7/25/2022: What Happened to Sri Lanka?
The double whammy of debt and COVID bankrupt the country
Sri Lanka is running out money. Its president fled the country amid the economic crisis Inflation touched a year-on-year record of 54.6% in June while the Sri Lanka rupee exchange rate has fallen more than 40% since the end of February. They don’t even have enough money in their foreign reserve to buy fuel. The country is grinding to a halt and riots are erupting. How does a country with such rich natural resources on a strategic location in the Indian Ocean get to this point?
This article gives a pretty good overview on what happened to Sri Lanka. In summary, the country was already in trouble even before COVID. Their debt grew from $11.3B in 2005 to $50.72B in 2021 while their gross GDP only grew from $24.4B in 2005 to $80.7B in 2020. They borrowed money for various infrastructure projects that didn’t quite pay off. They owe $10B to China alone and two big infrastructure projects are already under China’s control because Sri Lanka defaulted on the loans. The fleeing president Rajapaksa’s family has been in control of the Sri Lanka government since 2005 and they obviously didn’t take the country into the right direction. The government debt skyrocketed. They also banned chemical fertilizers which decreased the agricultural output and made the price of staples like rice go up. This excessive borrowing for unsuccessful infrastructural projects and decreased agricultural output set them up for the perfect storm. To make things worse, the government decided to do a tax cut in 2021, further emptying the government coffer.
Sri Lanka is a net importer and runs on a trade deficit. Tourism has been a big source of foreign reserve for Sri Lanka and 12% of their GDP. Tourism and worker remittance are the main sources to maintain their foreign currency reserve and to keep their exchange rate steady. But in 2019, a terrorist attack that killed 269 and injured 500+ people deeply affected the tourism industry and the COVID pandemic practically stopped the tourists from arriving until late 2021. The demand for the Sri Lanka Rupees collapsed and their foreign currency reserve runs really low, not even enough to pay for the fuel shipments. But it’s hard for them to borrow more money because they already have too much debt and are already defaulting on the interest payments. They would need some kind of bailout to get out of this hole. India is reluctantly doing it as Sri Lanka is in a strategically important location and they don’t want China to take over the country.
If we think of Sri Lanka as a corporation and its currency as its stock, I believe it’s quite straightforward to understand how they get to this point. Sri Lanka was a small-cap company with okay finances to begin with. But they hired a bad CEO(President) who made a series of terrible decisions including excessive borrowing, hiring his family members as company executives, big and unsuccessful investments (infrastructure projects), nonsensical price cuts on their product (tax cuts) and cash flow reduction in the name of doing good (chemical fertilizer ban). Coupled with external factors such as COVID and terrorist attacks that torpedoed its revenue sources, the company is now bankrupt. The CEO was forced out. But most likely, he left with millions of dollars (corruption) while shareholders (Sri Lankans) are left with a crashing stock price and little hope to get back to normal.