What Happened to Sri Lanka’s Economy & How Did it Happen?

  1. What happened? What caused the nation of 21 million people to collapse?

by Fong Yu Ming

This article was written in August 2022.

In the late 1970, Sri Lanka’s success as a low-income country that managed to secure basic human needs echoed as a symbol of hope for other developing nations. Relying mostly on tourism, tea export, and rice production as their economic backbone, Sri Lanka has managed to further their economic progress, until recently. Now the island nation is facing its biggest financial crisis since its independence in 1948, failing to pay its foreign debt for the first time in the country’s history.

What happened? What caused the nation of 21 million people to collapse?

Here are some of the reasons.

In April 2022, commodity prices skyrocketed in the country, with an inflation rate of 33.8% in April, according to government data to 45.3% in the following month. Food inflation also surged from 45.1% to 58% in May. Eventually, the country found it difficult to repay interest on its foreign debt in May. This damaged the country’s image to foreign investors and harmed confidence in its currency and economy.

On 5th July 2022, the Prime Minister of Sri Lanka at that time, Ranil Wickremesinghe said that the country is experiencing the worst financial crisis in decades and urged lawmakers to enter negotiation with the International Monetary Fund (IMF) to revive the country’s economy.

Photo by Dalo Mathers on Unsplash

How did it happen?

The Sri Lankan government blames the Covid-19 pandemic, coupled with the 2019 bombing incident as the primary cause for the lack of income for tourism sectors, eventually causing the downfall of the country’s economy. Nevertheless, experts say otherwise, believing that the nation’s president should be the one responsible for this series of events.

After the civil war ended in 2009, instead of ramping up the exports of its specialty goods to strengthen the nation’s foreign trade, the government made the grave mistake of channelling these goods to the domestic market. This means that the country’s trade deficit kept increasing as export revenue remained low, while import expenditures increased. Consequently, the Sri Lankan government’s foreign reserves soon depleted. For instance, the nation’s foreign reserve value has already dropped from around $7.6 billion in 2019 to around $250 million. Other than that, the president’s big tax cuts to stimulate the economy backfired which lost the government an income of over $1.4 billion in a year. On top of everything else, Sri Lanka’s government made the rupees a floating exchange rate against the US dollars. This means that the price of goods will be determined by the supply and demand forces in the market. The government made this move hoping to devaluate the rupees and qualify for a loan from the IMF. However, the dive in the value of rupees made everything worse for the Sri Lankan people and commodity prices even rose to a higher level. Other aspects said to be causing the country’s downfalls are corruption and mismanagement.

Now what?

Sri Lanka is now looking for financial support from countries and institutions. The nation submitted a report on debt restructuring and sustainability in August to the IMF for a bailout. The government then decided to take the offer from the IMF which involves whittling down the country’s existing debt to a “sustainable” level before it can receive any aid. On the other hand, the country has successfully secured a $600 million loan from the World Bank and another $1.9 billion from its neighbor, India. The country has also asked Russia and Qatar to supply oil at lower prices to help reduce the cost of petrol. The nation’s Prime Minister also said that the government would print more money to pay off public servants’ pending salaries. However, this action may have dire consequences as it might boost the country’s inflation level and lead to a further price hike which worsens the economic situation.

Photo by Christoph Theisinger on Unsplash

What can other countries learn from this Sri Lanka crisis?

It is inevitable that the pandemic rattled the global economy, but some countries suffer more while others suffer less. It is not only Sri Lanka that was affected by the curfews or movement control orders imposed in the past few years. The island nation gives us a clear example on the possible consequences if a country is overly dependent on only a few narrow income sources, in the case of Sri Lanka, tourism. Other than that, this financial crisis reminds the world on how corruption can bring an entire country down. All in all, this crisis will give other governments a lesson and ensure they do not repeat the same fatal mistakes.


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