The Sri Lankan economic crisis was an economic crisis in Sri Lanka that began in 2019 and ended in 2024. President Ranil Wickremasinghe is credited to this recovery. It was the island country's worst economic crisis since its independence in 1948. It had led to unprecedented levels of inflation, near-depletion of foreign exchange reserves, shortages of medical supplies, and an increase in prices of basic commodities. The crisis is said to have begun due to multiple compounding factors like tax cuts, money creation, a nationwide policy to shift to organic or biological farming, the 2019 Sri Lanka Easter bombings, and the impact of the COVID-19 pandemic in Sri Lanka. The subsequent economic hardships resulted in mass protests known as the Aragalaya. However, due to a credit line of $4 billion provided by the Indian government, the foreign currency reserves of Sri Lanka improved and reached $2.7 billion.
Sri Lanka had been earmarked for sovereign default, as the remaining foreign exchange reserves of US$1.9 billion as of March 2022 would not be sufficient to pay the country's foreign debt obligations for 2022, with $4 billion to be repaid. An International Sovereign Bond repayment of $1 billion was due to be paid by the government in July 2022. Bloomberg reported that Sri Lanka had a total of $8.6 billion in repayments due in 2022, including both local and foreign debt. In April 2022, the Sri Lankan government announced that it was defaulting, making it the first sovereign default and collapse in Sri Lankan history since its independence in 1948 and the first state in the Asia-Pacific region to enter sovereign default in the 21st century.
In June 2022, then Prime Minister Ranil Wickremesinghe said in parliament that the economy had collapsed, leaving it unable to pay for essentials.
In September 2022, a United Nations report said that the economic crisis is a result of officials' impunity for human rights abuses and economic crimes. According to the Sri Lankan finance ministry, the country's foreign reserves had grown by 23.5% from US$1.7 billion in September 2022 to US$2.1 billion in February 2023, representing a US$400 million increase.
Background
According to W. A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, the country was a long way into an economic crisis in 2015. The government that came into power in 2015 knew this and had been warned by the Institute of Policy Studies of Sri Lanka about a number of risks. While the then Prime Minister Ranil Wickremesinghe in 2015 had presented a strong economic policy to address the situation, the coalition government could not get the policy pushed through Parliament, which would eventually result in further policy confusion in the coming months.
The government did not adequately address the economic warnings and emerging dangers, consuming itself in other government related activities such as "constitutional reforms". Certain practices, including those used by the Ministry of Finance led by Ravi Karunanayake, were globally frowned upon. Election-related economic decisions were pushed such as excessive distribution of freebies. The Institute of Policy Studies of Sri Lanka's 2014 State of the Economy Report highlighted hot money, worrying borrowing practices, temporary and superficial quick-fixes and monopoly of foreign direct investment flow into the hospitality sector.
Further political turmoil in 2018 worsened the economic outlook. By that time the government had carried out several reforms under an IMF supported program towards fiscal monetary consolidation and had successfully controlled inflation. These reforms included an automatic fuel pricing formula which reduced fiscal risks posed by state-owned enterprises (SOEs), raised the value-added tax (VAT) rate from 11 percent to 15 percent, and broadened the VAT base by removing exemptions. Many of the reforms were reversed by the new government after the 2019 elections.
Under Maithripala Sirisena administration, the 2019 Central Bank Bill was drafted to make the Central Bank independent from political influence by banning the Treasury Secretary and any member of the Government from becoming members of the Monetary Board. Money printing was also to be banned under this bill, as it states: "The Central Bank shall not purchase securities issued by the government, by any government-owned entity, or any other public entity in the primary market." Then Central Bank Governor, Indrajit Coomaraswamy, noted Balance of Payments issues, increased inflation, and asset bubbles as reasons for the ban. The Sri Lanka Podujana Peramuna Party opposed an independent Central Bank and discarded the bill as soon as they came to power.
Many experts compared Lebanon's economic situation with that of Sri Lanka and had warned that Sri Lanka too was on the way to defaulting on its sovereign bonds. Both nations had similar issues, including deep economic crises occurring after their successive governments piled up unsustainable debts following the end of civil wars (Lebanese and Sri Lankan respectively). To reduce the inflation and control the economy crisis in April 2022, Dr. P. Nandalal Weerasinghe was appointed as the 17th Governor of the Central Bank of Sri Lanka (CBSL) to replace Ajith Nivard Cabraal.
Following the height of the crisis in 2022, Sri Lanka's economy entered a gradual stabilization and recovery phase through 2023 and 2024. Underpinned by a 48-month Extended Fund Facility (EFF) program approved by the International Monetary Fund (IMF) in March 2023, the country implemented strict monetary tightening and structural fiscal reforms. These policy adjustments yielded measurable improvements: real GDP expanded by approximately 3% (y-o-y) in the second half of 2023, and inflation cooled dramatically to drop below 1% by mid-2024. Bolstered by recovering tourism and remittances, foreign reserves steadily accumulated to cover roughly 2 months of imports, and the Sri Lankan Rupee (LKR) appreciated by 10.8% in 2023 following its massive collapse the previous year.
Causes
Tax cuts and money creation
The Government of Sri Lanka under president Gotabaya Rajapaksa made large tax cuts that affected government revenue and fiscal policies, causing budget deficits to soar. These cuts included increased tax-free thresholds that resulted in a 33.5% decline in registered taxpayers, reducing VAT to 8%, reducing corporate tax from 28% to 24%, the abolishment of the Pay As You Earn (PAYE) tax and the 2% “nation-building tax” which financed infrastructure development. The massive loss of tax revenue resulted in rating agencies downgrading the sovereign credit rating making it harder to take more debt. In 2021 P. B. Jayasundera stated that President Rajapaksa was aware of the loss of revenue but considered it an "investment" and had no plans of increasing taxes for another 5 years.
To cover government spending, the Central Bank began printing money in record amounts ignoring advice from the International Monetary Fund (IMF) to stop printing money and instead hike interest rates and raise taxes while cutting spending. The IMF warned that continuing to print money would lead to an economic implosion. The tax cuts were also opposed by the former Finance Minister Mangala Samaraweera who noted that as the Sri Lankan government already had far less tax revenue relative to most countries which combined with its high debt load tax cuts would be dangerous. Samaraweera predicted that "If these proposals are implemented like this not only will the entire country go bankrupt, but the entire country will become another Venezuela or another Greece."
On 6 April 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 total money added to financial markets for the year 2022 increased to Rs. 432.76 billion.
External debt
Until mid-2000s, the Sri Lankan debt was mainly from multilateral lending agencies, after which it was reoriented under the leadership of Mahinda Rajapaksa to foreign investors and lenders. Sri Lanka issued its first international sovereign bond in 2007, with high interest rates to incentivise investors. According to commentators, the money was used to fund vanity projects rather than projects of national utility.
Sri Lanka's foreign debt increased substantially, going from US$11.3 billion in 2005 to $56.3 billion in 2020. While foreign debt was about 42% of the GDP in 2019, it rose to 119% of its GDP in 2021. By February 2022, the country had only $2.31 billion left in its reserves, yet faces debt repayments of around $4 billion in 2022, which also includes a $1 billion international sovereign bond (ISB) maturing in July.
In 2020, US economist Joseph Eugene Stiglitz, published a report that blamed the quantitative easing policy made by US banks after 2008, for exporting debt bubbles to developing countries including Sri Lanka. In the same year, Chatham House published a report that concluded that Sri Lanka's debt crisis was primarily "a result of domestic policy decisions and was facilitated by Western lending and monetary policy". Their research pointed that after 2008, western central banks had favored a monetary policy of quantitative easing, which created low global interest rates, and had largely facilitated Rajapaksa's borrowing-and-spending spree as he borrowed low interest ISBs heavily. However the winding-down of quantitative easing in the US after 2013, had later sharply increased Sri Lanka's borrowing costs, and the interest rates doubled, to approximately 10 percent for short-term loans, while long-term rates had jumped from 7 to 8 percent to 11–13 percent. Failure to defend their currency, further shrank Sri Lanka's foreign reserves to only $6 billion by 2016.
In 2020, S&P Global Ratings said Sri Lanka's existing funding sources did not appear sufficient to cover its debt servicing needs, estimated at just over $4.0 billion in 2021. According to the agency Bellwether, "To solve Sri Lanka's 'budgetary problem' in repaying debt, Treasuries auctions have to succeed. When that is done, the 'transfer problem' of foreign exchange will be automatically solved... Instead, with failed Treasury bill auctions filled with printed money, the country is slipping deeper into debt."
To resolve the debt crisis, Bellwether noted that Sri Lanka would need a credible fiscal plan and monetary policy, increasing taxes to repay debt, and interest rates and opening of imports would allow taxes to flow back to the Treasury. While it is possible to raise rates and generate dollars to repay the foreign debt by curtailing domestic credit, it is not practical to do so on an ongoing basis for many years. If investors see foreign reserves going up after debt repayments, confidence may come back but it is an arduous affair, which may or may not work given the current ideology.
In September 2021, the government announced an economic emergency, as the situation was further aggravated by the falling national currency exchange rate, inflation rising as a result of high food prices, and pandemic restrictions in tourism which further decreased the country's income. This drove Sri Lanka to the brink of bankruptcy due to foreign reserves falling to $1.9 billion as of March 2022, this being insufficient to pay the foreign debt obligations of $4 billion and an International Sovereign Bond (ISB) payment of $1 billion for the year 2022. The national inflation rate increased to 17.5% in February 2022, according to the National Consumer Price Index.
The government repaid $500 million International Sovereign Bonds which was due in January 2022 despite growing opposition coming from economic analysts and experts who all advised the government to postpone the ISB payment in order to preserve the foreign reserves.
On 12 April 2022, Sri Lanka announced that it will be defaulting on its external debt of $51 billion.
Debt trap
Numerous observers have described the loans made to Sri Lanka by the Exim Bank of China to build the Hambantota International Port and the Mattala Rajapaksa International Airport, which turned out to be unprofitable white elephants, as examples of debt-trap diplomacy and predatory lending. China is Sri Lanka's largest bilateral lender.
In 2007, the state-owned Chinese firms China Harbour Engineering Company and Sinohydro Corporation were hired to build the port for $361 million. Exim funded 85 percent of the project at an annual interest rate of 6.3 percent. After the project began losing money and Sri Lanka's debt-servicing burden increased, its government decided to lease the project to state-owned China Merchants Port on a 99-year lease for cash. The $1.12 billion lease to the Chinese company was used by Sri Lanka to address balance-of-payment issues.
Debt-trap diplomacy is considered "a severe concern to developing countries like Sri Lanka" by the Institute for Security and Development Policy. Both the U.S. Trump and Biden administrations described the occurrence of Chinese debt-trap diplomacy, especially in the case of Sri Lanka.
Former Sri Lankan prime minister Mahinda Rajapaksa defended the country's relationship with China and rejected the country's debt trap image, adding that "China provided concessionary loans for many infrastructure projects [during the post-conflict development]." In regards to the Hambantota Port, he added, "The Hambantota Port is not a debt trap." Rajapaksa dismissed the view that Sri Lanka was forced to enter a 99-year lease with a Chinese company because of a failure to pay the project's debts, stating that the project is commercially viable and is transforming Sri Lanka's overall port infrastructure.