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Why did Sri Lanka collapse?

Sri Lanka's economy has "entirely collapsed," Prime Minister Ranil Wickremesinghe stated, as the crisis-hit nation faces an increasingly alarming crisis that has left millions struggling with fuel, electricity and food deficits. In this article, we will cover the recent news regarding the Sri Lanka crisis and why Sri Lanka collapsed.

Sri Lanka's prime minister expressed late last month that the island nation's debt-laden economy had “collapsed” as it operates out of money to pay for food and fuel. Short of cash to pay for imports of such essentials and already defaulting on its debt, it is striving for help from neighbouring India and China and from the International Monetary Fund.

Prime Minister Ranil Wickremesinghe, who handled office in May, was underlining the huge task he faced in turning around an economy he stated was heading for “rock bottom.”

President Gotabaya Rajapaksa consented to quit amid huge pressure from protesters who stormed both their residences and put fire on one of them. Sri Lankans are skipping meals as they take shortages and lining up for hours to try to buy scarce fuel. It's a severe reality for a country whose economy had been rising quickly, with a growing and comfortable middle class, until the latest crisis deepened.

The stark assertion in June by Wickremesinghe,who is in his sixth term as prime minister, intimidated to undermine any confidence in the state of the economy and didn't reflect any distinct new development. The prime minister seemed to be underscoring the challenges facing his government as it seeks help from the IMF and confronts objections over the lack of progress since he took office weeks earlier. The comment might have been planned to try to buy more time and support as he tries to get the economy back on track.

The Finance Ministry enunciated Sri Lanka had only USD 25 million in usable foreign reserves. That has exited it without the wherewithal to spend on imports, let alone repay billions in debt.

Meanwhile, the Sri Lankan rupee has diluted in value to about 360 to the US dollar. That makes the costs of imports even more prohibitive. Sri Lanka has discontinued repayment of about $7 billion in foreign loans due this year out of USD 25 billion to be repaid by 2026.

How did Sri Lanka get here?

The near-term triggers of the present emergency have been a litany of poor recent policy choices. In 2019, following his election as President, Gotabaya Rajapaksa’s administration presented swingeing tax cuts to individual and corporate taxation, as well as to VAT; the latter being cut from 15% to 8%. The consequence was inevitably a dramatic and immediate reduction in tax revenues from 11.6% in 2019 to 8.1% of GDP in 2020. By 2021 the fiscal deficit had swollen to over 12% of GDP – roughly double what it had been in the five years pre-2019.

Sri Lanka’s foreign debt has also looped out of control. Already in the latter part of 2020, credit rating agents had devalued Sri Lanka to near-default status with the result that the country was mainly banned from international capital markets. Further, the government had opposed any debt restructuring programme or help from the IMF. Yet, despite losing access to international capital markets, Sri Lanka resumed paying sovereign bondholders by drawing down foreign reserves, even settling a bond amount of $500 million in early 2022.

How Serious Is This Crisis?

The government owes USD 51 billion and is unable to make interest charges on its loans, let alone put a dent in the amount borrowed. Tourism, an essential engine of economic growth, has sputtered because of the pandemic and concerns about safety after the terror attacks in 2019. And its currency has collapsed by 80%, making imports more costly and worsening inflation that is already out of command, with food costs increasing 57%, according to authorised data.

The effect is a country hurtling towards bankruptcy, with hardly any money to import gasoline, milk, cooking gas and toilet paper. Political corruption is also a concern; not only did it play a role in the country squandering its wealth, but it also confuses any financial rescue for Sri Lanka.

Anit Mukherjee, a policy fellow and economist at the Center for Global Development in Washington, stated any aid from the IMF or World Bank should arrive with strict conditions to make sure the aid isn't mismanaged. Still, Mukherjee remarked that Sri Lanka sits in one of the world's busiest shipping lanes, so letting a country of such strategic importance collapse is not an alternative.

Government Support during Crisis

So far Sri Lanka has been muddling through, primarily supported by USD 4 billion in credit lines from India. An Indian delegation came to the capital, Colombo, in June for discussions on more assistance, but Wickremesinghe warned against predicting India to keep Sri Lanka afloat for long. “Sri Lanka pins last expectancies on IMF,” read a June headline in the Colombo Times.

The government is in negotiations with the IMF on a bailout plan, and Wickremesinghe has stated he expected to have a preliminary agreement later this summer. Sri Lanka has also sought more support from China. Other governments like the US, Japan and Australia have delivered a few hundred million dollars in support.

Earlier in June month, the United Nations launched a worldwide public request for assistance. So far, launched funding barely scratches the surface of the $6 billion the country requires to stay afloat over the next six months. To counter Sri Lanka's fuel shortage, Wickremesinghe notified The Associated Press in a recent interview that he would think of buying more steeply discounted oil from Russia.