Photo Courtesy of CNN.

Decoding the Sri Lankan Economic Crisis

Sri Lanka is currently going through its worst ever economic crisis post-independence. What led the country to this situation, and how can we better understand this?

I write this article days after Sri Lanka defaulted on its $51 billion external debt and as its people suffer from dire shortages of food, fuel and lifesaving medical supplies. In a time of turmoil, the aim of this article is to provide clarity on the Sri Lankan economic crisis by tracing recent economic policies in order to understand the problem as the first step in assessing probable solutions for the country’s recovery. The root problems that led to the current climax are complex and are made up of a combination of socio-political and economic factors; however the focus of this article is solely based on understanding the economic policy failures and is not reflective of any personal or political paradigms that currently surround the crisis.
Before heading into the policy timeline, I would like to highlight a few fundamental problems of the Sri Lankan economy that made it vulnerable to recent shocks. A trade deficit of approximately $5 billion, a budget deficit which was 11.1 percent of the total GDP (as of 2020) and a debt to GDP ratio of 101 percent (2020) along with a lack of measures to reduce these deficits were historical characteristics of the Sri Lankan economy which catalyzed external shocks leading it to a stalemate situation by 2021. I highlight these three indicators since they were suggested as necessary improvements when Sri Lanka started its Fitch and S&P rating in 2005 who then gave ratings on BB- and B+ respectively, two years before issuing its first International Sovereign Bond in 2007. Sri Lanka failed in making these improvements and on the 13th of April 2022 was further downgraded to CC. With these fundamental weaknesses in mind, let me take you through an analytical timeline of policy failures and shocks since 2019, that is since the beginning of the term of the current government (though once again, economic mismanagement can be traced back many generations but will be left for another day's discussion).
I start the timeline of concern with the Easter Bombings in April 2019 that shocked the eonomy with a halt to tourism, drop in investor confidence and opportunity for the current government to come to power in November 2019 with promises to boost national security and prosperity. These were initiated with tax cuts soon after appointment, which affected government revenue and fiscal policies, causing budget deficits to soar. The motive? Increasing investments. The effect? Tax revenue as a percent of GDP dropped from 11.6percent in 2019 to 8 percent by 2021 (only 6 countries in the world have a lower tax revenue to GDP percent). The desired effects backfired as the Central Bank of Sri Lanka (CBSL) began printing money in record amounts to cover government spending (On April 6 2022, the CBSL allegedly printed 119.08 billion rupees,making it the highest reported amount printed on a single day by the CBSL for the year 2022). The necessity of tax cuts is questionable in the first place. Expert advice pointed towards a need to stop printing money and instead hike interest rates and raise taxes while cutting spending.
With the first Covid-19 case in Sri Lanka being identified in January 2020 and the global impact of the pandemic, Sri Lanka’s foreign reserve inflow was further hampered as tourism halted once again. As revenue avenues closed, the response to the pandemic increased expenditures (Sri Lanka’s vaccination campaign gained international appreciation), thereby worsening the trade and budget deficits. It was at such a crucial stage that the disastrous implementation of the policy to ban imports of chemical fertilizer and become an organic only country was imposed in June 2021. Whilst the government justified the policy on health risks related to chemical fertilizer, the unsustainable implementation without necessary grace periods or training programs for essential stakeholders such as farmers and agricultural product traders is what brought upon disastrous results. Recently, the government of Sri Lanka acknowledged that this policy implementation was a failure. The cost of this policy was a 20 percent drop in crop harvests resulting in a need to import rice. If a hidden objective of this policy was to save on foreign reserves (which SL was desperately running out of by then) it was surely short sighted for once more a shortage of food created a need to import food items ($450 million worth of rice).
However, we must not stop with just criticizing this policy. If it was a measure to save foreign reserves (which was followed by a ban on importing luxury goods), now that we have seen the recent barriers to increasing foreign reserves (diminished revenues of Tourism, Agriculture, Tax and Remittances), we must trace how Sri Lanka’s remaining reserves were exhausted. By the year 2016, Sri Lanka had a reserve position of $8 billion. By 2020, it had dropped to $2 billion. This was due to continued unsustainable debt resettlement financed through foreign reserves. From 2019-2021 Sri Lanka’s reserve position declined by 70 percent leading to the current foreign reserve crisis situation. Though this decline is blamed on Covid-19, the aforementioned negative effects of policies and the fact that neighboring countries including India (39 percent), Bangladesh (41 percent) and Bhutan (35 percent) increased their official reserves prove that this is not the case.
Understanding and acknowledging the failures of economic policies in Sri Lanka between April 2019 and April 2022 is the first step in the country’s economic recovery. Thus, having understood our current situation, the next step in this process is to analyze the limited options available and their effects to revive Sri Lanka that currently has only $1.94 Billion for its 22 million people, slightly over the net worth of Kylie Jenner, the 24 year old American model.
Sachintha(Sachi) Pilapitiya is a Finance Columnist. Email her at
gazelle logo