Sri Lanka: Diagnosis of An Economic Disaster

6 mins read

In the 74 years since our independence, Sri Lanka has achieved much in terms of human development, despite lingering human rights issues and gaps in democratic governance. Yet we have been economically mediocre: our per capita income was only USD 3,815 in 2021 and will be far lower in 2022. We have been left behind by nations that were lagging behind us in the 1960s. Why?

 Historical local causes: Shortsighted and inward-looking policies

In the 1970s, Sri Lanka followed statist, inward-looking policies while other countries liberalised markets and integrated globally. After liberalising in 1977 and 1988, subsequent leaders did not allow markets to function efficiently: they postponed essential reforms, took short-sighted decisions for political gain, and allowed crony capitalism to prosper. Every post-independence administration ran fiscal and current account deficits and used welfare politics to win votes. The 2003 attempt to bring fiscal discipline was thwarted by weakening the Fiscal Management (Responsibility) Act. In 2016, the coalition government attempted to reverse this trend with International Monetary Fund (IMF) support: it entered a disciplined revenue-enhancing fiscal consolidation program and registered a primary account surplus for the first time in decades. Yet key reform items (e.g., rationalising border tariffs, unbundling utilities, revamping foreign direct investment (FDI) policy, entering into regional trade agreements) were abandoned due to ideological clashes between the coalition parties, so external debt continued to grow.

Contributing global factors: Major external shocks

The onset of the Covid-19 pandemic in 2020 and the complete closure of national borders caused a major external shock to the economy, demolishing forex inflows through tourism. The Russian invasion of Ukraine in 2022, and the global supply chain crisis it prompted, exacerbated our crisis.

Immediate local causes: Poor policies, mismanagement, and ego

The Gotabaya Rajapaksa government subjected the economy to two major, unnecessary, policy shocks: Firstly, it implemented unprecedented tax cuts in December 2019, based on a wrong interpretation of ‘Modern Monetary Theory’. This wiped off one third of government revenue (estimated LKR 600 bn in 2020) and caused a high budget deficit, which was financed with printed money. Sovereign rating agencies immediately downgraded Sri Lanka’s outlook, affecting our ability to access private credit markets. Secondly, the administration implemented an overnight ban on imported chemical agricultural inputs, which resulted in the harvest falling by one third to half of usual output, depending on the crop. This caused an unprecedented produce shortage and increased import reliance.

 This government treated the looming crisis as a temporary liquidity shock due to the pandemic and ignored the systemic issues of solvency. They thus took short-term actions such as quantitative import restriction and forex restrictions on current account transactions, sought short-term financial support via swaps from Bangladesh, India, and China, and financed essential imports from supplier credit and foreign exchange reserves.

 Misguided exchange and monetary policy put the final nail in the coffin. The government used forex reserves to repay debt and defend the pegged exchange rate at around LKR 200/USD, draining Sri Lanka’s reserves from USD 7.6 bn in end-2019, to less than USD 50 mn in April 2022. The Central Bank of Sri Lanka (CBSL) took the contradictory policy of artificially holding interest rates as well as exchange rates, putting further pressure on the rupee. The CBSL printed money nonstop, resulting in the broad money supply increasing 41% between January 2020 and December 2021. Blackmarket rates for forex rose rapidly, at a 30% premium of the official rate. Exporters held dollars abroad and remittance inflows dried up to less than 40% of usual values.

After 18 months of denial, the CBSL abandoned the LKR 200/USD rate on 7 March 2022, and since they did not sequence the adjustment (e.g., relaxing import and forex transaction restrictions), the market exchange rate plummeted to LKR 365/USD by July 2022. The black-market rate of the dollar continues to trade at 10% over the official rate. The weak rupee meant that the price of all goods and services would inevitably shoot up.

This government treated the looming crisis as a temporary liquidity shock due to the pandemic and ignored the systemic issues of solvency.

The consequences: A predictable but terrible crisis

This economic catastrophe is therefore no surprise. But what has it resulted in?

Sovereign insolvency: In April 2022 Sri Lanka announced unilateral suspension of all external debt repayments (apart from multilateral debt), signaling bankruptcy for the first time since independence. The government has run out of forex and is unable to open letters of credit for essential imports.

Inflation, criticalshortages, and a national shutdown: Inflation is at unprecedented levels for almost all goods and services. Lack of forex for fuel resulted in 12-hour power cuts due to power plant closures and fuel queues that are kilometers long. Private and public transport has been decimated, so schools and government offices have closed. Agriculture, fishing, and industry cannot function. Other essential items such as medicine and food are also facing shortages and inflation, affecting the average person’s daily subsistence. More than 15 people have died in fuel queues, and there have been incidents of parents unable to feed their children committing suicide. Crime has increased and shortages may result in further breakdown of social order.

Political crisis: The public demanded leadership change, especially President Rajapaksa’s resignation – hence the cry, “#GotaGoHome.” On 31 March, there were protests outside his private residence. Despite emergency laws, a 36-hour curfew, and a social media ban, crowds reiterated this call across Sri Lanka on 3 April, causing the Cabinet including Basil and Namal Rajapaksa to resign. Protestors established ‘Occupy’-style protest sites outside the Presidential Secretariat in Colombo (GotaGoGama), and around the island. On 19 April, the police killed a protester in Rambukkana. On 9 May, goons from the Prime Minister’s (PM) official residence attacked GotaGoGama, prompting counter-violence from protestors. A ruling party Member of Parliament (MP) and his security officer were killed, and some 50 government MPs’ properties were burnt down. Mahinda Rajapaksa resigned as PM. The President falsely promised constitutional reform and appointed Ranil Wickremesinghe, the sole representative of the United National Party in Parliament, as the new PM. On 9 July, enormous crowds gathered in Colombo despite the lack of transportation and stormed the President’s and PM’s official residences. PM Wickremesinghe’s private residence was torched. President Rajapaksa fled the country, and finally resigned on 15 July. PM Wickremesinghe took oaths as interim President and was elected President by Parliament on 20 July, despite protestors rejecting his leadership as being proxy for the Rajapaksas. Sri Lanka is under a dark cloud of upheaval and uncertainty.


Though our economic position is dire, there is a way out of the crisis through reforms in ten key areas, which this document outlines. As this is not a holistic policy manifesto, it does not address important reform areas such as health, education, reconciliation, and climate protection: it is simply a blueprint for economic salvation and survival.

The ten pillars of reform:

1. Debt Crisis Management

2. Monetary and Exchange Rate Policy

3. Revenue Consolidation

4. Expenditure Control

5. Public Sector Management

6. Energy and Utilities Reform

7. Trade, Agriculture, Industry and Services Promotion

8. Factor Market Reform

9. Stronger Social Safety Nets

10. Transparency and Accountability


A Social Market Economy Philosophically, we believe in a social market economy: a synthesis between economic liberalism emphasising individual freedom and autonomy, and political freedom emphasising equity and justice. In this context, we must drive market competition and competitiveness while providing public support and social protection. We firmly believe that market competition is the key to economic success of the individual and the economy; yet we know that this requires regulation and assistance.

 To attain long-term development sustainably, opportunities should be offered to all citizens, and they should be empowered to harness these opportunities for their wellbeing. The government should actively facilitate and ensure this, by building an appropriate knowledge and information base, and maintaining proper economic policy, governance, law and order, and property rights. We believe economic growth is central to poverty alleviation. Compelling evidence from around the world shows that outward-oriented growth is more ‘pro-poor’ and effective at reducing poverty than statist, inward-oriented strategies. Our own economic history illustrates this well.

Yet we know that growth does not provide every need in poverty alleviation: the government must combine growthpromoting policies with a well-targeted social safety mechanism. Building a strong, transparent, and equitable social welfare system is an integral part of our development strategy: this facilitates achieving shared growth and makes difficult economic reforms palatable. That is why we believe in the total transformation of welfare politics, so that the subsidy is provided to the consumer directly rather than to the supplier of the service, which is then consumed mostly by the rich. Paraphrasing the economist Jagdish Bhagwati, although growth “opens the doors” for everyone, some people have starting lines further back than others – their government should help them over the threshold.

Concluding Remarks

At independence, Sri Lanka was one of the most prosperous countries in Asia, with per capita income above even South Korea and Thailand. Yet over the next 70 years, we fell further and further behind, eventually ending up in a sovereign debt crisis with the stigma of being the only Asian country to default on foreign debt in half a century. Our mission is to make this unprecedented crisis the springboard for lifting Sri Lanka onto a sustainable growth path, to regain our lost paradise. We are committed to transforming the closed ‘twin deficit’ economy characterised by stopstart growth and periodic macroeconomic crises, into a dynamic, outward-oriented economy that delivers sustainable, shared growth for all its citizens to enjoy. This requires achieving a strong, sustainable fiscal position by undertaking government revenue and fiscal reforms with complementary monetary, exchange rate, trade, factor market, and competition reforms; and underpinning this with complementary monetary, exchange rate, trade, factor market, and competition reforms; and underpinning this with a coherent, well-targeted social welfare net and strong anti-corruption legislation.

[ The article is based on a policy document named Ten-point Blueprint issued by the author on behalf of his political party]

The historical depreciation of the Sri Lankan rupee

3 mins read

Is the recent rapid depreciation of the Sri Lanka Rupee (LKR) against the US$ unexpected or a result of foreign exchange policies adopted by the Central Bank of Sri Lanka (CBSL) since 2005 to keep the depreciation at a rate much lower than the observed trend since 1977?

The historical depreciation of the Sri Lankan rupee since exchange control was introduced in the 1960s is depicted in this time series graph. The exchange rate per US$ has been plotted on a logarithmic scale to clearly illustrate the full range of values from Rs4 in the 1960s to the current Rs360, and the rate of change of depreciation.

The early 1970s was an era of strict exchange control when you could get only a few dollars when travelling abroad, various devices like Foreign Exchange Entitlement Certificates (FEECs) which effectively created two different exchange rates. The value of the Rupee was devalued from Rs 8.60 to Rs 16.13 on 1977 Nov 16th by the JR Jayewardene government to open the economy. Over the next 27 years, the Rupee depreciated at an almost constant rate of about 7.6% per year with respect to the US$. Although it can be seen to deviate from the fitted line on occasions, it always seems to come back to this trend line within about a year.  When you extend this trend line back it cuts the value in the early 1960s when exchange control was first introduced. The 90% depreciation in 1977 appear to be catchup for about 15 years of strict exchange control,

This trend continued till 2005 when the devastating Tsunami of 2004 December, brought in so much foreign aid that the exchange rate to the US$ dropped very soon after, from Rs 105 to Rs 95. Since then over the next 13 years, the Rupee depreciated at a much lower rate of 3.4% per year.

Ajith Nivard Cabraal took over as Governor of the Central Bank in 2006 July and maintained the lower trend even though Sri Lanka still had an ongoing civil war with the LTTE. When this war ended in 2009 May, the Rupee appreciated by 5% over the next two years. Did CBSL release more US$ to maintain an exchange rate lower than the natural trend? The CBSL may have wanted to reduce the amount of rupees that needs to be paid for the foreign exchange remitted from abroad by the large number of migrant workers, which was supporting our economy.

With a Rupee depreciating less, Sri Lanka was able to show an apparent higher rate of increase in the GDP and migrate proudly from a low income to a middle income country. With a GDP over US$ 4000 Sri Lanka lost the ability to get loans at a lower interest. After the Government changed in 2015 January, many irregularities, such as hidden foreign debts were exposed and compounded with a Bond Scam the Financial Rating for Sri Lanka dropped, and the cost of borrowing money increased. In 2018, the Rupee was depreciated 19% from Rs 153 to Rs 183 to the US$, with Indrajit Coomaraswamy as Governor of CBSL.

In 2021 July, Basil Rajapakse entered parliament via the national list and was made Finance Minister. In 2021 September Ajith Nivard Cabraal resigned as national list member in Parliament and became Governor of CBSL again.

CBSL maintained a non-credible peg at Rs200 to the US$. In 2022 January they paid back a Sovereign Bond of US$500 million and interest, despite all economic indicators that CBSL could not afford to do so. CBSL anyway defaulted on its Sovereign Debt in March. For many years the Kerb rate had been only a few rupees different from the official rate, even less than the selling rate of some Banks. From about 2021 September the Kerb rate started to increase and Undial and Hawala transfers got well established. The amount of Foreign exchange sent through legal channels decreased to about 35% YoY by 2022 February. By 2022 March the Kerb rate was Rs250.

When the exchange rate was floated on March 9, 2022, CBSL hoped it would settle at about Rs 230. However it rose rapidly to Rs 365 in two months when CBSL removed the float and pegged it around Rs 360. The exchange rate had almost caught up, to what it would have been if the previous long-term depreciation had continued from 2005 as shown on the graph.  Both Cabraal and Basil, blamed for the financial crisis, resigned in early April. CBSL has however confirmed in an RTI, that banknotes dated September 15, 2021 were printed with their signatures and are expected to come into circulation in the near future. The Aragalaya will not be amused.

The rapid depreciation by 80% in two months has created over 100% inflation in food prices, and a loss of trust in the Sri Lankan rupee. Assuming that it will precipitate a depreciation like in Venezuela or Lebanon, it has made those with significant rupee assets, decide to try to change it to US$ at whatever cost. Therefore the Kerb rate has remained Rs 30 to 50 above the official rate. Most of this Foreign exchange never reaches Sri Lanka, as it is accepted in cash overseas and LKRs are paid in cash directly to the recipient at their home, avoiding any record in the banking System. Although CBSL has outlawed it, such exchanges in cash are impossible to track. Over the last year Sri Lanka has lost over US$4 Billion from Foreign remittances.

The natural trend is just an observation that I will leave to the economists to explain. There are probably many factors that need to be considered to properly understand its cause and effects.

The way out of the shortage of US$, by the exchange rate remaining much lower than the natural trend, has still to be worked out.   The catch 22 situation is that this shortage of foreign currency will not improve till foreign remittances return to previous levels, and that will not happen till the Economic combined now with a political crisis is more stable.

This article first appeared in Sunday Times, Colombo, click here to read the original 

Indian Oil Company Brags on their Excessive Profits in Bankrupt Sri Lanka

1 min read

Despite the operational challenges stemming from forex crisis, inflation and higher global oil prices, Lanka IOC PLC reported robust performance for the quarter ended June 30, 2022 (1Q23) with significant growth in revenue and profits while the Indian government continued to brag their “economic assistance” to revive Sri Lanka’s broken economy.

The company said its revenue increased by 196 percent year-on-year (YoY) to Rs.49.93 billion. The Sales volume of the company also increased to 139,762 MT from 135,354 MT on YoY basis.

The cost of sales for the quarter was Rs.34.4 billion compared to Rs.16 billion a year ago as a result of the steep rise in international oil prices.

The company reported earnings of Rs.18.64 per share for the quarter under review on net profit of Rs.9.93 billion compared to earnings of 51 cents a share or Rs.273 million in the corresponding quarter of the previous year.

However, Lanka IOC said the sudden devaluation of currency from Rs.299 to Rs.367 per US$ coupled with extremely high borrowing costs, raised its finance expenses during the quarter to Rs.1.79 billion as against Rs.123 million a year ago.

“The company ventured into a new line of business of selling diesel directly to export houses, tourism services providers registered under Sri Lanka Tourism Development Authority, licensed telecommunication service providers and power generation companies, against remittance in US dollars. The collection in US$ eliminated the exchange rate risk and allowed sale of fuel to industries at a predetermined price,” Lanka IOC Managing Director Majoj Gupta said.

“On the other hand, it met the essential fuel requirement of innumerable industries which are responsible for livelihoods of millions of employees and their dependent family members. It is beyond imagination to believe the repercussion in case fuel requirements were not met on time.

I am so indebted to my workforce at Trincomalee Terminal who have had a round-the-clock operation of the terminal for more than 3 weeks with limited resources to supply fuel not only to industries but also to ensure supply of 7500 MT of diesel to CPC for onward dispatches for essential services,” he added.

Gupta also said the company’s bunkering business has registered exceptional performance, amid the exchange gain in view of depreciation of the currency, as sales take place in US$.

He further said the revision in retail prices (RSP) for auto-fuel in line with the pricing formula has been beneficial for the company.

“RSP revisions played a crucial role in circumventing the price volatility in the international oil market to a large extent. The bottom-line of the company has also been transformed by exceptional performances by Lubricants, Petrochemicals and Bitumen. We are extremely grateful to CBSL authorities and Ministry of Power and Energy, GoSL for their continuous support,” Gupta said.

Ceylon Chamber Cheers President’s Call to Form All-Party Government

1 min read

The Ceylon Chamber of Commerce welcomes the call by President Ranil Wickremesinghe to initiate the formation of an All-Party Government, as a concerted and united effort is necessary to address the current challenges facing the country. At this extremely crucial juncture for Sri Lanka, all political parties must join hands and put Sri Lanka First over individual agendas.

An All-Party Government that is acceptable to all sections of the public and equitably represents the views of all parties, which will work towards a common minimum programme is the first step toward addressing the current crisis. A policy framework with broad consensus by all parties is required so that an agreed reform agenda will spur global confidence amongst investors, the private sector, and the public.

We appreciate the steps taken by the Government to improve the shortages as a result of the economic stresses including ongoing power cuts, shortage of fuel, securing adequate essential drugs and food items, and the provision of adequate fertiliser to ensure food security. This stresses the importance of leveraging technology and communications to find solutions to these shortages.

The Chamber has in the recent past highlighted the need to urgently resume IMF negotiations with a view to reaching a staff level agreement expeditiously, proposed amendments to the Constitution, and the need for State-Owned Enterprise reforms as being among key priorities.

The implementation of a sustainable economic recovery plan will take time to bear fruit and key milestones will need to be set. We therefore call for all parties and the public to work together and be patient to usher in a new era for Sri Lanka.

Sri Lanka: Tragedy of a Donor Darling

3 mins read

A tragedy is unfolding in Sri Lanka. Citizens must queue for food and pharmaceuticals, vehicle owners cannot fill their tanks, and there have been rolling power outages. The economy is paralyzed, and because the country’s debts are already unsustainable, it cannot borrow. The country is suffering the world’s worst economic crisis since World War II.

The situation is so dire that millions of people have taken to the streets. The president has fled the country, and now parliament has elected a new, but unpopular, replacement. If all goes smoothly (a big if given the events of recent weeks), the International Monetary Fund can come to Sri Lanka’s aid with a rescue loan package (allowing for the purchase of essential imports) and a programme to achieve sustainable fiscal, monetary, and exchange-rate policies.

Sri Lanka’s plight serves as a lesson to other governments. When a country’s economic problems are obviously becoming insurmountable, postponing a reckoning through various piecemeal measures will only make matters worse in the end.

For years, Sri Lanka was a “donor darling,” owing to its relatively high standard of living, good social services, and robust economic growth. In the first half of the last decade, it boasted a 6.5 per cent average annual growth rate – one of the world’s highest – and very low population growth. Though economic growth slowed after 2015, it still averaged well over 3 per cent through 2019.

But at the end of that year, a new government came to power and immediately announced a large tax cut. In both 2020 and 2021, the government ran a fiscal deficit of more than 10 per cent of GDP. The annual inflation rate rose from an average of under 5 per cent in previous years to 39.1 per cent in May, and then to 54.6 per cent in June.

Worse, even with inflation already accelerating, the government announced in the spring of 2021 that it was banning all chemical-fertiliser imports. Predictably, rice production fell by 20 per cent, tea exports fell to their lowest level in more than two decades, and more than one-third of the country’s farmland was left fallow.

The COVID-19 pandemic came on top of these self-inflicted wounds, causing a sharp decline in tourist revenues, which then deepened Sri Lanka’s foreign-exchange shortage and further curtailed its ability to purchase imports. By late 2021, the situation was spinning out of control; and in May, the government defaulted on its foreign debt.

Now, Sri Lanka cannot obtain essential inputs to restart the economy until it has restructured its debt and installed a working government. Restructuring the country’s debt will be unusually complicated because a significant portion is owed to China, which does not participate in the multilateral Western-led restructuring exercises for overly indebted sovereign borrowers.

Again, the lesson for other debt-distressed countries is clear. While a country’s economic authorities can delay some of the consequences of ill-advised policies for a while through import rationing and prohibitions, price controls, fiscal deficits, foreign borrowing, and printing money, the music eventually will stop. When a government’s only remaining choice is to implement serious reforms or pursue desperate and economically irrational measures, doing the latter will merely deepen the misery and human suffering caused by the earlier policy mistakes.

Had Sri Lanka approached the IMF late in 2021 (or even earlier) and implemented the painful reforms needed to rein in inflation and reduce its current-account and fiscal deficits, at least six months of suffering could have been avoided. The country’s external debt would not have risen quite so high, and the road to recovery would not have been quite so long. More to the point, the country’s descent into complete political chaos might have been avoided altogether.

Since the start of the pandemic, the international community has appropriately been directing more attention to the plight of heavily indebted developing countries, with the G20 rolling out a Debt Service Suspension Initiative that extended some $13 billion of relief to 48 countries in 2020-21, but that was a drop in the bucket relative to needs.

Worse, there has been very little differentiation between countries whose underlying economic policies were sustainable and those whose policies would have become unsustainable without reform, even in the absence of COVID-19. Lending to a country in the latter category without ensuring that it has or will implement sustainable economic policies is not doing it any favours. On the contrary, such “support” merely postpones the day of reckoning and leaves it with an even higher debt-service burden when the time comes.

Policymakers in other economically struggling countries should take heed of Sri Lanka’s tale. The lessons can be paired with those from Brazil, which, following its 2002 debt crisis, quickly adopted the necessary policy reforms and went on to enjoy years of sustained growth. Brazil, too, had a choice between swift painful action to create the conditions for recovery, and denial and delay to put off the inevitable. Its leaders proved wiser than those who have since high-tailed it out of Sri Lanka.

Joint Chambers seek smooth transition of power in accordance with constitution

1 min read

Joint Chambers welcome the announcements made by the President that he will resign on the 13th of July respecting the wishes of the citizens and the Prime Minister’s willingness to resign once an interim Government is in place. The Chambers believe that they should submit their letters of resignation immediately in accordance with constitutional provisions clearing all doubts and paving the way for a smooth transition. We also request the Speaker to step forward to fulfil the important role he is expected to play in accordance with the constitution at this calamitous moment. First, we request him to expeditiously set in motion the process of selecting a President to serve the balance part of the current presidency. Secondly, we call upon him to assume the office of Acting President for a short period of time from 13th July until the Parliament decides on the new President.

After the new President selected by Parliament has assumed duties, the Joint Chambers expect him/her to invite a person who enjoys the confidence of a majority in Parliament to become the Prime Minister and appoint an interim cabinet drawn from all political parties who wish to participate in an All-Party Government. Joint Chambers are also of the view that a clear time frame should be established for this interim administration and a firm commitment should be made with regard to the date of the next General Election.

The importance of implementing the above process in a speedy and smooth manner is absolutely critical in order to focus on addressing the essential needs of the public and businesses such as fuel, electricity and gas while taking forward the much needed economic reform agenda in line with the IMF programme under negotiation and the debt restructuring process. It is also imperative that the rule of law is established as soon as possible in accordance with the constitution and the Joint Chambers expect all citizens to cooperate in upholding the law.

The Joint Chambers also believe that the interim Government should consider the enactment of necessary amendments to the Constitution as a top priority to restore governance as desired by the people.

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