BY NICHOLAS BUTLER –
Sri Lanka, the island nation off the southern coast of India, is currently facing its worst economic crisis in 73 years (by its government’s estimation). Inflation is skyrocketing and shortages of food, medicine and other critical supplies are crippling the country. The country faces defaulting on its debt. Severe political unrest has predictably erupted in response. The crisis facing Sri Lanka is an example of a true perfect storm: multiple economic stressors have hit the country all at once.
Though the causes of the crisis are diverse, the very first step appears to be a drastic increase in Sri Lanka’s foreign debt. In 2005, this stood at 11.3 billion USD, but by 2020 had risen to 56.3 billion USD. The overwhelming plurality — 47% — of this debt is in market borrowings; no other lender holds more than 10% of the total debt. Between 2014 and 2020, foreign debt increased to 40.4% of GDP.
The Sri Lankan government’s handling of the increasing debt did not help the situation. Sri Lanka’s current President, Gotabaya Rajapaksa, was elected in 2019 following a campaign in which he promised to enact tax cuts. This promise is not necessarily what delivered him victory: some analysts have identified Rajapaksa’s nationalistic campaign, which played well in the year of the Easter bombings that killed 269 people, as the principal factor behind his success. Nevertheless, Rajapaksa kept his promise and enacted the cuts — exacerbating the debt crisis in turn. (It’s also worth noting the nepotism infecting the Sri Lankan government’s decision-making: following his election as President, Rajapaksa appointed his brother, Mahinda, as Prime Minister, and last year appointed another brother, Basil as Finance Minister.)
With debt growing, Sri Lanka took a gamble with Modern Monetary Theory, an unorthodox economic theory which holds that governments can print more money with no significant negative consequences. In December 2020, Governor of Sri Lanka’s Central Bank W. D. Lakshman told an economic forum hosted by Sri Lanka’s Ceylon Chamber of Commerce that “the domestic currency debt… in a country with sovereign powers of money printing as the modern monetary theorists would argue, is not a huge problem.” By August last year, Sri Lanka’s money supply was 42% higher than in December 2019. Alas, the gamble didn’t work, and inflation soared. By March this year, food inflation had hit 30.2% compared to March last year.
These “reforms” led to inflation, but did not help Sri Lanka pay back debts. At the end of February, Sri Lanka’s foreign currency reserves (from which it pays its debts as they mature) had dropped to 2.31 billion USD, even though the country faces 4 billion USD in debt repayments by this year’s end. To address this problem, Sri Lanka’s Central Bank devalued the Sri Lankan rupee by 15% in March. This step was taken to both encourage more remittances, and to meet a likely condition for assistance from the International Monetary Fund. (Remittances are payments from Sri Lankan expats to their families back home, and are a major source of foreign exchange in Sri Lanka.) Yet currency devaluation has its own costs, of course, inflation being chief among them. And while devaluation can have upsides — for example, it makes exports cheaper and therefore more competitive — this upside doesn’t mean much if you don’t have enough to export in the first place.
Which brings us to another critical factor in Sri Lanka’s financial crisis: Russia’s invasion of Ukraine. Like many countries, Sri Lanka does not itself physically ship its exports to their destinations; shipping companies do that. But the war in Ukraine has prompted multiple shipping companies to suspend some deliveries to Russia and Ukraine. For example, Danish company Maersk — the second-largest of its kind in the world — has said that “the stability and safety of our operations is already being directly and indirectly impacted by sanctions”, leaving them with no choice but to take such action. For Sri Lanka, Russia and Ukraine are important export markets, especially in the realm of black tea. If ships aren’t sailing there, Sri Lanka will have trouble exporting there. Yet it is not only the war itself, but also the sanctions against Russia, that have exacerbated Sri Lanka’s financial crisis: Russia’s eviction from the international SWIFT banking system has left exporters to Russia struggling to get paid.
Sri Lanka’s economy has also suffered as a result of a comparatively less likely factor: agricultural policy. In April last year, the government banned the importation and use of inorganic fertilisers and pesticides. But most Sri Lankan farmers are not trained in organic farming, and could not produce the same volume of crops with the practice. The impact of the ban was thus disastrous: production of key crops grown in the country, chiefly rice and black tea, dropped precipitously, leading to both food shortages, and more money spent on imports, at a time when its rising debt was starting to cause problems. The drop in rice production forced Sri Lanka to import 450 million USD of the crop, and the drop in tea production is estimated to have cost Sri Lanka’s economy 425 million USD. So obvious was the harm inflicted by the ban that, last November, the Sri Lankan government largely repealed it.
That is not all: Sri Lanka has not been spared the economic turmoil caused by the COVID-19 pandemic, especially with regard to tourism. In 2019, travel and tourism accounted for 12.5% of its GDP. By way of comparison, for the same year, the figure for Australia — despite its impressive topography and natural beauty — was just 3.1%. The Sri Lankan government maintained strict limits on tourism until November last year, when it removed all quarantine requirements for doubly vaccinated tourists. Yet almost immediately after, its economic crisis began to bite hard, scaring away many of the tourists the country is desperately trying to win back.
Amidst this emergency, political unrest is taking hold in the country. Under the slogan “Go Home Gota”, tens of thousands of Sri Lankans are protesting against the government and are demanding that Rajapaksa resign as President. They have at times been violent; clashes have been reported near Rajapaksa’s residence. The government has responded with a mix of concession and repression: it has invited opposition parties to join the government, yet has also placed parts of the country under curfew, and has restricted access to social media. Troublingly, police have fired live ammunition at protesters, and at least one has been killed.
The task now facing the country is almost too difficult to comprehend. It must find a way to either pay back crippling debts with very little available money, or to manage a default on its debt, without incurring too much further damage or further impoverishing its people. It must do this while it juggles many other economic woes, including inflation, food shortages, and even rolling blackouts. Any move to fix one problem risks knock-on effects that make another problem worse. Recognising the dire circumstances, Sri Lanka is now seeking help from the International Monetary Fund (despite initially resisting doing so) and support from the World Bank.
Whatever help those two institutions can (or can’t) provide, things are unfortunately going to get worse before they get better.
