Sri Lanka Economic Crisis Inflicted by Self-Serving Elite

Yves here. This piece is important not simply for presenting the details of how Sri Lanka went from being a development success story to a train wreck, but also for debunking the notion that Sri Lanka’s woes are the result of a Chinese debt trap. Even though the IMF’s record gives countries on the receiving end of loans reason to worry, at least so far, China has not lowered the hammer on any of its borrowers.

By Anis Chowdhury, Adjunct Professor at Western Sydney University and University of New South Wales (Australia), who held senior United Nations positions in New York and Bangkok and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Jomo Kwame Sundaram’s website

Once deemed a basic human needs success story, Sri Lanka is now in its worst economic crisis since independence in 1948. Nonetheless, Sri Lanka’s ‘moment of truth’ now offers lessons for other developing countries.

China Scapegoat

Sri Lanka has just defaulted on its foreign debt for the very first time. Attributing its current predicament to a Chinese ‘debt-trap’ is a new Cold War propaganda distraction – which we will undoubtedly hear much more of.

In this fable, Sri Lanka is a country caught in a debt trap due to white elephant projects mooted and financed by borrowings from China. Blaming Sri Lanka’s debt crisis on Chinese loans is not only factually wrong, but also prevents understanding the origins and nature of its current crisis.

Outstanding Sri Lanka government foreign debt in April 2021 was US$35.1bn. Policy errors have reduced foreign direct investment (FDI), exports and government revenue, changing the composition of its foreign debt for the worst.

Debt to the Asian Development Bank (ADB), World Bank, China, Japan and other bilateral lenders, including India, came to about a tenth each. Borrowing from capital markets – 47%, or almost half – is mainly responsible for its debt unsustainability.

After all, borrowing from multilateral development banks – mainly the World Bank and ADB – and bilateral lenders are mostly on concessional terms, while debt from commercial sources incurs higher interest rates.

Commercial loans tend to be more short term, and subject to stricter conditions. As sovereign bonds or commercial loans become due, their full value must be repaid. External debt servicing costs surge accordingly.

As of April 2021, about 60% of Sri Lanka’s debt was for durations of less than ten years. The US dollar denominated debt share rose sharply – from 36% in 2012 to 65% in 2019, as Chinese renminbi denominated loans remained around 2%.

Adding government guaranteed debt to state-owned enterprises, total borrowings from China were 17.2% of Sri Lanka’s total public foreign debt liabilities in 2019. Meanwhile, commercial borrowings grew rapidly from merely 2.5% of foreign debt in 2004 to 56.8% in 2019.

The effective interest rate on commercial loans in January 2022 was 6.6% – more than double that for Chinese debt. Unsurprisingly, Sri Lanka’s interest payments alone came to 95.4% of its declining government revenue in 2021!

Deep-Rooted Problems

Following its 2001 recession, Sri Lanka recovered, before growth declined again after 2012 and the pandemic contraction in 2020. Sri Lanka also experienced premature deindustrialization, with manufacturing’s GDP share falling from 22% in 1977 to 15% in 2017.

Government tax revenue declined from 18.4% of GDP (1990-92 average) to 12.7% (2017-19), and a 8.4% pandemic nadir in 2020. Non-tax revenue – mainly dividends and profits from public investments – fell from 2.3% of GDP in 2000 to 0.9% in 2015.

Sri Lanka’s exports-GDP ratio almost halved from 39% in 2000 to 20% in 2010. This took a big hit during the pandemic, dropping to 17% in 2020. From 2000, FDI inflows into Sri Lanka were between 1.1% and 1.8% of GDP, before falling to 0.5% in 2020.

During 2012-19, the share of International Monetary Fund (IMF) Special Drawing Rights (SDRs) in Sri Lanka’s debt stock fell from 28% to 14%, as borrowings ballooned! Sri Lanka’s debt crisis is clearly due to the policy choices of successive governments since the 1990s.


In February 2022, Sri Lanka had only US$2.31 billion in foreign exchange reserves – too little to cover its import bill and debt repayment obligations of US$4 billion.

Its 22 million people face 12-hour power cuts, and extreme scarcities of food, fuel and other essential items such as medicines. Inflation reached an all-time high of 17.5% in February 2022, with food prices rising 24% in January-February 2022. But economic crisis is not new to Sri Lanka.

As a commodity producer – mainly exporting tea, coffee, rubber and spices – export earnings have long been volatile, vulnerable to external shocks. Foreign exchange earnings have also come from ready-made garments, tourism and remittances, but their shares have grown little over decades.

Since 1965, Sri Lanka has obtained 16 IMF loans, typically with onerous conditionalities. The last was in 2016, providing US$1.5 billion over 2016-19. Required austerity measures have squeezed public investment, hurting growth and welfare.

Two recent shocks made things worse. First, bomb blasts in Colombo churches and luxury hotels in April 2019 drastically cut tourist arrivals by 80%, squeezing foreign exchange earnings.

Second, the pandemic has damaged not only economic activity, but also foreign exchange reserves, as it often paid monopoly prices to get COVID-19 tests, treatments, equipment, vaccines and other needs.

Tax Cuts Galore

The ethno-populist policies of the Gotabaya Rajapaksa government – which came to power in 2019 – have added fuel to fire. Successfully mobilizing majority Buddhist Singhala sentiment – against Tamils, Muslims and Christians – he sought political support by cutting taxes on the ‘middle class’.

His government cut taxes across the board, collecting only 12.7% of GDP in revenue in 2017-19 – one of the lowest shares among middle-income countries. Losing about 2% of GDP in revenue, its tax-GDP ratio fell to 8.4% in 2020.

Sri Lanka’s value-added tax rate was cut from 15% to 8%, while the VAT registration threshold was raised from one to 25 million Sri Lanka rupees monthly. Other indirect taxes and the ‘pay-as-you-earn’ system were abolished.

The minimum income tax threshold was raised from 500,000 Sri Lanka rupees annually to three million, with few earning that much! Personal income tax rates were not only reduced, but also became even less progressive.

The corporate income tax rate was cut from 28% to 24%. With a 33.5% drop in registered taxpayers (corporate and individual) between 2019 and 2020, Sri Lanka’s tax base shrank.

Thus, even more of the population became exempt from direct taxes, increasing government popularity, especially among the middle class. But tax cuts failed to spur investment and growth – despite old claims by Ronald ReaganDonald Trump and their ‘guru’, Arthur Laffer.

Successive Sri Lanka governments thus failed to increase tax collection, squeezing government revenue. To finance budget deficits, they increasingly borrowed from international capital markets – at higher commercial rates, with shorter maturities.

As the government cut tax rates and exempted most from paying income tax, government revenue fell. Due to its falling revenue and deteriorating credit rating, the government had to borrow more, at higher interest rates.

Facing fiscal and foreign exchange constraints, the government declared Sri Lanka a 100% organic farming nation in April 2021. Banning all fertilizer imports – ostensibly to promote ‘agro-ecological’ farming as part of a larger ‘green’ transformation – compounded the looming ‘perfect storm’.

Dropped in November 2021, the policy drastically cut agricultural output, with more food imports becoming necessary. Falling tea and rubber output also reduced export earnings, exacerbating foreign exchange shortfalls.

Evidently, the Sri Lanka government addressed the economic challenges it faced with ‘populist’ policy choices. Instead of addressing longstanding problems faced, this effectively ‘kicked the can’ down the road, worsening the inevitable meltdown.

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  1. wolfepenguin

    Well, I’m not surprised by any of this. Accusations of Chinese debt trap has always been based on comparing it World Bank loans when the real comparison should have been to commercial loans since Chinese aid operated on the principle of mutual prosperity. The irony is many of the accusations against China has always been what the West would have done if they were in the place of the Chinese.

  2. ywhaz

    What were they thinking when they decided to transition to 100% organic farming? Organic fertilizers, whether plant- or animal-based, require both land and water, which are not what an island country can afford. If they revert back now, the crazily high fertilizer price will certainly not help with the situation. Looks like a terrible decision from the very beginning.

  3. Verifyfirst

    Regarding the headline, “Sri Lanka Economic Crisis Inflicted by Self-Serving Elite”. couldn’t “Sri Lanka” be replaced by……any country on earth……..and the headline would fit just fine?

    1. eg

      Isn’t the title an encapsulation of the entire globalization project? Local oligarchs exploit their fellow citizens to extract rents, the proceeds of which they squirrel away in offshore boltholes with the connivance of the UK/US PMC.

  4. Matthew G. Saroff

    When I read the headline, “Sri Lanka Economic Crisis Inflicted by Self-Serving Elite,” I think, “There has never been an economic crisis that has not been inflicted by a self-serving elite.”

  5. Bugs

    Amazing that they didn’t think though the VAT adjustment, which must have been the largest source of revenue. As for going purely organic, all good and fine but yields are always below green revolution levels. There must be people in government who knew that. Good intentions.

  6. VietnamVet

    If the USA survives WWIII, now ongoing with Russia, and the US dollar once again is based only on the resources, labor, and knowledge of Americans (not a mammoth global casino), the USA will be in the same position as Sri Lanka. War, Pestilence, and Famine have been human burdens from the beginning; aggravated by the rise of agriculture. Neoliberalism must be added to the list of human enemies. It destroys good government that is intended to be mankind’s Champion in the constant battle against the Four Horsemen of the Apocalypse.

  7. H. Alexander Ivey

    Evidently, the Sri Lanka government addressed the economic challenges it faced with ‘populist’ policy choices.

    Funny, that’s not how it looks here in Colombo from this small business owner and US passport holder resident. There was / is nothing for the population at large with the Rajapaksa government’s policy of white elephants and out right looting.

    Instead of addressing longstanding problems faced, this effectively ‘kicked the can’ down the road, worsening the inevitable meltdown.

    The Rajapaksas have been running the government here in a similar fashion as Marcos did on the Philippines. A best guess would be they may meet the same fate as Marcos.

    The take away point is there is nothing ‘natural, or scientific about the economic crisis here, it is entirely the Rajapaksa’s fault (the family had been in power for years); an observation the posting gives little emphasis to.

    1. bwilli123

      Thank you for this. It echoes what I’ve (rarely) read elsewhere.
      If you have the time and inclination to elaborate I’m sure it would be welcomed by many.

      1. H. Alexander Ivey

        Apologies to Yves and her crew for posting links on her site but much of my comment was formulated from the Daily FT, a Sri Lanka newspaper still printed and distributed around Colombo. See the Breaking News, Laws necessary for public declaration…story. (sorry, I can’t figure out links here).
        Funny thing, while also living in Singapore, I’m familiar with how LKY made all government officials declare their worth. If it wasn’t validated, it was confiscated. Beware of Singapore on the Thames, haha.

  8. PlutoniumKun

    I really wish people would stop repeating the nonsense that Sri Lanka went for some sort of overnight 100% organic, and this precipitated the crisis – the authors should know better. As the links embedded in the article itself demonstrates, nothing of the sort took place (did they even read the links they’ve used to back up the assertion?).

    Sri Lanka has a long term plan to go organic as part of a policy of reducing dependence on imports. There was a short term ban in April 2021 on the importation of artificial inputs – the reason for this was the shortage of foreign currency, it had nothing to do with agricultural policy. The crash in agriculture output is because of the economic crisis (i.e. a lack of foreign currency for imports), not the cause.

  9. sbarrkum

    What has not been mentioned in a nice article, the MOST important factor.
    Collapse of the Foreign Exchange Income stream.

    So why the economic crisis in Sri Lanka. Lanka is being hit by a perfect storm.

    a) The consequences of 2019 Easter bombing by Islamics and loss of tourism for three years (20% FX)

    b) Economic shut down by a 1+ year lockdown because of Covid (30% FX, eg Garments)
    The govt chose health and life over, economics.
    We have about 700/M deaths (compared to 2000+/M in US) and that mostly in 2021.

    c) Loss of mid east remittance for 2 years, as workers were sent back because of COVID fears. (30% FX)

    d) And now having to pay for refined fuels and diesel shortages. Our only refinery Sapugaskanda built by the Iranians is to process Iranian crude or Russian crude.

    In my opinion, fuel shortages are the biggest problem. 10 hour power cuts in urban areas. Lines to get diesel, petrol, kerosene and LPG if available. Again not too bad in rural areas. i.e. use firewood. I just built an outdoor fireplace.

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