Earlier this week, Sri Lanka deployed military troops at petrol stations to “discourage any unrest” among thousands of motorists waiting outside for hours to get their tanks filled up. While chaos at petrol stations is not a rare sight in a South Asian country, people dying because of it, is.

And this only scratches the surface.

What started off as a temporary decline of tourism due to the serial bomb blasts in 2019 turned out to be a huge economic crisis for Sri Lanka. The local government did try to control the situation with tax cuts and major policy changes in 2019, but it only kept getting worse since then.

First, it was the deadly Coronavirus. Then, the inflation. Then, even more debt.

India’s southern neighbour is now struggling to provide electricity, fuel and basic essentials to its citizens, leading to a massive unrest among its citizens. The situation is so brim that the country had to cancel school exams due to shortage of paper and lack of cash to buy essentials.

The entrepreneurs are unable to do their businesses, the country is running out of foreign exchange, and the recent Ukraine-Russia conflict has led to skyrocketing fuel prices.

How did it get so bad in the first place?

Sri Lanka has been running a trade deficit for decades, meaning the country imports more than it exports. A large amount of foreign exchange earned by the country is being utilised to pay for the cost of these imported items.

Sri Lanka’s financial crisis stems from a big shortfall of foreign currency, leaving traders unable to pay for imports. The company’s foreign exchange reserves have been declining since 2019, but it reached a low-point in November 2021 when it only had enough currency to support one month’s imports.

While a part of the problem did emerge from the policies of the local government, the rest had to do with the situations that emerged over the last three years.

You may remember the serial suicide bombings that took place in Sri Lanka’s top-end hotels and churches, commonly used by Western tourists, in April 2019 and left 250 dead. The blasts scared tourists away from the country and impacted the tourism industry, which represents over a tenth of the country’s gross domestic product (GDP). GDP is the sum of everything a country produces.

SIMPLY PUT: Why Sri Lanka is going through an economic meltdown
Sri Lanka's GDP has been declining over the quartersBI India

Before people could once again feel comfortable travelling to Sri Lanka, COVID-19 had taken over the world and travel restrictions were imposed across the globe. While the country was facing three waves of Coronavirus attacks, price rise was towering in the background and this deteriorated Sri Lanka’s condition even further.

Sri Lanka currently has the worst inflation among Asian nations. Inflation or price rise happens when too much money chases too few goods.

SIMPLY PUT: Why Sri Lanka is going through an economic meltdown
Sri Lanka's inflation has skyrocketed in the last four monthsBI India

Being a net importer of goods from fuel to medicines to paper, the Russia-Ukraine war could not have come at a worse time since movement of goods has also taken a hit.

A few things went wrong on the policy side too

Economists believe that Sri Lanka’s debt spiral was already on an unsustainable trajectory even before the pandemic made it worse for the country. The country borrowed foreign funds to fill its reserves, instead of boosting its exports. This move has only added more foreign debt on the country, and has done nothing to boost the local industry. The country’s public debt has increased from 94% of the GDP in 2019 to 119% of GDP in 2019, the International Monetary Fund (IMF) noted.

As the debt was mounting, the Sri Lankan government’s decision to introduce changes to the indirect tax regime in 2019 took a turn for the worse. There were loans to be repaid, the country’s tourism industry was on a decline, cash reserves were falling and these tax cuts reduced government’s revenue even further.

When the Britishers left Sri Lanka in the late 1940s, the country was in shambles. The civil war fought by the Liberation Tigers of Tamil Eelam (LTTE) led by Velupillai Prabhakaran – from the 1970s to the late 2000s – didn’t help the economy either. Now, the country is staring at an economic collapse and the scary part is that there are no easy solutions for a catastrophe of this scale.

Before we let you go, do check out Business Insider India’s personal finance series Money Insider, which brings together the country’s leading ‘Fin-fluencers’ who are heralding a new beginning in the world of financial literacy

SIMPLY PUT: Why Sri Lanka is going through an economic meltdown
BI India