Sri Lanka’s economic crisis is explained: how did the country end up in this situation, and who is assisting it?

Due to a significant lack of foreign money, Rajapaksa’s government has been unable to pay for basic imports, like fuel, resulting in power outages lasting up to 13 hours. Sri Lankans are also suffering from food shortages and rising inflation.

According to critics, the foundation of the crisis, which is the worst in decades, is economic mismanagement by successive governments, which established and maintained a dual deficit – a budget deficit as well as a current account deficit.

“Sri Lanka is a classic twin deficits economy,” according to a working paper published by the Asian Development Bank in 2019. “A country’s national expenditure exceeds its national revenue, indicating that its production of tradable products and services is insufficient.”

However, massive tax cuts promised by Rajapaksa during his 2019 election campaign and implemented months before the COVID-19 pandemic, which wiped out swathes of Sri Lanka’s economy, have worsened the current catastrophe.

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With the pandemic decimating the country’s vital tourism industry and foreign workers’ remittances, credit rating agencies downgraded Sri Lanka, virtually shutting it out of international capital markets.

As a result, Sri Lanka’s debt management program, which relied on access to those markets, fell apart, and the country’s foreign exchange reserves plunged by about 70% in just two years.

The decision by the Rajapaksa government to ban all chemical fertilizers in 2021, which was later reversed, harmed the country’s farm economy and resulted in a decline in the key rice production.

 

What happens with Sri Lanka’s foreign debt?
The government had only $2.31 billion in reserves as of February, but it faces debt repayments totaling about $4 billion in 2022, including a $1 billion international sovereign bond (ISB) due in July. The Asian Development Bank, Japan, and China are among the other main lenders, with ISBs accounting for the highest share of Sri Lanka’s foreign debt at $12.55 billion.

The IMF warned last month in an assessment of the country’s economy that public debt had reached “unsustainable levels” and that foreign exchange reserves were insufficient to cover short-term debt obligations.

In a note late last month, Citi Research said that the IMF report’s conclusion and the government’s recent measures were insufficient to restore debt sustainability, strongly indicating the need for debt restructuring”.

Who is helping Sri Lanka?

Despite mounting concerns, Rajapaksa’s administration and the Central Bank of Sri Lanka (CBSL) have rebuffed requests from experts and opposition leaders to seek IMF assistance. However, with rising oil prices in the aftermath of Russia’s invasion of Ukraine in late February, the administration devised a strategy to approach the IMF in April.

An IMF official said on Thursday that the IMF will begin talks with Sri Lankan authorities about a prospective loan program in the “coming days.”

Sri Lanka depreciated its currency sharply before going to the IMF, fueling inflation and aggravating the suffering of the populace, many of whom are suffering from hardship and long lines.

In the meantime, Rajapaksa has requested support from China and India, mainly in the form of financial assistance.

 

Wikimess