Sri Lanka Crisis – Unravelling of the Freebie Economy


Violent protests, a debt-ridden economy, devaluation of the currency, diminishing forex reserves, rising inflation, a President who fled the country, and residents facing a bleak future – this is Sri Lanka today.

With inflation reaching 54.6%, the country owes more than $51 billion (£39 billion) to foreign lenders and is plunging farther into economic and social calamity with no signs of improvement in sight.

This is a story about a country that was once hailed for its economic growth, beautiful beaches and warm weather, attracting tourists throughout the year.

Today, the country is in the midst of a crisis that may cause economic growth to slow down to a crawl.

While COVID-19 has battered the country’s economy, the pandemic has also exposed many flaws in the way the country operates.

However, have you ever wondered how it started and what the Government is doing to handle the crisis? Let’s delve deeper into the story to know how the crisis unfolded.

How did it all start? 

Though the Russia-Ukraine war and the Covid-19 situation exaggerated the situation, the country was already in trouble.

Before understanding how it started, let us understand what the prime problem is?

Due to a substantial imbalance in the Balance of Payments (BoP), the Sri Lankan economy has been in crisis. Its foreign exchange reserves are fast decreasing, making imports of basic consumer products increasingly challenging.

The country’s primary economic sectors are tourism, tea export, and agricultural products. It is essential to note that Sri Lanka is heavily dependent on imports to satisfy even its basic food needs.

To fund its public services, Sri Lanka has always been dependent on foreign funds. However, this borrowing has coincided with many challenges, ranging from natural disasters (such as severe monsoons) to man-made disasters.

These issues were exacerbated in 2018 when the President fired the Prime Minister, triggering a constitutional crisis. Soon after that, in 2019, Sri Lanka was shaken by the Easter suicide bombings at churches and hotels that killed around 290 people.

The bombings severely harmed tourism, a vital source of foreign exchange, and President Gotabaya Rajapaksa, who was elected then, promised to lift Sri Lanka out of a serious economic recession while keeping it safe.

All this was not over when the pandemic arrived in 2020. This further wiped off a large portion of Sri Lanka’s revenue base, particularly from the tourism industry.

Faced with a large fiscal deficit, President Gotabaya Rajapaksa lowered taxes in a futile attempt to boost the economy.

However, the approach backfired, reducing government revenue instead. Thus, credit rating agencies reduced Sri Lanka’s credit rating to near-default status, limiting its access to foreign markets. Due to all this, FDI (Foreign Direct Investment) in Sri Lanka reduced, and so did its foreign currency in its reserves.

Further, in April 2021, the Sri Lankan government banned using artificial fertilisers in agriculture and intended to become a 100% organic agriculture sector. The forced transition to organic farming reduced tea and other crop output by half, resulting in a food crisis.

Moreover, the Sri Lankan Government in March 2022 floated the Sri Lankan Rupee, which made matters worse for ordinary Sri Lankans.

Due to all these reasons, Sri Lanka was compelled to resort to its foreign exchange reserves to repay government debt. This led to a reduction in its reserves from $6.9 billion in 2018 to below $50 million in May 2022.

Sri Lanka now imports $3 billion more than it exports yearly, which is why it is out of foreign currency. As the situation worsened, inflation hit 54.6% in June 2022 and, according to the central bank, could surge to 70%.

According to critics, the issue stems from economic mismanagement by successive governments that built and maintained a dual deficit – a budget shortfall and a current account deficit.

How has this affected ordinary people?

The crisis has forced Sri Lankans’ daily life into a continuous loop of waiting in queues for necessities. Long lines at petrol stations and power disruptions around the country have resulted from fuel shortages.

Job losses are becoming common, and a drop in earnings has increased poverty rates. Pharmacies are running low on medicine, while hospitals are critically low on life-saving drugs and devices.

How has the Government handled the crisis? 

Due to a lack of foreign reserves and an inability to fulfil loan interest payments, the nation defaulted on a $51 billion debt in May 2022. Following the suspension of all debt payments, the administration initiated steps to restructure the country’s debt with the International Monetary Fund (IMF).

The Government is negotiating a rescue package with the IMF, and Wickremesinghe stated on June 22 that a preliminary deal with the IMF would be reached by late July.

Sri Lanka’s neighbouring countries like India and China are also helping the country to overcome the crisis.

Moreover, the Government is considering purchasing more heavily discounted Russian oil to assist the country get through its crisis.

Some policies that harmed the economy have subsequently been reversed, like the 2019 tax cuts and the chemical fertiliser import ban enacted last year. However, the impacts will take time to show.

What is urgently necessary is political stability to achieve economic stability and a readiness to accept protestor demands to overcome the trust gap between the public and policymakers.


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