Sri Lanka’s economic crisis explained: How did the country get here, who’s helping?

Anger over Sri Lankan President Gotabaya Rajapaksa’s handling of a deepening economic crisis in the island nation of 22 million people turned violent on Thursday night as hundreds of protesters clashed with the police for several hours. A severe shortage of foreign exchange prevented the Rajapaksa government from paying for essential imports, including fuel, leading to debilitating power outages lasting up to 13 hours. Ordinary Sri Lankans also face shortages and runaway inflation, after the country sharply devalued its currency last month ahead of talks with the International Monetary Fund (IMF) for a loan scheme.

How did Sri Lanka get here?

Critics say the roots of the crisis, the worst in decades, lie in the economic mismanagement of successive governments that 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. tradable goods and services is insufficient.”

But the current crisis has been accelerated by deep tax cuts promised by Rajapaksa during a 2019 election campaign that were enacted months before the COVID-19 pandemic wiped out parts of Sri Lanka’s economy. -lankan.

With the country’s lucrative tourism industry and remittances from foreign workers undermined by the pandemic, credit rating agencies moved to downgrade Sri Lanka and exclude it from international capital markets.

In turn, Sri Lanka’s debt management program, which depended on access to these markets, went off the rails and foreign exchange reserves fell nearly 70% in two years.

The Rajapaksa government’s decision to ban all chemical fertilizers in 2021, a decision which was later reversed, has also hit the country’s agricultural sector and triggered a critical rice crop drop.

Protesters run for cover as police use tear gas canisters to disperse them during a protest outside the Sri Lankan President’s private residence on the outskirts of Colombo, Sri Lanka, Thursday, March 31, 2022 (AP Photo/Eranga Jayawardena)

What’s going on with Sri Lanka’s external debt?

As of February, the country was down to just $2.31 billion in reserves, but has to repay about $4 billion in 2022, including a $1 billion International Sovereign Bond (ISB) maturing in July. ISBs account for the largest share of Sri Lanka’s external debt at $12.55 billion, with the Asian Development Bank, Japan and China among other major lenders.

In a review of the country’s economy published last month, the IMF said public debt had reached “unsustainable levels” and foreign exchange reserves were insufficient for short-term debt payments.

In a note late last month, Citi Research said the IMF report’s conclusion and recent government actions were insufficient to restore debt sustainability, a strong indication of the need for debt restructuring. “.

Who helps Sri Lanka?

For months, the Rajapaksa administration and the Central Bank of Sri Lanka (CBSL) have resisted calls from pundits and opposition leaders to seek IMF assistance despite mounting risks. But after oil prices spiked following Russia’s invasion of Ukraine in late February, the government finally drew up a plan to approach the IMF in April.

The IMF will begin discussions with the 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 devalued its currency sharply, further fueling inflation and adding to the pain of the public, many of whom are enduring hardship and long queues.

In the interim, Rajapaksa has also requested help from China and India, including fuel assistance from the latter. A shipment of diesel under a $500 million line of credit signed with India in February is expected to arrive on Saturday. Sri Lanka and India have signed a $1 billion line of credit for importing essentials including food and medicine, and the Rajapaksa government has requested at least another billion dollars from New Delhi.

After providing CBSL with a $1.5 billion swap and $1.3 billion syndicated loan to the government, China plans to offer the island nation a $1.5 billion credit facility and a separate loan of up to $1 billion.

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