depletion of the country’s foreign exchange reserves.

However, because farmers had only local, organic fertilizers available, the crops failed miserably and Sri Lankans were subsequently forced to rely even more on imports, further depleting reserves.

Apr 2022

Mass protests broke out in early April this year calling for the resignation of President Gotabaya Rajapaksa in Sri Lanka’s capital, Colombo.

May 2022

In May, pro-government supporters brutally attacked protesters. Subsequently, Prime Minister Mahinda Rajapaksa, President Rajapaksa’s brother, resigned and was replaced by former Prime Minister Ranil Wickremesinghe.

June 2022

Recently, the government approved a four-day work week to give citizens an extra day to grow food as prices continue to rise. Food inflation more than up 57% in May.

In addition, rising grain prices resulting from the war in Ukraine and rising fuel prices worldwide have contributed to an already dire situation in Sri Lanka.

The most important information

“Our economy has completely collapsed.”
Prime Minister Ranil Wickremesinghe in parliament last week.

One of the main causes of the economic crisis in Sri Lanka is its dependence on imports and the amount spent on them. Let’s look at the numbers:

  • Total Imports 2021 = $20.6 Billion USD
  • 2022 total imports (to March) = $5.7 billion USD

By contrast, the most recently reported levels of foreign exchange reserves in the country were a staggering $50 million, with an astonishing drop of an astonishing 99%from $7.6 billion in 2019.

Some of the top imports in 2021, according to the country’s central bank, were:

  • Refined petroleum = $2.8 billion
  • Textiles = $3.1 billion
  • Chemicals = $1.1 billion
  • Food and drink = $1.7 billion

Of course, without the money to buy these goods from abroad, Sri Lankans face an increasingly drastic situation.

In addition, the debt incurred by Sri Lanka is huge, further hindering their ability to increase their reserves. Recently they failed to pay a $78 million loan from international creditors, and in total they borrowed $50.7 billion

The largest source of their debt is by far the result of loans on the market, closely followed by loans from the Asian Development Bank, China and Japan, among others.

What it means

Sri Lanka is home to over 22 million people who are quickly losing the ability to buy everyday goods. Consumer inflation reached 39% end of May.

Due to power cuts intended to save energy and fuel, schools are currently closed and children have nowhere to go during the day. Protesters calling for the president’s resignation have been camping in the capital for months, with police tear gas and resistance from supporters of President Rajapaksa, but many have also reacted violently to the push.

India and China have agreed to send aid to the country and the International Monetary Fund recently arrived in the country to discuss a bailout. In addition, the government has sent ministers to Russia to discuss a deal for discounted oil imports.

A harbinger for low-income countries

Governments need foreign currency to buy goods from abroad. Without the ability to buy or borrow foreign currency, the Sri Lankan government is unable to purchase much-needed imports, including basic foodstuffs and fuel, causing domestic prices to rise.

In addition, loan defaults discourage foreign direct investment and devalue the national currency, making future lending more difficult.

What’s happening in Sri Lanka is perhaps an ominous preview of what’s to come in other low- and middle-income countries, as the risk of debt problems continues to rise globally.

The Debt Service Suspension Initiative (DSSI) was implemented by the G20 countries, suspending nearly $13 billion in debt from the start of the pandemic to the end of 2021.

Sri Lanka Economic Crisis - Countries by Degree of Indebtedness

Some DSSI and LIC countries that are at high risk of indebtedness include Zambia, Ethiopia, and Tajikistan, just to name a few.

Going forward, Sri Lanka’s next steps in managing this situation will serve either as a helpful example to other countries at risk or as a warning worth heeding.

Ongoing updates

Since this article was published, the situation in Sri Lanka has changed significantly. Protesters have received their original demand asking President Rajapaksa to resign – both he and Prime Minister Wickremesinghe have agreed to resign. This comes after protesters stormed the president’s palace, forcing him to flee the country.

Note: The debt breakdown in the main visualization shows total outstanding foreign debt to foreign creditors, rather than total debt.

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