Decoded: How did the Sri Lanka economic crisis get so dire?

Surreal scenes from Sri Lanka’s Presidential Palace dominated the headlines all across the world over the weekend, as protestors stormed the official residence and treated themselves to the compound’s luxuries.

Protestors were seen playing cards, using the swimming pool, and trawling through the President’s drawers, eager to farcically participate in the luxury enjoyed by the country’s elite, while the masses face the worst of the economic downturn.

In stark contrast to the riches of the palace, is the plight of the citizens of Sri Lanka. The price of everyday goods has risen sharply, inflation is running at more than 50%, and a lack of medicines has brought the health system to the verge of collapse.

The country doesn't have enough fuel for essential services like buses or trains, or foreign currency to import more. Prices for petrol and diesel have risen dramatically, and sales of fuel remain heavily restricted. Schools have closed and people have been asked to work from home to help conserve supplies. A state of emergency has been declared.

Much of the anger for the economic crisis has been directed at former President Gotabaya Rajapaksa and his brother, Mahinda, who he appointed to be prime minister, but dismissed in May. As protests escalated, the brothers were prevented by the public from leaving the country at multiple points. Gotabaya Rajapaksa finally fled to the Maldives, flying on a military jet.

How did Sri Lanka get here?

Sri Lanka’s foreign currency reserves have run dry, meaning that the country doesn’t have enough funds to import necessary goods. In May, it failed to make a payment on foreign debt for the first time in its history.

The government blames the Covid pandemic bringing down demand for tourism, which accounts for a large amount of the country’s foreign currency import.

But many experts concur that economic mismanagement is to blame. President Rajapaksa has been criticised for big tax cuts he introduced in 2019, which the Finance Minister recently said lost the government more than $1.4Bn per year in income.

A controversial chemical fertiliser ban in 2021 also caused widespread crop failure, and Sri Lanka had to supplement its food stocks from abroad, further worsening the foreign currency shortage.

At the end of 2019, Sri Lanka had $7.6 Bn in foreign currency reserves. By March 2020, this had fallen to $1.93 Bn. Recently, the government said it had just $50M left.

Conversely, the country has racked up $51Bn in foreign debt. It will be required to pay $7Bn of that this year, and similar amounts for years to come.

As Sri Lanka begins its path towards economic recovery, it is important for the new regime to regain public trust. The country’s path towards self-sufficiency is fraught with complexities, and it will require help.

The country is in talks with the IMF over a bailout package, which will depend on negotiations over debt restructuring. The G7 group of countries have also promised to help. India has also stepped in to help in a big way.

The Government of India has provided food, health and energy security packages, as well as foreign reserves support, amounting to more than $3.5 Bn, along with a consignment of 40,000 Metric Tonnes of fuel.

India’s support to Sri Lanka is also aimed at working on a multi-sectoral approach, which is “more long-term” and aimed at “deepening trade and investment linkages”.