Economic Crisis in Sri Lanka: Reasons and lessons from the Island nation

  • Sri Lanka’s  $81 billion economy struggled to manage its external debt, which had grown in part due to loans from China to fund ambitious infrastructure projects.
  • Family control in government is not liked by the opposition and the people. They blame their dynasty for the crisis and mismanagement.
  • From 2020 onwards with the arrival of the Covid-19 pandemic tourists stopped arriving in Lanka. As Lanka’s economy depended on Tourists, terror and Covid 19 gave a big jolt to the economy with no foreign tourists.
  • Sri Lanka had to release its foreign exchange reserves to pay off government debt, shrinking its reserves from $6.9 billion in 2018 to $2.2 billion this year.
  • Sri Lanka is seeking financial support from the IMF and turning to regional powers that may be able to help.

The world got alarmed after the Covid19 crisis with supply chain obstacles and lockdowns. Then came the Russia Ukraine conflict when energy prices shot up for oil-importing nations. In India’s immediate neighbourhood, the political crisis in Pakistan and the economic emergency with the collapse of the economy in Sri Lanka is having a great impact on the region. If we examine what were the reasons for the economic collapse in Lanka external borrowings, Islamic Terrorism, Covid19 lockdown with no tourists, fall of foreign remittance, rise in fuel prices, Lanka’s decision to go for Organic Farming, Forex crisis are a few.

First, Sri Lanka’s  $81 billion economy struggled to manage its external debt, which had grown in part due to loans from China to fund ambitious infrastructure projects. It has been unable to regularly pay for imports of fuel and essential foods. Making matters worse was Rajapaksa’s pivot last year to organic farming with a ban on chemical fertilizers that triggered farmer protests and saw the production of critical tea and rice crops decline. President Gotabaya Rajapaksa slashed taxes to stimulate the economy. But the move backfired, instead of hitting government revenue. These natural disasters such as heavy monsoons to man-made catastrophes ruined the economy. This prompted rating agencies to downgrade Sri Lanka to near default levels, meaning the country lost access to overseas markets.

Second, due to Islamic Fundamentalist Terror in 2019 hundreds of people at churches and luxury hotels were killed in the famous 2019 Easter bombings. 259 people were killed and more than 500 injured by self-radicalized local Muslims who claimed to be affiliated with the Islamic State. Riots erupted in multiple parts of the country Lanka had neglected warnings by India and the United States of an imminent terror attack. From 2020 onwards with the arrival of the Covid-19 pandemic tourists stopped arriving in Lanka. As Lanka’s economy depended on Tourists, terror and Covid 19 gave a big jolt to the economy with no foreign tourists.

Making matters worse was Rajapaksa’s pivot last year to organic farming with a ban on chemical fertilizers that triggered farmer protests and saw the production of critical tea and rice crops decline.

Third, Sri Lanka had to release its foreign exchange reserves to pay off government debt, shrinking its reserves from $6.9 billion in 2018 to $2.2 billion this year. And Sri Lanka has to repay about $4 billion in debt over the rest of this year, including a $1 billion international sovereign bond that matures in July. This impacted imports of fuel and other essentials, which sent prices soaring. Besides this, in March the government floated the Sri Lankan rupee meaning its price was determined based on the demand and supply of foreign exchange markets. However, the plunging of the rupee against the US dollar only made things worse for ordinary Sri Lankans. Cash-strapped Sri Lanka has decided to temporarily shut its embassies in Norway and Iraq, as well as the country’s Consulate General in Sydney, the Ministry of Foreign Affairs said on Tuesday.

Fourth, households and businesses have endured daily power cuts since March, with the duration stretching to 13 hours in April during the hottest time of the year. Long lines for fuel and shortages of food staples like milk powder and rice. There are long lines at petrol stations. Few protesters complained when there is no electricity, no jobs, no food, no fuel, why was the government in power. Mass protests have become a norm and are demanding a change in government.  

Fifth, following the 2019 Sri Lankan elections, the Rajapaksa family kept several portfolios in the government under their control. While President Rajapaksa holds the all-powerful executive presidency, his elder brother Mahinda, who is a former president, was the current prime minister. Basil held the finance ministry and Mahinda’s son Namal, the heir apparent, was the minister of youth and sports. Family control in government is not liked by the opposition and the people. They blame their dynasty for the crisis and mismanagement. President Rajapaksa declared a nationwide public emergency on April 1, giving authorities powers to detain people without a warrant and blocking social media platforms. Crowds of student protesters surrounded Rajapaksa’s residence again, calling for his resignation. The emergency ordinance was revoked on April 5. The government’s entire cabinet was effectively dissolved on April 3 due to mass resignations by top ministers.

Strong political leadership, stopping external borrowings at the cost of the nation from countries like China’s debt-trap diplomacy, keeping a check on terrorism on the island, financial management and assimilation with regional countries like India can solve the Sri Lanka crisis.

President Rajapaksa issued a statement “The current crisis is a result of several economic factors and global developments,” the statement read. “As one of the leading democratic countries in Asia, solutions should be found to this within a democratic framework.”

Lastly, one can say that either an election or a great political miracle can solve the crisis. For now, Sri Lanka is seeking financial support from the IMF and turning to regional powers that may be able to help. During last month’s address, President Rajapaksa said he had weighed the pros and cons of working with the IMF and had decided to pursue a bailout from the Washington-based institution something his government had been reluctant to do. Sri Lanka has also requested help from India. India recently announced to extend a USD 1 billion line of credit to Sri Lanka as part of its financial assistance to the country to deal with the economic crisis following a previous USD 500 billion line of credit in February to help it purchase petroleum products.

During his recently-concluded visit to Colombo, External Affairs Minister S Jaishankar had assured India’s continued support in Sri Lanka’s economic recovery process. There is still much uncertainty around what comes next; national consumer price inflation has almost tripled, from 6.2% in September to 17.5% in February. Strong political leadership, stopping external borrowings at the cost of the nation from countries like China’s debt-trap diplomacy, keeping a check on terrorism on the island, financial management and assimilation with regional countries like India can solve the Sri Lanka crisis.

(The author is an expert on Korean affairs and writes regularly on international affairs. He is the spokesperson of BJP Karnataka. Views expressed are the author’s own)

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