Sri Lanka: Why is the country in an economic crisis?

By Ayeshea Perera
BBC News

  • Published
Protesters celebrate after entering PM's officeImage source, Reuters

Sri Lankan Prime Minister Ranil Wickremesinghe has told the country's military to do "whatever is necessary to restore order", after protesters stormed his office.

A state of emergency was declared after President Gotabaya Rajapaksa fled the country, following months of mass protests over the island's economic crisis.

What has been happening in Sri Lanka?

Protests started in the capital, Colombo, in April and spread across the country.

People have been struggling with daily power cuts and shortages of basics such as fuel, food and medicines.

Inflation is running at more than 50%.

The country doesn't have enough fuel for essential services like buses, trains and medical vehicles, and officials say it doesn't have enough foreign currency to import more.

This lack of fuel has caused petrol and diesel prices to rise dramatically.

In late June, the government banned the sale of petrol and diesel for non-essential vehicles for two weeks. Sales of fuel remain severely restricted.

Schools have closed, and people have been asked to work from home to help conserve supplies.

Media caption,

Watch: Police fire tear gas at Sri Lanka protesters storming the prime minister's office

What happens when a country runs out of money?

Sri Lanka is unable to buy the goods it needs from abroad.

And in May it failed to make an interest payment on its foreign debt for the first time in its history.

Image source, EPA-EFE/REX/Shutterstock
Image caption,
Long queues for fuel - like this one in Colombo - have made normal life impossible

Failure to pay debt interest can damage a country's reputation with investors, making it harder for it to borrow the money it needs on international markets.

This can further harm confidence in its currency and economy.

What's the plan to tackle the crisis?

President Rajapaksa resigned after fleeing to Singapore.

Mr Wickremesinghe declared a state of emergency across the country and imposed a curfew in the western province while he tries to stabilise the situation.

But, on Wednesday, hundreds of protesters stormed his office, amid calls for his resignation.

Image source, Reuters
Image caption,
Mr Wickremesinghe has been prime minister six times, without seeing out a full term in office

The president's departure threatens a potential power vacuum in Sri Lanka.

It needs a functioning government to tackle the financial crisis.

The country owes more than $51bn (£39bn) to foreign lenders, including $6.5bn to China, which has begun discussions about restructuring its loans.

The G7 group of countries - Canada, France, Germany, Italy, Japan, UK and the US - had said it supports Sri Lanka's attempts to reduce its debt repayments.

The World Bank has agreed to lend Sri Lanka $600m, and India has offered at least $1.9bn.

The International Monetary Fund (IMF) is discussing a possible $3bn (£2.5bn) loan.

But it would require a stable government that could raise interest rates and taxes to help fund the deal, so any bailout may be delayed until a new administration is in place.

Image source, Getty Images
Image caption,
Banging dishes together to protest at the food price hikes.

Mr Wickremesinghe had already said the government would print money to pay employees' salaries, but warned this would be likely to boost inflation and lead to further price hikes.

He also said state-owned Sri Lankan Airlines could be privatised.

The country has asked Russia and Qatar to supply it with oil at low prices to help reduce the cost of petrol.

What led to the economic crisis?

The government blamed the Covid pandemic, which badly affected Sri Lanka's tourist trade - one of its biggest foreign currency earners.

It also says tourists were frightened off by a series of deadly bomb attacks in 2019.

However, many experts blame President Rajapaksa's poor economic mismanagement.

Image source, Getty Images
Image caption,
Mr Rajapaksa's departure ends a family dynasty that has dominated Sri Lanka's politics for the past two decades

At the end of its civil war in 2009, Sri Lanka chose to focus on providing goods to its domestic market, instead of trying to boost foreign trade.

This meant its income from exports to other countries remained low, while the bill for imports kept growing.

Sri Lanka now imports $3bn (£2.3bn) more than it exports every year, and that is why it has run out of foreign currency.

At the end of 2019, Sri Lanka had $7.6bn (£5.8bn) in foreign currency reserves, which have dropped to around $250m (£210m).

Mr Rajapaksa was also criticised for big tax cuts he introduced in 2019, which lost the government income of more than $1.4bn (£1.13bn) a year.

Image source, Getty Images
Image caption,
The switch to organic fertilisers resulted in widespread crop failure, exacerbating foreign currency shortages

When Sri Lanka's foreign currency shortages became a serious problem in early 2021, the government tried to limit them by banning imports of chemical fertiliser.

It told farmers to use locally sourced organic fertilisers instead.

This led to widespread crop failure. Sri Lanka had to supplement its food stocks from abroad, which made its foreign currency shortage even worse.

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