A severe shortage of foreign currency has left the Rajapaksa government unable to pay for essential imports, including fuel, leading to debilitating power cuts lasting up to 13 hours. Ordinary Sri Lankans are also struggling with shortages and soaring inflation.Against Sri Lankan President Gotabaya Rajapaksa’s handling of the deepening economic crisis in the island nation of 22 million people, which spiraled into violence late Thursday as hundreds of protesters clashed with police for several hours. A severe shortage of foreign currency has left the Rajapaksa government unable to pay for essential imports, including fuel, leading to debilitating power cuts lasting up to 13 hours. Ordinary Sri Lankans are also facing shortages and soaring inflation after the country sharply devalued its currency last month ahead of talks with the International Monetary Fund (IMF) on a loan programme.
How did Sri Lanka get here?
Critics say the roots of the crisis, the worst in decades, lie in economic mismanagement by successive governments that have created and maintained a twin deficit – a budget deficit alongside a current account deficit.”Sri Lanka is a classic twin-deficit economy,” said a 2019 Asian Development Bank working paper. “Twin deficits signal that a country’s national expenditure exceeds its national income and that its production of tradable goods and services is insufficient.”
But the current crisis was precipitated by deep tax cuts promised by Rajapaksa during the 2019 election campaign, which were enacted months before the COVID-19 pandemic devastated parts of Sri Lanka’s economy.With the country’s lucrative tourism industry and foreign worker remittances hit by the pandemic, rating agencies moved to downgrade Sri Lanka, effectively excluding it from international capital markets.
Sri Lanka’s debt management program, which depended on access to these markets, again derailed, and foreign exchange reserves fell by almost 70 percent in two years.The Rajapaksa government’s decision to ban all chemical fertilizers in 2021, a move that was later reversed, also hit the country’s agriculture sector, triggering a decline in the critical rice crop.
What will happen to Sri Lanka’s foreign debt?
As of February, the country had only $2.31 billion in reserves, but faces debt repayments of around $4 billion in 2022, including a $1 billion international sovereign bond (ISB) due in July. ISB accounts for the largest share of Sri Lanka’s $12.55 billion external debt, with the Asian Development Bank, Japan and China among other major creditors.
In an overview of the country’s economy published last month, the IMF said public debt had risen to “unsustainable levels” and foreign exchange reserves were insufficient for short-term debt repayments.In a note last month, Citi Research said the conclusions of the IMF report and recent government measures were not enough to restore debt sustainability, strongly suggesting the need for debt restructuring.
Who is helping Sri Lanka?
For months, the Rajapaksa administration and the Central Bank of Sri Lanka (CBSL) have resisted calls from experts and opposition leaders to seek help from the IMF despite mounting risks. But after oil prices soared in the wake of Russia’s invasion of Ukraine in late February, the government eventually drew up a plan to approach the IMF in April.The IMF will begin talks with Sri Lankan authorities on a possible loan program in the “coming days”, an IMF spokesman said on Thursday. Before heading to the IMF, Sri Lanka sharply devalued its currency, further fueling inflation and adding to the pain of the public, many of whom endure hardship and long lines.
Meanwhile, Rajapaksa also asked for help from China and India, especially fuel help from India. A shipment of diesel under a $500 million credit facility signed with India in February is expected to arrive on Saturday. Sri Lanka and India have signed a $1 billion line of credit to import essential goods, including food and medicine, and the Rajapaksa government has requested at least another $1 billion from New Delhi.After providing a $1.5 billion swap to CBSL and a $1.3 billion syndicated loan to the government, China is considering offering the island nation a $1.5 billion credit facility and a stand-alone loan of up to $1 billion.
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