Sri Lanka Economic Crisis
A Nation in Crisis
On April 12, 2022, the Sri Lankan government announced that it had defaulted on $51 billion of foreign debt. The president, Gotabaya Rajapaksa, has fled the country as he faces massive protests due to the devastating economic crisis. The 2022 Sri Lanka economic crisis is the worst since its independence in 1948 and makes it the first Asian-Pacific country to enter sovereign debt. Sri Lanka’s infrastructure is in meltdown, important commodities are skyrocketing in price, and violent protests have taken over the streets. The country has run out of money which prohibits it from purchasing foreign goods. The lack of commodities and goods has caused hyperinflation within the country. This is because as demand remains the same, supply decreases, meaning that prices of goods increase. Current inflation figures are 54.6% with predictions that it could exceed 70%. Food prices have soared more than 80% along with other important commodities, creating long lines of desperate people at stores. There are also frequent power outages because the government struggles to pay for fuel. Since the quality of life has dropped exponentially, there have been mass protests and violence by angry citizens who struggle to provide for themselves and their families. After president Gotabaya Rajapaksa fled the country, protesters stormed and raided his mansion, sealing the former president’s fate.
The Cause
Since 1965, Sri Lanka has obtained 16 loans from the International Monetary Fund. These loans have come with conditions regarding monetary policies and economic strategies that have contributed to the ongoing crisis. IMF loans were needed to fund the country’s expenditures such as infrastructure as it did not have enough funding from tax revenue alone. For each loan, the IMF required Sri Lanka to tighten its monetary policy and raise taxes. The IMF also required Sri Lanka to implement economic growth plans such as shifting focus toward exports to attract foreign investment. As this continued, Sri Lanka encountered more balance of payment crises and became more debt-burdened. This was because the loaned money was generally not used for revenue-generating assets such as building ports. In 2020, COVID-19 impacted one of Sri Lanka’s biggest foreign revenue source: tourism. Tourism was already heavily impacted due to the Easter Bombings in 2019 and was then obliterated by COVID. This vital sector contributed to 5.6% of Sri Lanka’s GDP in 2018 which dropped to 0.8% in 2020. Making the situation even worse, in April of 2021, the government banned chemical fertilizers and only allowed organic farming which devastated the agriculture industry. Major export crops such as tea and rubber fell, further hurting the economy. Realizing that tea made up almost 10% of Sri Lanka’s exports, the government exempted important crops such as tea from the ban later that year. President Gotabaya Rajapaksa then lowered taxes to bring relief to the people and stimulate the economy. However, this backfired and led to a large fiscal deficit as the government received much less revenue from taxes. Sri Lanka’s foreign reserves depleted as it repaid foreign debt using reserve cash. Finally, the Sri Lankan rupee was floated, meaning that its price was determined by supply and demand from foreign exchange markets. This caused the currency to plummet because nobody wanted to buy and use the weak Sri Lankan rupee.
IMF: Savior?
The International Monetary Fund has already been involved in talks to bring a rescue package to bail the country out. The institution has ruled that Sri Lanka must restore debt sustainability by reprofiling or restructuring debt. Reprofiling debt often extends the repayment length giving time for lenders to prepare for an eventual discount the borrower would ask for. Restructuring debt on the other hand not only can extend repayment length but is also a process where changes can be made to loan conditions such as interest rates. This would require talks between Sri Lanka and countries that have loaned to them such as China. Sri Lanka has requested a Rapid Financing Instrument which is an urgent balance of payments needed and is available to member states. However, as of July 2022, talks have been suspended as violent protests ravage the country. President Gotabaya Rajapaksa's fleeing resulted in an unstable government that threatens to further worsen the situation. On July 6, the Central Bank announced an interest rate hike of 100 base points from 14.50 to 15.50 percent in an attempt to suppress inflation.
Nearby countries such as Laos also are in a similar condition, struggling to repay their debts. Moody’s Investor Services have already downgraded the country to “junk” category which means there is a high chance it may not be able to repay obligations. Laos also is dealing with high inflation as the Ukraine War pressures the oil supply leading to inflation. Sri Lanka shows that poor decisions and fiscal policies by an incompetent government will lead to devastating consequences. Sri Lanka’s economic collapse and debt default are a strong warning to developing nations with high debt levels.