EXPLAINER - Why Sri Lanka's economy crashed and what's next

COLOMBO (Sri Lanka) -- Sri Lanka's prime Minister said last month that the debt-laden island nation's economy has "collapsed" due to a lack of money to pay for fuel and food.

EXPLAINER - Why Sri Lanka's economy crashed and what's next

COLOMBO (Sri Lanka) -- Sri Lanka's prime Minister said last month that the debt-laden island nation's economy has "collapsed" due to a lack of money to pay for fuel and food. It is short of cash to import these necessities, and has defaulted on its debt. The country seeks help from China and India as well as the International Monetary Fund.

Ranil Wickremesinghe was the Prime Minister when he took office in May. He was emphasizing his monumental task in turning around an economy that he claimed was headed for "rock bottom." Both he and President Gotabaya Rajapaksa resigned on Saturday amid increasing pressure from protesters, who stormed their homes and set fire one of them.

As fuel shortages worsen, Sri Lankans are lining up to buy fuel and skipping meals. This is a stark reality in a country that had a rapidly growing economy and a comfortable middle class until the current crisis.

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HOW SERIOUS IS THIS CRISIS?

The government owes $51Billion and cannot make interest payments or reduce the amount of its loans. The pandemic and fears about safety following the terror attacks in 2019 have slowed down tourism, which is an important driver of economic growth. Its currency has plummeted by 80%, increasing import costs and worsening the already high inflation rate, which is 57% according to official data.

This has led to a country that is on the verge of bankruptcy with little money to import gasoline and milk, cooking fuel, toilet paper, or other necessities.

It is also a problem because of its role in Sri Lanka's wealth squandering and it complicates any financial rescue.

Anit Mukherjee is a policy fellow and economist at The Center for Global Development in Washington. She said that any aid from the IMF/World Bank should be subject to strict conditions to ensure the aid is not mismanaged.

Mukherjee said that Sri Lanka is located in one of the busiest shipping lanes in the world, so it's not possible for a country with such strategic importance to collapse.

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WHAT IMPACT DOES IT HAVE ON REAL PEOPLE

Although tropical Sri Lanka is normally not starved, people in the country are becoming hungry. According to the U.N. World Food Program, nearly 9 out of 10 families are not eating enough or are cutting back on food in order to save money. Meanwhile, 3 million people are being provided with emergency humanitarian assistance.

Social media has been used by doctors to obtain critical equipment and medicines. Many Sri Lankans are applying for passports to travel overseas in search of work. Three months of extra time has been granted to government workers to enable them to grow their own food.

People are in pain and want things to improve.

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WHY IS THE ECONOMY IN SUCH DIRE STRAITS?

According to economists, the crisis is caused by domestic factors like years of corruption and mismanagement.

The public has been angry at President Rajapaksa, his brother and former Prime Minister Mahinda Rajapaksa. After weeks of protests against the government that turned violent, Rajapaksa resigned in May.

The situation has been worsening over the last few years. More than 260 people were killed in suicide bombings of churches and hotels during Easter 2019. Tourism, which was a major source of foreign currency, was devastated.

Rajapaksa was able to pass the biggest tax cuts in Sri Lankan History, which helped boost government revenues. Although the tax cuts were reversed recently, it was only after Sri Lanka's credit ratings were downgraded by creditors. This prevented Sri Lanka from borrowing more money, as its foreign reserves fell. The pandemic caused tourism to plummet again.

Rajapaksa banned the import of chemical fertilizers in April 2021. Farmers were taken by surprise when organic farming was promoted. This caused a decline in staple rice crops and drove prices up. Imports of other items that are considered luxuries were also banned to save money on foreign exchange. The Ukraine war has driven up the prices of oil and food. Inflation was at 40%, and food prices rose nearly 60% in May.

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WHY WAS THE PRIME MINISTER SAYING THAT THE ECONOMY HAS COLLAPSED

Wickremesinghe's June declaration, which was in his sixth term of prime minister, threatened to undermine confidence in the economic state and didn’t reflect any new developments. As his government seeks IMF assistance and faces criticism for the slow progress since his election, the prime minister seemed to be emphasizing the difficulties facing his government. This comment could have been made to purchase more time and support while he attempts to get the economy back on its feet.

According to the Finance Ministry, Sri Lanka has only $25 million worth of usable foreign reserves. This has rendered it unable to pay imports or repay billions of debt.

The Sri Lankan rupee is now worth about 360 US dollars. This makes import costs even more prohibitive. Sri Lanka has stopped repayments of approximately $7 billion of foreign loans this year, out of $25 billion due by 2026.

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WHAT DOES THE GOVERNMENT DO ABOUT CRISIS?

So far, Sri Lanka has struggled to make ends meet thanks to $4 billion in Indian credit lines. In June, an Indian delegation visited Colombo to discuss further assistance. Wickremesinghe cautioned against expecting India to keep Sri Lanka on its feet for too long.

Colombo Times headline June: "Sri Lanka places last hope on IMF" Wickremesinghe stated that he expects to reach a preliminary agreement with the IMF this summer.

China has offered more assistance to Sri Lanka. Other countries like Australia, Japan, and the U.S. have also provided support in the form of a few hundred millions dollars.

The United Nations issued a global appeal for help earlier in June. The $6 billion needed to keep the country afloat in the next six months is barely covered by the projected funding.

Wickremesinghe said that he would be open to buying oil at a steeply discounted price from Russia in order to counter Sri Lanka's fuel crisis.

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Kurtenbach, Asia business editor at the AP, contributed from Bangkok.

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