Social, political, and economic conditions in the island-state of Sri Lanka have grown increasingly difficult since 2019. Levels of inflation have started drastically plummeting, foreign exchange reserves are on the brink of depletion, supplies are running out, the prices of basic commodities—everything from food, staples, medicines, fuel, and others—are skyrocketing, and power outages lasting up to 15 hours a day are expected to continue in the coming weeks. As we speak, we are witnessing an island-state’s economic collapse—the ripples of which would soon cascade across the world.
Sri Lanka is heading toward its worst financial crisis since independence in 1948. But considering the extent of the problem and the many inextricably-linked factors surrounding it, the worst is likely yet to come. Some experts warn that whatever is happening is just the tip of the iceberg—arguing that Pakistan, whose economy is currently in similar rapid decline, will likely be the next domino to fall. Whether or not Sri Lanka is a harbinger of a much bigger economic collapse is of no consequence—the suffering of millions of Sri Lankans are not just numbers on a graph to be studied by economists.
In the face of severe economic conditions marred by power blackouts, fuel shortages, lack of oil and food, Sri Lankan protesters marched in unity and stormed the president’s mansion in Colombo on July 9. Christians, Hindus, Muslims, and Buddhists, who fought each other in the recently-ended civil war, are now joining hands on the streets. Their primary demands revolve around the dissolution of the current government, establishment of an interim government that will hold new elections, and a referendum to establish a new constitution that endorses people’s sovereignty and reduces the president’s executive powers.
After years of poor economic management and corruption, anger toward the government spiraled and Former President Gotabaya Rajapaksa was ousted. He fled to Maldives on July 13. With no leader to steer the rapidly disintegrating country away from its absolute demise, this further left the country in chaotic disarray. On July 15, when Rajapaksa filed his formal resignation, Rani Wickremesinghe was sworn in as the country’s acting president. He declared a state of emergency on July 17 to quell protests while attempting to tackle the economic upheaval.
The world watches as Sri Lanka plans its next move to stop its economy from free falling. Understanding how this island-state of 22 million people arrived at this precarious position—unable to afford even paper and ink— and what this political and economic crisis may mean for the rest of the world offers a glimpse of what comes next.
Here are some of the factors assumed to have caused Sri Lanka’s seemingly inescapable plight:
Civil War’s Impact to Foreign Trade
Much of the current turmoil in Sri Lanka can be traced to the 26-year ethnic civil war in the country from 1983-2009. The aftermath of this war severely destabilized the economy and worsened existing tensions (i.e., racism and Buddhist fundamentalism). It also distracted people’s attention from the persisting corruption within the government.
After the civil war ended in 2009, then President Mahinda Rajapaksa, brother of recently ousted Gotobaya Rajapaksa, took out massive foreign loans to not only pay for war expenses but also to start “vanity projects in the middle of nowhere.” The government was slammed for building a lavish 280-million dollar airport nearly no one uses. It was even dubbed by Forbes as the “World’s Emptiest International Airport.” These projects, the opposition argued, “epitomized the waste, indulgence, and lack of transparency of the Rajapaksa regime.”
“World’s Emptiest International Airport”
Photo taken from Shepard Wade, Forbes
During the war, Sri Lanka focused on providing goods to its domestic market to the point that foreign trade was completely neglected. This resulted in low export income despite increasingly high imports. Sri Lanka now has run out of foreign currency as it imports 3 billion dollars more than it exports.
A trade deficit occurs when a country imports more than it exports. Conversely, if it exports more than it imports, trade surplus occurs. Sri Lanka’s trade deficits may instantly be seen as a direct factor for the ongoing crisis, but it is much more complicated than that. For instance, the United States has the largest trade deficit in the world  while China has the highest trade surplus. These are two of the strongest and most powerful countries in the world despite their deficit or surplus. Thus, foreign trade, or Sri Lanka’s lack of it, cannot automatically justify the country’s failure.
It is not uncommon or necessarily catastrophic for a country to have trade deficits, per se. Most countries make up the difference by borrowing. But what sets Sri Lanka apart is that its government has a long history of gross mismanagement. Their trade deficit can no longer be supported as they have exhausted all of their borrowing power. The country is put in a precarious position where they can only either focus on economic reforms to increase foreign reserves or turn to foreign lenders to pay already existing debt.
When we consider the aftermath of Sri Lanka’s civil war and its repercussions in economic development, it becomes easy to recognize that this crisis was, in one way or another, destined and that it was only a matter of when.
Government’s Poor Economic Management
Photo taken from Wikipedia
The dynast Gotabaya Rajapaksa led the Sri Lankan administration from November 2019 until he was ousted last July 13. During his term, he appointed his brothers Prime Minister Mahinda Rajapaksa and former Finance Minister Basil Rajapaksa, and his nephew to his cabinet. Despite their dictatorial tendencies coupled with nepotism, corruption, militarization of public spaces, and serious violations of human rights during the Sri Lankan civil war, Rajapaksa and his family maintained power and continued to ensnare the state for many years. Ultimately, their gross mismanagement of Sri Lanka’s economy, matched with the complications brought about by the pandemic, led to economic crisis.
With the ongoing crisis, there was no concrete response from the government until the citizens decided to take matters into their own hands. In fact, before the uprising, the Rajapaksa administration was accused of devaluing its currencies since the country is heavily reliant on imports. To keep staple goods cheaper, the government managed to convince the people that the exchange rate from rupee to US dollar is low. While this maintains political stability for a time, the central bank cannot keep the same value when its real market value takes over. This ultimately takes a heavy toll on the economy as it spends more than it saves. Artificial exchange rates can only be maintained by borrowing or buying/selling foreign currency, which Sri Lanka is already running out of. This also explains why migrant workers stopped sending remittances (one of the country’s primary sources of foreign exchange) through official channels. As a result, the central bank ran out of foreign currency and the fake exchange rate became harder to maintain. This is when things spiraled out of control.
The Sri Lankan government’s economic plan amounted to a series of shortcomings and false hopes that led to the collapse of one of South Asia’s most vibrant and economically promising nations. By late 2019, Sri Lanka had 7 billion dollars in foreign currency reserves. At present, this dropped to around 250 million dollars. Moreover, when the country needed public revenue the most, the government introduced big tax cuts. This led to a loss of government income amounting to 1.4 billion dollars.
When Rajapaksa fled the country, Wickremesinghe declared that the economy had completely collapsed. Yet again, this was not a surprise anymore. Everything that could theoretically go wrong, went wrong with the Sri Lankan economy  owing to years, even decades, of poor economic management. Now, Sri Lanka struggles with unsustainable trade deficits, hyperinflation, devalued currency, and massive foreign debt that it can no longer pay. These economic shocks exposed the nation’s weak governance. From here, things can only get worse.
Skyrocketing Inflation and Chronic Undersupply of Commodities
Photo taken from Steve Hanke
Considering Sri Lanka’s trade deficit, it is heavily reliant on imported goods. Among other necessities, it imports food, textile fabrics, paper, sugar, medications, and transportation equipment. Imports are so crucial that the government had to temporarily shut down its only fuel refinery for 50 days because it ran out of crude oil stockpiles. This explains why it is no longer surprising that households immediately started stocking up essential goods as soon as commodities ran short. Long queues at gas stations went on for days that two men were reported to have collapsed and died waiting in line.
Due to a lack of foreign cash, the country is now unable to purchase, that is, import certain goods to keep up with the demand. This means that there is no longer enough rice, paper, fuel, or any basic commodity to go around. Chronic undersupply of commodities in the middle of increasing demand, by the very logic of the law of supply and demand, drives up prices of domestic goods. However, according to reports, inflation increased to 39.9% in June 2022 from 10.2% in May 2022,. This means what is left of people’s savings are also suddenly worth far less at present than they were pre-crisis. Evidently, this crisis is already a huge blow to middle class Sri Lankans, but we can only imagine what it will do to the poorest of the poor.
What makes all this even worse is that there really is no telling where exactly the bottom is—Sri Lankan rupee is already rapidly depreciating in value with the passage of time, but no one knows when this would stop or if it would even stop in the first place.
Onset of a World Health Crisis
The pandemic has put many countries in a chokehold, and Sri Lanka is no exception. With the onset of a world health crisis in 2020, almost all economic activities came to a screeching halt. During these times, the Sri Lankan government had to rely on their remaining US currency reserve to make up for their unsustainable deficit. However, because of a lack of income and high prices of commodities, such reserves are practically gone in no time. Akhil Bery, the director of South Asia Initiatives at the Asia Society Policy Institute asserted that “One of Sri Lanka’s tragic mistakes was in 2020 when the pandemic hit, it did not engage in restructuring negotiations with its creditors.” This exposes yet another misstep of the government.
The pandemic also took a heavy toll on Sri Lanka’s tourism economy, which accounts for a whopping 12% of their Gross Domestic Product. Due to the foreign exchange problem, several countries, including Canada, have recently issued travel restrictions to their citizens on visiting the island country. Tourism subsequently sunk to zero overnight. However, it is also important to note that the decline in tourism began even before the pandemic. In the spring of 2019, terrorists bombed a string of churches and hotels across the capital, Colombo. The tragic and shocking death of 269 people, at least 45 of which were foreign nationals, led to a 70% drop in tourist arrivals. While the economy was negatively affected by the bombings, the pandemic prevented recovery.
Disastrous Transition to Organic Farming
Photo taken from Bloomberg
During the Green Revolution in the 1960s, Sri Lanka subsidized farmers to use synthetic fertilizers. This proved to be a productive move as crops significantly increased and food security was maintained for a time. This also culminated in Sri Lanka’s upper middle income status before the crisis. However, by 2020, fertilizer imports amounted to almost 500 million dollars. With Sri Lanka’s foreign reserve shortage and/or depletion and devalued currency, the government banned imports of chemical fertilizer. The Rajapaksa administration assumed that banning fertilizers would solve two problems at once—address the nation’s trade deficit and cut down massive subsidy expenditure from the pandemic budget—but its repercussions on present conditions tell otherwise.
The government’s 10-year agriculture plan left farmers with no other choice but to use locally sourced organic fertilizers in farming and producing agricultural products. While organic farming is a viable step towards sustainability, agricultural inputs (i.e., fertilizers) are crucial to productive agricultural output. As expected, and Sri Lankan agronomists also warned this as soon as the plan was announced, agricultural yields substantially fell. While the government promised that it would increase the production of organic fertilizers, there was no conceivable way the nation could domestically produce enough of them to make up for the deficiencies.
In an attempt to transform the country’s agriculture industry into one that is entirely organic, the country suffered in widespread lower crop yields and crop failure. Agricultural output supposedly for export completely crashed as imported food prices climbed up due to the war Russia-Ukraine conflict. Supplementing food stocks from abroad by importing exacerbated the country’s trade deficit.
Sri Lanka’s employment in agriculture, according to the World Bank collection of development indicators, was at 23.73% in 2020. This means almost one-fourth of the population were directly affected by this sudden shift to organic farming while the rest of the country suffers equally burdensome impacts.
Stuck in a Debt Trap
Foreign debt trap is easily pointed as one of the major contributors for Sri Lanka’s economic turmoil. As the economy sinks further in the quicksand of economic collapse, the government defaulted on its foreign debt pile of about 51 billion dollars.
Under its “Belt and Road Initiative” in 2013, China invested approximately 5 billion dollars in Sri Lanka. This global infrastructure development strategy was initiated by the Chinese government to build ports, roads, railways and pipelines across Asia, Europe and Africa. When Sri Lanka struggled to repay foreign debts on time, it entered Hambantota Port, the country’s second largest port, into a 99-year lease to the Chinese State-owned company that constructed it for some immediate cash. Some analysts  argue that the Hambantota Port deal is an example of how China deliberately drowns developing countries such as Sri Lanka into a debt trap by offering loans to finance extravagant infrastructure projects. As the country defaults on its debt, it would have to sign over national territory or make excessive compromises.
It is important to note that China is only one of the many countries Sri Lanka is indebted to. The country also owes a huge sum of money to international bondholders as well as bilateral creditors including Japan and India. By far, the largest portion (56%) of Sri Lanka’s debt is held by commercial lenders held by private banks at much higher interest rates, according to official government statistics. Huge chunks of this debt were used for lavish infrastructure projects that failed to yield promised outcomes. Sri Lanka’s confinement in foreign debt trap undergirds the crisis and makes any attempt for recovery seemingly futile.
Like trade deficits, defaulting on debts is not all that uncommon. Organizations like the International Monetary Fund (IMF) and World Bank would usually step in to provide bailout or loans to member countries who are struggling to meet their international obligations. Sri Lanka last received a bailout from the IMF in 2016 for 1.6 billion dollars. This time, however, is different. Bailouts are provided in exchange for adhering to IMF conditions such as having a functional government and implementing economic policies. This is to ensure that the country will not end up in the same situation after the bailout. These are also the same conditions Sri Lanka simply cannot meet considering its paralyzed economy. Moreover, while citizens are understandably and justifiably angry at their government, political turmoil and sustained social unrest will likely discourage foreign assistance. Sri Lanka has reached a stalemate where economic compromises would have political consequences just as political compromises would have economic consequences.
What is Next for Sri Lanka?
The crisis has now ballooned beyond control that the government plans to hire a global law firm to help restructure its debt to China, India, Japan, and other commercial lenders. As debt payments are suspended due to dried up foreign reserves, Sri Lanka must pull itself back up from the brink by restructuring its debts with the IMF. The Sri Lankan government must not waste any opportunity to call for assistance to nations it has historically established good relations with. This is, quite literally, their only hope.
Recently, India extended substantial humanitarian assistance by providing currency swaps, loans, food, fuel, and others amounting to 3.8 billion dollars. It has also pledged a comprehensive plan to increase economic and infrastructure ties and reassert its historic influence in Sri Lanka as opposed to growing Chinese influence. Members of the QUAD alliance (the United States, Australia and Japan) have also expressed support for Sri Lanka. Australia is set to provide $50 million in Official Development Assistance to support Sri Lanka in meeting the food and healthcare needs of its citizens. Meanwhile, Japan will provide an Emergency Grant Aid of $3 million to provide medicine and food directly to Sri Lankan people. US President Joe Biden announced that it would also provide $20 million-worth of additional humanitarian assistance for Sri Lanka,.
In an era of geopolitical conflict, Sri Lanka’s economic and political collapse sends a loud warning to other countries of the perils of incompetent governance and unchecked foreign debt. Even as a small economy, Sri Lanka’s predicament can cause giant ripples across the globe. It may even be just the start of a chain of events that would completely destabilize the global economy. This is to say that the impacts will be far-reaching when many small economies descend into economic crises.
Sri Lanka’s economic woes did not come from nowhere. While it is easy to connect the dots between an unprecedented global health crisis and a sudden economic collapse caused by foregn debt pile, this does not capture the whole truth. Sri Lankan officials, both those who left and stayed, need to be held accountable for pursuing years of disastrous policies before any of the recent events and factors espoused in this article. The absolute lack of a robust internal economy plan made this a predestined issue, the pandemic merely accelerated it while the government allowed it.
For developed countries, this crisis may mean high commodity prices, disorganized supply chains, and possibly even economic decline. But for developing countries such as Sri Lanka, this would mean completely obliterating decades-worth of developments in healthcare, education, and infrastructure. If there is anything we can take from this crisis, it is that this tragic disaster is nothing new and it could have been avoided if only institutions that fuel it are disempowered. Countries, in ensuring that they do not fall into the same fate, must now look out for the potent combination of governmental incompetence, corporatist hubris, and economic short-sightedness.
Cautionary Tale for the Philippines
The Philippine economy is about twelve times bigger than that of Sri Lanka, according to the World Bank. While figures between the two countries significantly vary, their trajectories would almost always tell us that it would not be unthinkable for the Philippines, or any country for that matter, to end up in the same rut as Sri Lanka. When poor governance is met with an unprecedented crisis, the economy’s collapse is a guarantee. The new administration under President Marcos. Jr. must learn from the missteps of not only Sri Lanka but also of the administrations before him. The current administration must steer away from lavish projects and policies that produce no substantial benefit for the people and leave long-lasting economic damage.
At present, the Philippines has an outstanding external debt of $106.4 billion while its Gross International Reserves (GIR) as of end-March is $107.3 billion, according to the Department of Finance. This is to say that the country’s debt can immediately be paid off and there would still be an offset. However, obviously, exhausting our resources in one full sweep to repay all debts would not be a prudent step.
Moreover, similar to Sri Lanka, the Philippines also depend on trade imports for food, fuel, and other basic goods. Therefore, we are also vulnerable to unsustainable import inflation. Under Former President Ferdinand Marcos, import dependency was heightened. This resulted in chronic trade deficits which are, at present, merely covered up by bloating the economy with cheap labor export and Overseas FIlipino Worker (OFW) remittances. As we reopen our economy in the post-pandemic era, the Philippines’ trade deficit is also expected to further surge. This is yet another crucial economic strategy that the government must focus on in ensuring that we do not fall for the same traps as Sri Lanka.
To nip the bud before it grows, the government must thread steadily and ensure that our imports and structural flows through remittances are monitored. This is precisely where and how Sri Lanka found itself stuck in the reins of debt trap. The geopolitical, financial, and operational risks of participating in China’s Belt and Road Initiative must be mitigated by pursuing a debt-mix that puts priority on local financing. Likewise, the government should also work on strengthening Public-Private Partnerships (PPP) projects.
If it is true, as the government claims, that the country is enjoying a robust economic standing, this should be all the more reason to continue pursuing policies that will further strengthen the economy, and not hurt it in the long run. The government must remain vigilant as the economy tries to navigate the challenging global economic landscape. What is happening in Sri Lanka reminds us of our own unique economic problems at home—tax cuts, paralyzing debt burdens, close relations with China and the subsequent boost of infrastructure projects, declining tourism sector, longstanding war between insurgents and government forces, dynastic politics—it all seems too familiar. We cannot wait for a real crisis to unfold before we start addressing the deeply-rooted problems of our economy. We can never be too complacent and anyone who says otherwise must be urged to look at Sri Lanka.
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