Explained: Why Sri Lanka is on brink of bankruptcy and what the government is doing

Sri Lanka’s main opposition activists hold torches during a demonstration to denounce the shortage of cooking gas, kerosene oil and a few other commodities as the country faces a major foreign exchange crisis, in Colombo. AFP

Supermarket shelves in Sri Lanka are bare and restaurants can’t serve meals.

The country is facing a deepening financial and humanitarian crisis that could lead it to bankruptcy in 2022 as inflation rises to record levels.

According to World Bank estimates, five lakh people in Sri Lanka have fallen below the poverty line since the pandemic struck, which it described as a “huge setback equivalent to five years’ worth of progress”.

What’s happening in our neighbouring country and what could be the consequences for India and the region? Here are some answers to your questions:

The situation

Official figures have revealed that Sri Lanka consumer prices shot up a record 14 per cent in December, surpassing a previous high of 11.1 from a month earlier.

The Census and Statistics Department said year-on-year inflation in December was the highest since the National Consumer Price Index (NCPI) was established in 2015. It said food inflation also hit a record 21.5 per cent, up from 16.9 per cent in November and 7.5 per cent a year ago.

Sri Lanka’s foreign reserves have also fallen since President Gotabaya Rajapaksa took office in 2019, going from $7.5 billion to $3.1 billion at the end of December. The current figure is enough to finance less than two months of imports.

Supermarkets have been rationing milk powder, sugar, lentils and other essentials for months with a top official warning last month of more restrictions to feed those most in need.

Unemployment is also very high in the country as COVID-19 has eaten into the tourism industry, leaving thousands and thousands without a job.

The Guardian reported that the situation has gotten so bad that long queues have formed at the passport office as one in four Sri Lankans, mostly the young and educated, say they want to leave the country.

The older citizens say the conditions are reminiscent of the early 1970s when import controls and low production at home caused severe shortages of basic commodities and caused long queues for bread, milk and rice.

What has caused the problem?

The coronavirus pandemic is one of the main reasons for the country’s debilitating economic situation. The pandemic has caused several tourism-related businesses to shut down, leading to a massive loss in revenue.

But, there are other factors at play.

Many experts state that high government spending and tax cuts eroding state revenues has compounded the issue.

Disastrous planning and policy-making has also hurt Sri Lanka’s economy.

For instance, Rajapaksa’s sudden decision in May to ban all fertiliser and pesticides and force farmers to go organic without warning brought the agricultural community to its knees as many farmers, who had become used to using fertiliser and pesticides, were suddenly left without ways to produce healthy crops or combat weeds and insects.

Heavy debts to China and other nations

One of the most pressing problems for Sri Lanka is its huge foreign debt and debt service burden, in particular to China.

It owes China more than $5 billion in debt and last year took an additional $1 billion loan from Beijing to wean off its acute financial crisis, which is being paid in installments.

And it’s not only China, but other markets too that the government and private sectors that Sri Lanka owes money to.

“We have high debt from three countries — China, Japan and India. The total outstanding for this year would be $6.9 billion,” Prime Minister Mahinda Rajapaksa, the younger brother of President Rajapaksa, was quoted as saying in the PTI report.

Opposition MP Harsha de Silva, who is also an economist, told Parliament in December that the country’s foreign currency reserves would be minus $437 million by January, and the total foreign debt services would be $4.8 billion between February and October 2022. “The nation will be totally bankrupt,” Sri Lankan newspaper Daily Mirror quoted him as saying.

De Silva said he was not trying to scare anyone but it was a reality that “all imports will come to a halt, the entire IT system will be shut down, including the Google map as we will not be able to pay for it”.

The government has said it is trying hard and will meet its commitments and also renegotiating its Chinese debts with Beijing.

Minister Ramesh Pathirana has said they would try to settle past oil debts with Iran by paying them with tea.

Central Bank Governor Ajith Nivard Cabraal has also said that Sri Lanka would be able to pay off its debts “seamlessly”.

Economic relief

Sri Lankan government has said that they have a plan in place for the economic crisis. On 4 January, the finance minister announced a $1.2 billion economic relief package.

The relief measures include a special allowance of Rs 5,000 ($24) per month to 1.5 million government employees, pensioners and differently-abled soldiers from January 2022. Also, farmers, who faced a crop reduction by about 25 to 30 per cent in the harvesting season, would be offered subsidies.

India also extended $400 million to Sri Lanka under the SAARC currency swap arrangement and deferral of Asian Clearing Union settlement of $ 515.2 million by two months.

The Sri Lankan authorities are also contemplating a bailout package from the International Monetary Fund.

With inputs from agencies

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