Jul 25, 20226 min read

Violent Protests, Irregular Power Cuts and Storming Inflation: How a Nation Went Bankrupt

By Kaushal Agarwal

London, United Kingdom

A protest bursts in Colombo, Sri Lanka due to the nation’s economic collapse. (The New York Times)

Picture this:

The sun rises after a night of another blackout. You wake up drenched in your own sweat — the fan stopped working. It doesn’t feel like you've slept, and you’re tired, even more tired than last week. Here comes breakfast. Hold on, it’s less than you’re used to. But you know you’re lucky because the kids down your street haven’t had breakfast in days. Dhal is now a luxury — your stomach grumbles at the thought.

The house is quiet. Dad’s off queuing up in a line that stretches an entire suburb to get some fuel for the tuk-tuk. He’s been in the line for 16 hours already — that’s 16 hours gone without earning a cent. Mom’s gone in an attempt to acquire food. She won’t come back with much though — maybe nothing at all. Last week, your neighbor threw themselves in a river with their two children. A friend of yours died after the police shot them at a protest. Your own sister is imprisoned in her bed, boiling in her skin, because all the medicines are gone.

Your life has turned upside down.

People in the hundreds cue for oil and supplies. (The Conversation)

This story, although terrifying, is becoming a reality in Sri Lanka, a nation that has descended into an endless nightmare. The reason for this? An economic collapse that destroyed entire livelihoods and communities. The island is suffering from levels of inflation above 50%, with food prices at 80%. There are several shortages of food and medicine. Blackouts happen regularly. Markets have come to a standstill. Tourism has plummeted. The nation is bankrupt. And now political turmoil, as a consequence, makes ever more unlikely any form of settling this fire that has engulfed millions. The president has fled, the largest party is fractured, and there seems to be no clear majority in parliament and hence no certain way of getting the economic aid the nation so desperately needs.

But, upon reflection, one must wonder how such a nation has surrendered to such a collapse?

On the surface, there are two reasons: (1) Sri Lanka has dried up of foreign exchanges, meaning it can’t buy fuel, food, and other essential items. (2) Sri Lanka cannot pay the international debt it has accumulated from nations like China and the US. It’s the combination of these two factors that has destroyed the nation's economy. However, beneath this surface is a story of dire miscalculations and misfortune. It is this tangled narrative that explains, albeit partly, how a nation becomes bankrupt.

Lots of people claim the unfolding started in 2019, with astounding tax cuts, met with the Easter terror attacks which reduced tourism — further catalyzed by the pandemic. Although this makes for a rather straightforward explanation, the roots of the economic crisis do not begin here, but rather decades before.

In 1983, a civil war erupted in the north of Sri Lanka. Mostly dominated by the Sinhalese-dominated Sri Lankan government and the Liberation Tigers of Tamil Eelam (LTTE), the tension erupted in part due to longstanding differences between the Sinhalese majority and Tamil minority dating back hundreds of years. The war would last 26 years before Gotabaya Rajapaksa, the now ex-president and former defense minister, organized a military operation that destroyed the LTTE in 2009. It wasn’t just the unstable macro impacts of a civil war that laid the foundations of a weak economy — it was also political movements at the very end of the war.

During the later war years (the 2000s), ex-president Mahinda Rajapaksa, older brother of now ex-president Gotabaya Rajapksa, opened his country to international sovereign bonds with very promising high-interest rates — partly raised to balance the instability of a civil war creditors feared. Nation’s bit and proceeded to lend. Instead of this money going to investment or agriculture infrastructure, it was spent on political vanity stunts with no national utility. Take the enormous Colombo lotus tower for example. It is these very decisions of Mahinda in the 2000s which started the accumulation of the immense debt burdens Sri Lanka now faces.

When Gotobaya defeated the LTTE, for obvious reasons his popularity exploded. In 2009, he won the presidential election, placing his brothers Mahinda, who was president, as prime minister and Basil as finance minister, with several other positions filled by former military and intelligence personnel — securing a family domination of Sri-Lankan politics. This laid the ground for corruption, utter mismanagement and populist macroeconomic policies.

There is a long notorious tradition in the Island’s politics of politicians promising unrealizable promises. Some range from cheaper bread, free fertilizer and, tax cuts. Given the opaque media culture, voters find it impossible to distinguish between the trustworthy and not, thus giving power, in an endless cycle, to parties and politicians which continually fail to deliver sound and effective policy. Or in the case of 2019, do deliver tax cuts but do it in such a way that disastrous consequences soon follow. Take for example policies aimed at the rural populous. Due to how important rural communities are to elections, policies have followed to stifle competition in agriculture instead of promoting it (making the farmers happy) but, in the long term, actively hurting productivity.

A second example would be Sri-Lanka's immense import-substitution techniques. Due to a low-funded export beneficiary lobby (those benefiting from trade), the government has created barriers to free trade, which make imports more expensive, whilst promoting selling goods only to the domestic market. This meant its income from other countries was low, while the bill of imports kept rising. Sri Lanka imports $3 billion (£2.3 billion) more than it exports every year - and that's exactly why it ran out of foreign currency reserves (used to buy goods from the world) which dropped from $7.6 billion (£5.8 billion) in 2019 to around $250 million (£210 million).

This does not even mention the vast subsidies Sri-Lanka used to give out to reduce prices of food and gas (which was politically popular), government revenue it handed out to public servants (36% of all revenue went out as salaries) and national reports of corruption which left little in the coffers for development or saving which meant the country had to borrow again and again. In 2021, when Rajapaksa began to realize foreign reserves would soon disappear, he implemented a sudden policy change which outlawed imports of chemical fertilizer leading to immense crop failure, which exacerbated the debt problem. To pay some off, he then proceeded to transfer foreign reserves away — then free-floated the Sri-Lankan rupee which led to a massive devaluation, making imports even more expensive.

Couple all this with the tax cuts in 2019 which lost the government $1.4 billion (£1.13 billion) a year, the proceeding Easter bombing attacks, and a terribly timed pandemic which destroyed the tourism industry (an important export), and it isn’t much of a surprise that Sri Lanka now owes $51 billion (£39 billion) to foreign lenders — money the country doesn’t have.

Without foreign reserves, and without the ability to lend more, seeing as the country has now defaulted (missed its payment deadline), reducing confidence in its currency and economy, Sri Lanka can’t import much needed fuel and supplies. A fall in supply leads to the rise in prices known as inflation, and that is precisely what is happening.

Certainly, the pandemic, the terror attacks of 2019 and severe monsoons which hurt output in 2016 and 2017 have been misfortune — but the Sri Lankan government has been central in digging this massive hole their country suffers in and must now be pulled out of. It has been blunder after blunder — all of which have been suffered by the middle to lower classes.

So what’s next?

In terms of much needed money, the World Bank has agreed to lend Sri Lanka $600 million, and India has offered at least $1.9 billion already. The International Monetary Fund (IMF) is discussing a possible $3 billion (£2.5 billion) loan. Wickremesinghe, the current president, says he wants to print money to pay employee’s salaries. This would boost inflation further. The Government is moving to debt restructuring talks with China and the G7 and has sought to plead with Russia and Qatar to supply Sri Lanka with lower-priced oil.

Every decision here comes with a consequence. Any loans will be met with future interest payments, and every debt restructuring program will have conditions. Getting oil from Russia, which indirectly feeds into their war, could further raise the price of wheat from Ukraine. But all this still requires a stable government who first need to raise interest rates and taxes.

A vote is set to be taken on Wednesday, 20th of July with 225 MPs voting in parliament. Wickremesinghe should win. Yet, no matter how large the mandate is, it is crucial not to equate its size to any form of stability or good decision-making. Gotabaya had a record mandate of 6.9 million votes - yet he catalyzed, not prevented, the largest economic collapse the nation has seen since its independence. The violence and death this has created must be met with admittance, on part of Gotabaya and the rest of his government, and then punishment.

My hope is with the Sri Lankan people — who, in no fault of their own, have fallen prey to the wrath of populist politics and misdirected media forces that have weakened the structural and economic foundations on which their country lives. I pray this foundation is secured quickly and so pray they don’t fall any further — for I fear, and so does the world, that they will.