Ukraine war hastens Sri Lanka’s economic meltdown

Internal factors alone cannot explain Sri Lanka’s economic collapse. In a forewarning of wider international instability, Sri Lanka slid from a serious balance-of-payments crisis to bankruptcy due to the spiraling global fuel and food prices triggered by the Western sanctions against Russia.

Brahma Chellaney, Nikkei Asia

Auto rickshaw drivers line up to buy gas near a fuel station in Colombo on April 13: A forewarning that more vulnerable countries could go bust. © AP

Sri Lanka’s economic collapse exemplifies how poorer countries are paying the price of Western sanctions on Russia following its invasion of Ukraine.

Instead of focusing on how the sanctions are fueling a global energy and food crisis, much of the international attention is on the new Cold War between the West and Moscow. Unable to pay for basic imports and crippled by domestic shortages of fuel, food and medicine, Sri Lanka is facing its worst financial crisis since independence in 1948.

After hundreds of thousands of protesters marched on Colombo over the weekend, and the risk of violent unrest intensified, Sri Lanka’s President Gotabaya Rajapaksa and interim Prime Minister Ranil Wickremesinghe separately announced they were stepping down. Gotabaya, however, fled the country on a military jet without handing in his resignation.

Rooted in fiscal imbalances, external debt and government mismanagement, Sri Lanka’s economic crisis predates the Western imposition of unparalleled sanctions on Russia over its attack on Ukraine.

But, thanks to spiraling international fuel and food prices in recent months, Sri Lanka has slid from a serious balance-of-payments crisis to bankruptcy, with Wickremesinghe declaring that the national economy had “completely collapsed.”

By taking out a crucial chunk of the global energy supply, the sanctions against Russia have triggered a surge in inflation in Western nations, which now confront cost-of-living crises. But in poorer countries, the sanctions are compounding national debt woes and threatening livelihoods and social stability.

Russia, the world’s largest exporter of oil and gas before the war, has been critical to stability in international energy markets, while its fertilizer exports remain vital for global food production, in which energy accounts for up to 30% of the cost.

Financial sanctions have made it so difficult to make payments to Russia that supplies of even sanctions-exempt commodities such as fertilizers and wheat — of which Russia is also the world’s biggest exporter — have been disrupted. Russia, for its part, has blocked shipments of Ukraine’s leading exports: sunflower oil, corn and wheat.

It is these unintended consequences that have hastened Sri Lanka’s economic meltdown. The rapid depletion of foreign exchange reserves has left its citizens without basic necessities. Rolling electricity outages and queues for fuel that run for miles have forced authorities to temporarily shut schools and offices.

Sri Lanka’s debt crisis first caught international attention in 2017 when, unable to repay Chinese loans, the nation handed a strategic port complex at Hambantota to China on a 99-year lease. Despite slipping into a debt trap, Sri Lanka went ahead with other grandiose Chinese projects, including a massive development project across the bay from Colombo on reclaimed land.

Other factors also contributed to making Sri Lanka’s debt unsustainable. A terrorist bombing spree on Easter Sunday in 2019 that killed nearly 300 people and led to a near cessation of foreign tourist arrivals, followed by the COVID pandemic, devastated the resource-poor nation’s revenue stream.

The Rajapaksa family, which has long dominated Sri Lanka’s political landscape and was instrumental in opening the door to China, racked up debt on a grand scale by committing to an array of ambitious infrastructure projects, several of which continue to bleed money. Worse still, drastic tax cuts in 2019 wiped out about a third of the government’s revenues.

More recently, after violent protests toppled Prime Minister Mahinda Rajapaksa’s government in May, his brother, President Gotabaya Rajapaksa, appointed an old political rival, former Prime Minister Wickremesinghe, to head an interim government and help rescue the nation from the economic death spiral.

Wickremesinghe, whose private home was set on fire by arsonists on Saturday, earlier described the national situation as unprecedented. “We’ve had difficult times [before]… But not like this. I have not seen… people without fuel, without food.”

Sri Lanka has confronted multiple economic crises in the past — since 1965 the country has secured 16 International Monetary Fund loans — but its current talks with the IMF for a bailout package are difficult because, in Wickremesinghe’s words, “we are participating in the negotiations as a bankrupt country.” An IMF approval appears months away.

China, now the world’s biggest official creditor, has balked at paring Sri Lanka’s debt, saying it would set a precedent for other borrowing countries to demand similar relief. With China’s typical loan contract compelling a borrowing country to keep confidential even the loan’s existence, Sri Lanka is reeling under a hidden debt problem, with its actual debt to Beijing perhaps making up as much as 20% of its total external debt.

To stay afloat in recent months, Sri Lanka has largely relied on help from India, which has provided over $4 billion in credit lines and other aid. But Wickremesinghe says Sri Lanka urgently needs more assistance, especially from India, Japan, the U.S. and China.

Sri Lanka’s economic meltdown, which has forced it to seek Russian oil, wheat and fertilizers on credit, may be an extreme example of the global fallout from the U.S.-led sanctions on Moscow.

But violent demonstrations from Latin America to Africa over the dizzying spiral in fuel and food prices are a forewarning that more vulnerable countries could go bust. “I think by the end of the year, you could see the impact in other countries” as well, Wickremesinghe said.

Brahma Chellaney is a geostrategist and author of nine books, including “Asian Juggernaut: The Rise of China, India and Japan.”