Sri Lanka’s Government Falls
On July 9th, the homes of both the Sri Lankan President and the Prime Minister’s office were stormed and burned by protesters. For the past few months, the Sri Lankan economy has crumbled apart due to bad decisions at the top. There are shortages of medicine, essential supplies, food prices inflating by 80%, and an overall currency inflation rate in June at 54.6%. Due to these protests, President Gotabaya Rajapaksa fled the country and Prime Minister Ranil Wickremesinghe agreed to resign due to these protests resulting from a series of systemic issues.
Protesters entered the Presidential Palace on July 9th. Image from the National Review.
Economics - Debt, Trade Deficits, and Currency Overvaluation
Because Sri Lanka is an island nation, it relies on importing a wide variety of goods to sustain itself, leading to the country running a trade deficit. This isn’t inherently bad, but what can be is how deficits are run. To buy goods on the international market, buyers and sellers all want to use the dominant currency, USD. So, for Sri Lanka, how much USD it has available to spend matters because it needs USD to import goods. Think for a moment of this trade deficit not through the lens of the material goods traded, but instead of the price these things cost in USD. Let’s say Sri Lanka buys bread from India for 10 USD, while Sri Lanka also sells tea to Japan for only 3 USD. In this situation, Sri Lanka will quickly run out of money to conduct trade.
Playing this game of economics requires other sources of USD through international loans and other income.
In part, to solve this problem, remittances were the solution. This is when workers go work overseas and send money made back home to their families, increasing the supply of USD. Plus, in 2019, tourism comprised 22% of the country's GDP, bringing in a lot of foreign currency. Sri Lanka also intentionally overvalues its currency to save money on USD. Let's say the cost of grain is 1 USD on the international market, and 1 USD costs 200 Sri Lankan Rupees (SLR). If Sri Lanka can convince the world that 1 USD is actually worth 150 SLR, then Sri Lanka can save 25% on the cost of grain. To pull this off, the central bank must buy and sell foreign currency to overvalue the SLR.
Sri Lankan Rupee collapses in value compared to USD in 2022, revealing currency overvaluation and fueling the ongoing crisis. Image from Federal Reserve Economic Data.
Negligence - Taxes, Corruption, and Nepotism
Prior to the election of the current Rajapaksa government that is being overturned, from 2015 to 2019, the country was run by a coalition of opposition parties that all opposed the Rajapaksa family rule. They could agree on their opposition to the Rajapaksa family, but not much else. This led to the government not doing much, running a rickety tax system struggling to generate enough revenue to maintain the government. This was worsened when the Rajapaksa family came back to power in 2019. They ran on a platform of cutting taxes by nearly 50%. Now, only 13% of Sri Lanka's GDP comes from taxes, while similar developing countries see about 20% of their GDP from tax revenue.
Then Presidential Candidate Gotabaya Rajapaksa at a campaign rally in 2019. Image from the AP.
The Sri Lankan government also relies on international loans to maintain its trade deficit, particularly from the IMF. However, the government has a track record of spending loaned money on vanity projects and has issues of corruption, meaning loans of foreign currency don't always get spent on reducing their trade deficit. Particularly, the Rajapaksa government has been accused of nepotism by the opposition parties because they loaded their cabinet with family members.
Protesters stand on a vandalized police water cannon truck and shout slogans at the entrance to the president's official residence in Colombo, Sri Lanka, Saturday, July 9, 2022. Image From AP.
Bad Policy - Fertilizer and Gas Regulations
Two standout policies added to the image that the Rajapaksa government was incompetent, and needed to be replaced. The first policy was the government's decision to ban all chemical fertilizers, pesticides, herbicides, and imports of such. Allegedly pressured by environmental groups, the ban was intended to switch the country's farming techniques into organic practices. Farmer’s livelihoods and crops were decimated as one-third of the country's farmland lay dormant, making the government deeply unpopular among farmers. This policy would last from May 2021 to November 2021. The catastrophe has severely weakened the country's domestic food production, adding fuel to the fire.
Rice farmers work on a paddy field in February 2022 while the nation's farmers recover from massive crop losses. Image from Reuters.
The issue was the gas explosion incident. Starting in October 2021, a series of unexplained cooking gas explosions occurred in Sri Lanka, with the Police reporting some 800 incidents, one of which caused the death of a 53-year-old woman. The government conducted its own internal investigation, concluding its very own decision to change regulations on the composition of gas cylinders was the result of these explosions.
Image of the resulting damage from a gas explosion at someone's home in Sri Lanka. Image from the Daily News.
The Formation of a Perfect Storm
These ingredients were the perfect storm to create what happened in Sri Lanka. The collapse of tourism in 2020 took out a large source of foreign currency while chemical fertilizer bans devastated a portion of the economy. Corruption and a poor tax system took away money that could have been better spent on preventing these issues. As things got worse, the currency began to lose value, and remittances stopped coming in because USD was not worth as much once turned into SLR at the bank. Trade slowed significantly as the country didn’t have the USD sellers wanted. As foreign goods stopped coming, in March 2022, exams in the country's largest province for grades 9, 10, and 11 were canceled because the school board couldn't buy enough paper and ink. As things worsened, widespread medicine, food, and gas shortages put on pressure.
The Bigger Picture
Due to economic issues, political incompetency, and harmful policies, the government's cabinet resigned en masse on April 3rd. This was promptly followed by protests calling for the President and Prime Minister to resign. There were discussions about holding a snap election, however, shortages were so bad that the government did not have the physical resources to hold an election. With the President and Prime Minister unwilling to resign and elections off the table, protests continued which led to the events of Saturday 9th unfolding. This was followed by President Gotabaya Rajapaksa fleeing the country and Prime Minister Ranil Wickremesinghe agreeing to resign.
Have a question about something in the news? Shoot me an email and I might answer it in a future article!