The death of Sri Lanka by the national debt

The nation of Sri Lanka was many things. A beautiful country, international tourism was a major industry. Fertile land, it produced enough rice to feed all its people. Prosperous, it has earned its place as an upper middle income nation. Then it all went to hell.

steve hanke provides an executive summary:

Sri Lanka, an island nation of 22 million people, is in the grip of economic collapse. This slow-motion train wreck began in November 2019 when Gotabaya Rajapaksa won a decisive victory in the country’s presidential elections. He immediately placed family members in key government positions and suspended parliament. Then, in August 2020, his Sri Lanka Podujana Peramuna party – the People’s Front of Sri Lanka – won a landslide victory. This victory gave Rajapaksa the possibility of modifying the country’s constitution, which he quickly availed himself of. In total control, President Rajapaksa and his brother Mahinda, the prime minister, embarked on a spending spree funded in part by Sri Lanka’s central bank. The results were economic devastation.

But it’s the details that are overwhelming.

A story of political greed

National examby Dominic Pino lists line items who got the ball rolling by blowing up the government budget:

The government has embarked on a number of unnecessary megaprojects. A India time report on these projects includes an international airport, a seaport, many unnecessary roads and bridges and a cricket stadium which “has only had a few international matches and is so remote that arriving teams risk being attacked by animals savages”. Many of these projects were named after the Rajapaksas, an association that would come back to bite them.

You’ve probably heard elected officials in your community bragging about their version of these big, bold initiatives. All promising, they will stimulate the economy and create hundreds or thousands of jobs. But because these are little more than projects of political vanity, they will never be able to deliver on that promise.

What they do is do whatever it takes to retain power. In 2019, Gotabaya Rajapaksa acted to cut taxes while increasing spending in a bid to better control the Sri Lankan government in its upcoming elections. He succeeded in achieving his political goal, but to say it was not a smart thing to do is an understatement.

A bad combination

Politicians set out to increase spending without having the tax revenue to cover the cost and get the money they want by borrowing it. Sri Lanka’s national debt soared as it borrowed more and more from foreign lenders to fund Rajapaksa’s spending. But in 2020, the coronavirus pandemic has devastated the country’s economy, especially its large tourism industry, a major source of foreign currency. Without this foreign currency, the Sri Lankan government was soon deprived of the money it relied on to repay its loans.

Rajapaksa’s response to this cash crunch led to the next stage of Sri Lanka’s economic collapse.

The price of excessive borrowing

As with people who depend on borrowing to support themselves, the first bills that indebted governments pay are those owed to their creditors. Under Rajapaksa, the Sri Lankan government had to find the money to continue its debt-fueled run. They got it in April 2021 by ending government purchases of imported fertilizers. They sold this program to the Sri Lankans by telling them that they were committed to adopting 100% organic farming.

Foreign Police‘s Ted Nordhaus’ sets the stage for what happened next:

Then, just months after Rajapaksa was elected, COVID-19 arrived. The pandemic has devastated Sri Lankans tourism sectorwhich represented almost half of the national population exchange in 2019. From the first months of 2021, the government’s budget and currency were in crisis, with the lack of tourist dollars depleting foreign exchange reserves so much that Sri Lanka was unable to pay its debts to Chinese creditors following a frenzy of infrastructure development over the previous decade.

Having become so indebted, the rulers of Sri Lanka have become desperate. They needed the money and that now meant they had to take it elsewhere. What could go wrong?

A desperate and crazy plan

Their choice of how they would get the money they needed to keep their debt-funded party going was as desperate as it was crazy.

Enter Rajapaksa’s Biological Commitment. From the earliest days of the green revolution in the 1960s, Sri Lanka has subsidized farmers to use synthetic fertilizers. The results in Sri Lanka, as in much of South Asia, were startling: yields of rice and other crops more than doubled. Hit by serious food shortages as recently as the 1970s, the country became food secure while tea and rubber exports became critical sources exports and foreign exchange reserves. The increase in agricultural productivity has enabled widespread urbanization and much of the country’s labor force has moved into the formal sector. wage economyculminating in Sri Lanka achieving official upper-middle-income country status in 2020.

In 2020, the total cost of fertilizer imports and subsidies was close to $500 million every year. With rising fertilizer prices, the tab is expected to rise further in 2021. The ban on synthetic fertilizers has apparently allowed Rajapaksa to kill two birds with one stone: improve the country’s foreign exchange situation while reducing massive expenditure subsidies from the public budget affected by the pandemic.

It went horribly wrong. Because organic farming is far less productive than modern farming practices, crop yields have dropped. Sri Lankans went from food self-sufficiency to starvation in a matter of months. The country’s cash burn worsened, as it now had to import food from foreign sources.

Complete collapse

It took only a few months for the fiasco of organic farming in Sri Lanka to become evident. Rajapaksa reacted to this crisis by diverting funds from other Sri Lankan imports, such as diesel fuel. But these new tax diversions have only accelerated Sri Lanka’s decline. On May 20, 2022, all the money the Sri Lankan government had access to finally ran out. The Government of Sri Lanka by default on its national debt for the first time in its history.

The country’s new prime minister, Ranil Wickremesinghe recognize the lamentable economic situation of the country:

Sri Lanka’s debt-ridden economy has “collapsed” after months of food, fuel and power shortages, the prime minister told lawmakers in comments that highlighted the country’s dire straits as he sought assistance from international lenders.

Ranil Wickremesinghe told parliament the South Asian nation faced “a much more serious situation” than just shortages, and he warned of “a possible bottoming out”.

“Our economy has completely collapsed,” he said on Wednesday.

That would be Wednesday, June 23, 2022, just over a month after the government defaulted on its national debt. It didn’t take long to find out how much ruin there were in Sri Lanka.

Comments are closed.