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Imagine a scenario where you are living in a country which is running out of all its resources and reserves. The prices of essential commodities are soaring at an all time high, leaving families unable to even afford the basic amenities of survival. The government even has to close down its foundations and embassies in other countries since they are completely incompetent to even fund their functioning. Pathetic, right? The above-mentioned situation isn’t just an imaginary scenario, but it has in no time, become a bitter reality for our neighbour, Sri Lanka. Sri Lanka is currently going through a woeful economic crisis with the projection that it might face bankruptcy in 2022 as inflation has skyrocketed, food prices are constantly increasing, with its coffers running dry. The Sri Lankan government, headed by president Gotabaya Rajapaksa, is encountering a state of breakdown as the Lankan economy hits an all-time low, with the living condition of the people miserable as ever.

  • When does a country become bankrupt?

Countries cannot literally go bankrupt because there is no bankruptcy process for sovereign states, but they can default on their debt. Sovereign debt is a bit counter-intuitive. A country borrows money and has to repay it through a normal loan repayment procedure. However, when a country defaults on its debt, the consequences take a toll on the entire economy of the country.

Famous Examples:

  1. Iceland (2008), Debt: $85 Bn

  2. Argentina (2001) Debt: $145 Bn

  3. Russia (1998), Debt: $17 Bn

When a country defaults on its debt, there is no international court where the creditors can go and file a suit. Neither can they take over a country’s assets nor can they force the country to pay. However, it does not mean that the creditors will suffer a 100% loss. Usually, in case of default, some sort of settlement takes place, and the creditors are able to recover at least a part of the amount due to them. The major consequence that a country has to face when it defaults on its debt is that they will be cut off from future access to credit from international bond markets. As countries always need credit to finance their development, this hampers the country’s growth in a very detrimental manner. Some of the common effects of a sovereign default are as follows:

  • Interest rates rise

  • Exchange Rate rises

  • Bank Runs out of Funds

  • Stock Market crash

  • Rising Unemployment

  • Beginning of the Economic Meltdown

This economic disaster in Sri Lanka wasn’t just an outcome of the pandemic, it was something which had been piling up for years, and now it has burst all at once just like a volcano, leaving the country in a very miserable state. Sri Lanka has observed a sharp upsurge in foreign debt since 2014. It may be attributed to the following factors:

  • Regular rise in oil and gas costs

  • Worldwide Supply Chain Crisis

  • Execution of anti chemical fertilisers act to promote organic farming (withdrawn as of now)

  • Sustaining Inflation

In the year 2019, their foreign debts amounted to about 43% of the country’s GDP. The global recession caused by the COVID-19 pandemic further piled up on the misery as by 2021, the foreign debt has upsurged to 101% of the country’s GDP, leading to an economic collapse.

  • Factors Responsible/ What Went Adrift?

  1. Hit To Tourism During Pandemic: The tourism industry of Sri Lanka was greatly affected by the pandemic. According to a recent report published by the World Travel and Tourism Council, more than 2 lakh people have lost their jobs in the tourism sector since the pandemic started. The result was a sizable loss of foreign revenue from the travel and tourism sectors.

  2. Huge Dearth of Forex Reserves: Sri Lanka depends heavily on imports to meet even its basic food supply needs. Due to loss of forex supply from tourism, the Sri Lankans have had to shell out of their forex reserves to import the necessary goods. As a result, the Sri Lankan forex reserves reduced from $7.5 Bn in November 2019 to a mere $1.6 Bn in November 2021.

  3. China's Inescapable Debt Trap: One of the most important factors that led to this financial breakdown in Sri Lanka is its huge debt burden. It owes China more than $5bn in debt. Furthermore, it took an additional loan of $ 1bn from Beijing last year, which is still being paid in instalments. As of November 2021, Sri Lanka’s total debt stands at $7.3bn, whereas the available foreign exchange reserves are only $1.6bn.

  4. Aggravated Agricultural Crisis: The government’s ban in April 2021 on the use of chemical fertilisers in farming further aggravated the crisis by dampening agricultural production. The vision of Rajapaksa government was to make Sri Lanka the world’s first country with a 100 percent organic agriculture sector. The farmers opposed the move and warned that this overnight shift could affect food production on a large scale. The government further worsened things by making a U-turn in late October, but that was of no help. All of this led to food shortage in the country which further worsened the economic crisis.

Covid-19 Catastrophe

The Coronavirus (COVID-19) scenario has brought a big shock to Sri Lanka’s economy and common man. A village grocery store owner said that he had to divide 1kg of milk powder packets into 100gms ones because people were unable to buy large quantities. This is also the case for other food items. Whereas financial condition was comparatively better in Democratic Socialist Republic of Sri Lanka before the pandemic, pre-existing vulnerabilities were high, partly because of high levels of informality. But now Several employees don't even have access to employment protection or different job-related social protection edges, creating them vulnerable throughout times of economic condition. As per the world bank estimates,500,000 people have fallen below the poverty line which is equal to the country's five year ‘s progress in the cause of fighting poverty. Livelihood support programs and varied relief measures enforced by the government over the course of the pandemic were expected to compensate for the labour market shock.

Four months down the road, even basic products are currently unaffordable for several folks, and even previously well-off families are unable to make ends meet. The government had appointed a former army general as commissioner of essential services, giving him the power to seize food stocks hoarded by traders and retailers, and guarantee essential things were sold at minimum costs set by the government, however very little was done on the bottom to bring people out of their misery. This could increase inequality in the long run.A person comments that the conditions were much better before the pandemic food prices have risen up by 50-60%.

The Present Picture

People have been in financial distress since the pandemic affected, with rising prices forcing people to cut on their basic necessaries. Sri Lanka’s external reserves have drastically dropped to $1.6 billion within the month of Nov 2021, in several quarters. Forex reserves are reducing drastically therefore it may solely mean that a sovereign default is close at hand . The American credit rating agency has brought the island nation to a ‘CC’ rating, which is the lowest rating as compared to the default.

Despite its increasing foreign debt over the years, Sri Lanka has never defaulted as yet. The present economic meltdown – existing financial crisis, rising living prices, expected to have food shortage this year .Democratic Socialist Republic of Sri Lanka is facing an economic and humanitarian crisis that would lead to its bankruptcy in 2022 due to inflationary trends.

The Take of The Government

Member of parliament Dr Harsha de Silva commented that the “only one solution” to come over the problem is to seek assistance from the International Monetary Fund (IMF).He also said home grown solutions would not be able to help, and only the IMF can be the saviour for reviving the country’s economy. Agriculture Secretary Udith Jayasinghe also said in late December that authorities may have to seek foreign aid to help feed the needy. The government has also resorted to temporary relief measures, such as credit lines for importing foods, medicines,fuel and other necessities from its neighbouring allies like India, as well as currency exchanges from India, China and Bangladesh and loans to buy petroleum from Oman. The Sri Lankan government also plans to settle its past oil debts with Iran by paying them with tea, sending them USD 5 million worth of tea every month in order to save "much-needed currency."

Cash-strapped Sri Lanka has also sought to reschedule its huge Chinese debt burden ,and has also discussed the same with foreign minister of China Wang Yi. It has also announced a USD 1.2 billion economic relief package, farmers facing a crop loss by about 25-30 per cent this season would be offered subsidies, and each family in the plantation sector would get 15 kg wheat every month. People were assured that the relief package would not contribute to further inflation, and that there won't be any new taxes.Also there would be payment of a special monthly allowance of Rs 5,000 to 1.5 million government employees, pensioners and differently-abled soldiers from January 2022. India has also agreed for an extension of a 400 million US dollars swap facility.

  • Key Takeaways

This offers a cautionary tale for several countries. One big lesson learned from their bankruptcy is the importance of a good credit rating. For example, having a poor credit rating means you don't get the best interest rates for your loan. Higher interest rates mean more debt to repay, which often snowballs into serious debt, and eventually bankruptcy. China's debt trap is also partly to blame here. A country should always try to maintain it’s forex reserves and look for other economic activities and not rely only on one income source like Sri Lanka had relied a lot on the tourism industry which contributes more than 10 per cent of the island nation's GDP but it got ruptured and was not able to bring substantial income due to Covid-19. Also there should be more tendencies towards exports rather than imports and try to produce in one's own country. For now, India has extended a hand of help towards its fellow neighbour in its trying times. It is believed that it will certainly help in boosting Sri Lanka's economy.


CONTENT- Mokshit Kaushal, Charvi Arora & Rajat

INFOGRAPHICS - Mokshit Kaushal & Aanchal

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