Why Sri Lanka is going through an economic meltdown
Pradeep Dambarage/NurPhoto via Getty Images
- Sri Lanka is suffering shortages of electricity, fuel, and essentials.
- The crisis stems from its lack of foreign-exchange reserves and government policies.
- Bombings in 2019 also hit its tourist industry, which represents more than 10% of GDP.
This article originally appeared on Business Insider India on March 25, 2022. It has been edited.
On March 22, Sri Lanka deployed military troops at petrol stations to "discourage any unrest" as thousands of motorists waited outside for hours to get fuel.
It was the latest development in a worsening economic situation.
Tourism declined in the wake of a series of bombings in 2019, and this has turned into an economic crisis for Sri Lanka. The local government tried to address this with tax cuts and major policy changes in 2019, but the situation has continued to deteriorate.
The COVID-19 pandemic was followed by rising inflation and mounting debt.
Sri Lanka is now struggling to provide electricity, fuel, and basic essentials to its citizens, leading to massive unrest. The country has even had to cancel school exams due to a shortage of paper and lack of cash to buy essentials.
Entrepreneurs are unable to do business, the country is running out of foreign exchange reserves, and the Russia-Ukraine war has led to skyrocketing fuel prices.
Sri Lanka has been running a trade deficit for decades, and a large amount of its foreign exchange reserve is being used to pay for the cost of imported items
The country's financial crisis stems from its lack of foreign currency, leaving traders unable to pay for imports. Its foreign exchange reserves have been declining since 2019, but it reached a low-point in November 2021 when it only had enough currency to support one month's imports.
While the problem has been partly caused by government policies, other factors over the last three years have had significant impacts.
In April 2019, a series of bombings hit three top-end hotels and three churches in Sir Lanka, killing more than 250 people. The bombings had a significant impact on the tourist industry, which represents more than 10% of the country's GDP.
Central Bank of Sri Lanka/Business Insider India
Before tourists had the chance to get comfortable with traveling to Sri Lanka again, the COVID-19 pandemic took hold and travel restrictions were imposed across the globe.
While the country battled the waves of the pandemic, prices continued to rise. Sri Lanka currently has the highest inflation among Asian nations.
Central Bank of Sri Lanka/Business Insider India
As a net importer of goods, from fuel to medicines to paper, the Russia-Ukraine war has also taken its toll on Sri Lanka. The increased difficulty of moving goods around the globe has left them with a shortage of many essentials.
Economists believe that Sri Lanka's debt was unsustainable even before the pandemic
The country borrowed foreign funds to fill its reserves, instead of boosting its exports. This move added more foreign debt and has done nothing to boost local industry. The country's public debt has increased from 94% of the GDP in 2019 to 119% of GDP in 2021, the International Monetary Fund (IMF) said.
As the debt was rising, the Sri Lankan government's decision to introduce changes to indirect taxation in 2019 took a turn for the worse. These tax cuts reduced the government's revenue at a time when there were already loans to be repaid, the tourism industry was in decline, and cash reserves were falling.
The country is now staring at economic collapse and there seems to be no easy way out.
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