Sri Lanka economy: Why Sri Lanka’s economy collapsed and what’s next

Sri Lanka’s prime minister says the island’s debt-laden economy has “collapsed” as it runs out of money to pay for food and fuel. Lacking cash to pay for imports of such supplies and already defaulting on its debts, it is seeking help from neighboring countries India and China and from the International Monetary Fund.

Prime Minister Ranil Wickremesinghe, who took office in May, emphasized the monumental task he faces in turning an economy that he believes is headed for a ‘bottom’.

Sri Lankans skip meals due to shortages, and queue for hours to buy scarce fuel. It is a harsh reality for a country whose economy grew rapidly, with a growing and comfortable middle class, until the last crisis worsened.

HOW SERIOUS IS THIS CRISIS?

Tropical Sri Lanka does not normally lack food, but people are going to go hungry. The UN’s World Food Program says nearly nine out of ten families skip meals or otherwise skimp on stretching their food, while 3 million receive emergency humanitarian aid.

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Doctors have resorted to social media to try to get essential supplies of equipment and medicines. A growing number of Sri Lankans are seeking passports to go abroad in search of work. Government workers have been given an extra three months off to give them time to grow their own food. In short, people are suffering and desperate for improvement.

WHY IS THE ECONOMY IN SO NATURAL NEGATIONS?

Economists say the crisis stems from domestic factors such as years of mismanagement and corruption, as well as other problems such as a growing debt burden of $51 billion, the impact of the pandemic and terror attacks on tourism, among other issues.

Much of the public’s anger has been directed at President Gotabaya Rajapaksa and his brother, former Prime Minister Mahinda Rajapaksa. The latter resigned after weeks of anti-government protests that eventually turned violent.

Conditions have worsened in recent years. In 2019, the Easter suicide bombings in churches and hotels killed more than 260 people. That devastated tourism, a major source of foreign exchange.

The government had to increase its revenues as external debt for major infrastructure projects soared, but instead Rajapaksa has implemented the largest tax cuts in Sri Lankan history, which were recently reversed. Creditors downgraded Sri Lanka, preventing the country from borrowing more money as foreign reserves declined. Then tourism came to a standstill again during the pandemic.

In April 2021, Rajapaksa suddenly banned fertilizer imports. The push for organic farming surprised farmers and decimated key rice crops, driving prices higher. In order to save on foreign exchange, the import of other items considered luxury was also banned. Meanwhile, the war in Ukraine has pushed up food and oil prices. Inflation was close to 40% and food prices rose by almost 60% in May.

WHY DID THE Prime Minister SAY THE ECONOMY HAS COLLAPTED?

Such a stark statement could undermine any confidence in the state of the economy and did not reflect any specific new development. Wickremesinghe appeared to underline the challenge his government faces to turn things around as it seeks help from the IMF and faces criticism for the lack of improvement since he took office weeks ago. He also fends off criticism from within. His comment may be aimed at trying to buy more time and support as he tries to get the economy back on track.

The Treasury Department says Sri Lanka has only $25 million in usable foreign reserves. As a result, the country has no means to pay for its imports, let alone repay billions in debt.

Meanwhile, the Sri Lankan rupee has fallen in value by almost 80% to about 360 to USD 1. That makes the cost of imports even more prohibitive. Sri Lanka has suspended repayment of about $7 billion in foreign loans due this year, of the $25 billion due by 2026.

WHAT DOES THE GOVERNMENT DO?

Wickremesinghe has extensive experience. The latter is his sixth term as prime minister.

Sri Lanka has been muddling through so far, mainly supported by $4 billion in credit lines from neighboring India. An Indian delegation was in the capital, Colombo, on Thursday for talks on more aid, but Wickremesinghe warned that it expected India to keep Sri Lanka afloat for a long time to come.

“Sri Lanka places last hopes in the IMF,” said Thursday’s headline in the Colombo Times newspaper. The government is negotiating a rescue plan with the IMF. Wickremesinghe said on Wednesday that he expects to have a preliminary agreement with the IMF by the end of July.

The government is also seeking more help from China. Other governments such as the US, Japan and Australia have provided additional aid of several hundred million dollars.

Earlier this month, the United Nations launched a global public appeal for help. So far, projected funding barely exceeds the $6 billion the country will need over the next six months to stay afloat.

To counter the fuel shortage in Sri Lanka, Wickremesinghe told The Associated Press in a recent interview that he would consider buying discounted oil from Russia to help the country through the crisis.

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