EXPLAINER: Why Sri Lanka’s economy collapsed and what comes next

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COLOMBO, Sri Lanka (AP) – Sri Lanka’s prime minister says the island nation’s debt-ridden economy has “collapsed” as it runs out of money to pay for food and fuel. Short of funds to pay for importing such necessities and already defaulting on its debt, it is turning to neighboring India and China, as well as the International Monetary Fund, for help.

Prime Minister Ranil Wickremesinghe, who took office in May, underscored the monumental task he faces to turn around an economy he said is heading for a “bottom”.

Sri Lankans skip meals as they suffer from shortages and queue for hours to try to buy scarce fuel. It’s a harsh reality for a country whose economy was growing rapidly with a burgeoning and comfortable middle class until the recent crisis intensified.

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HOW DIFFICULT IS THIS CRISIS?

Food is not usually scarce in tropical Sri Lanka, but people are starving. The United Nations World Food Program says nearly nine in 10 families are skipping meals or otherwise skimping to extend their diet, while 3 million receive emergency humanitarian assistance.

Doctors have resorted to social media to try to obtain essential supplies of equipment and medicines. More and more Sri Lankans are looking for passports to go abroad in search of work. Government workers have been given an extra day off for three months so they have time to grow their own food. In short, people are suffering and desperate for improvement.

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WHY IS THE ECONOMY IN SUCH DEFEAT?

Economists say the crisis stems from domestic factors like years of mismanagement and corruption, but also other issues like a growing $51 billion in debt, the impact of the pandemic and terrorist attacks on tourism, among other issues.

Much of the public anger has been focused on President Gotabaya Rajapaksa and his brother, former Prime Minister Mahinda Rajapaksa. The latter resigned after weeks of anti-government protests that eventually turned violent.

Conditions have deteriorated in recent years. In 2019, more than 260 people were killed in suicide bombings in churches and hotels at Easter. This devastated tourism, an important source of foreign exchange.

The government needed to boost revenue as external debt for major infrastructure projects soared, but instead Rajapaksa pushed through the largest tax cuts in Sri Lanka’s history, which were recently reversed. Creditors downgraded Sri Lanka’s credit ratings and prevented it from borrowing more money as its foreign exchange reserves dwindled. Then tourism collapsed again during the pandemic.

In April 2021, Rajapaksa suddenly banned imports of chemical fertilizers. The push towards organic farming caught farmers by surprise and decimated mainstream rice crops, driving up prices. In order to save foreign exchange, the importation of other items considered luxury goods was also banned. Meanwhile, the war in Ukraine has pushed up food and oil prices. Inflation was nearly 40% and food prices rose nearly 60% in May.

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WHY DID THE PRIME MINISTER SAY THE ECONOMY IS COLLAPSING?

Such a blatant statement could undermine any confidence in the economy and did not reflect any concrete new development. Wickremesinghe seemed to underscore the challenge his government faces in turning things around as it seeks help from the IMF and faces criticism over a lack of improvements since he took office weeks ago. He also defends himself against domestic criticism. His comment could be aimed at gaining more time and support as he tries to get the economy back on track.

Treasury says Sri Lanka has only $25 million in usable foreign exchange reserves. It lacks the funds to pay for imports, let alone repay billions in debt.

Meanwhile, the Sri Lankan rupee has depreciated by almost 80% to around $360 to $1. This makes the import costs even more prohibitive. Sri Lanka has suspended repayments of about $7 billion in foreign loans maturing this year, up from $25 billion due to be repaid by 2026.

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WHAT DOES THE GOVERNMENT DO ABOUT THIS?

Wickremesinghe has plenty of experience. This will be his sixth term as prime minister at the latest.

So far, Sri Lanka has muddled through, helped largely by $4 billion in credit lines from neighboring India. An Indian delegation was in the capital Colombo on Thursday for talks on more aid, but Wickremesinghe warned not to expect India to keep Sri Lanka afloat for long.

“Sri Lanka pinning last hopes on IMF,” read Thursday’s headline in the Colombo Times newspaper. The government is negotiating a rescue plan with the IMF. Wickremesinghe said Wednesday he expects a tentative deal with the IMF by the end of July.

The government is also seeking more help from China. Other governments such as the US, Japan and Australia have provided a few hundred million dollars in additional support.

Earlier this month, the United Nations launched a global public appeal for help. So far, projected funds barely scratch the surface of the $6 billion the country will need to stay afloat over the next six months.

To help address Sri Lanka’s fuel shortages, Wickremesinghe said in a recent interview with The Associated Press that he would consider buying more discounted oil from Russia to help get the country through its crisis.

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Kurtenbach, the AP’s Asia business editor, contributed from Bangkok.

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