Explaining Sri Lanka’s economic crisis

The country’s current situation is due to misguided policies and flawed external advice

The Sri Lankan economy has been facing a crisis owing to a serious balance of payments (BoP) problem. Its foreign exchange reserves are depleting rapidly. It is becoming increasingly difficult to import essential consumption goods. The country is unable to repay past debts. This article is an effort to locate the proximate causes of the current crisis and document the roles of different groups and organisations in its making.

One can, of course, trace the roots of the crisis to colonialism and Sri Lanka’s post-war developmental pathway but let us stick to the last decade for our purposes. Even in the 21st century, Sri Lanka’s economic fortunes continued to be tied to the export of primary commodities such as tea and rubber, and garments. It mobilised foreign exchange reserves through primary commodity exports, tourism and remittances, and used it to import essential consumption items including food.

Editorial | Crisis in Sri Lanka

When Sri Lanka emerged from a 26-year long war in 2009, it was expected that economic growth would revive. Possibly because of pent-up demand, Sri Lanka’s post-war GDP growth was reasonably high at 8-9% per annum between 2009 and 2012. However, the economy was on a downward spiral after 2013 as global commodity prices fell, exports slowed down and imports rose. The average GDP growth rate almost halved after 2013. A counter-cyclical fiscal policy was ruled out, as the hands of the then Mahinda Rajapaksa government were tied by a $2.6 billion loan obtained from the International Monetary Fund (IMF) in 2009. During the period of the war, budget deficits were high. Further, the capital flight that accompanied the global financial crisis of 2008 drained Sri Lanka’s foreign exchange reserves. The IMF loan in 2009 was obtained in this context, with the conditionality that budget deficits would be reduced to 5% of the GDP by 2011.

With no pick-up in growth or exports, and the continuing drain of foreign exchange reserves, the new United National Party (UNP)-led coalition government approached the IMF in 2016 for another US$1.5 billion loan for a three-year period between 2016 and 2019. The IMF’s conditionality was that the fiscal deficit must be reduced to 3.5% by 2020. Other conditionalities included a reform of the tax policy and tax administration; control of expenditures; commercialisation of public enterprises; flexibility in exchange rates; improvement of competitiveness; and a free environment for foreign investment.

The IMF package led to a deterioration of Sri Lanka’s economic health. GDP growth rates shrank from 5% in 2015 to 2.9% in 2019. Investment rate fell from 31.2% in 2015 to 26.8% in 2019. Savings rate fell from 28.8% in 2015 to 24.6% in 2019. Government revenues shrank from 14.1% of the GDP in 2016 to 12.6% of the GDP in 2019. Gross government debt rose from 78.5% of the GDP in 2015 to 86.8% of the GDP in 2019.

In 2019, there were two further shocks to the economy. First, the Easter bomb blasts of April 2019 in churches in Colombo led to the death of 253 people. Consequently, the number of tourists fell sharply leading to a decline in foreign exchange reserves. The blasts dealt a severe blow to the prospects of economic recovery.