This tropical island is being crushed by the war in Ukraine

With a population of about 22 million, Sri Lanka is a net importer of goods from medicines to fuel. In December, petroleum products accounted for about 20 per cent of inbound shipments and the cost jumped 88 per cent from a year earlier. The increase in oil prices this year is adding to the burden.

Turned-off tap

The country has also been paying off external debt it piled on to help rebuild an economy scarred by the bloody civil war between the majority Buddhist Sinhalese and a Tamil minority that’s predominantly Hindu. That has been draining its forex reserves.

Another pain point is tourism revenue. About 30 per cent of visitors this year were from Russia, Ukraine, Poland and Belarus, and the war is threatening to turn off that tap. Sri Lanka earned $US3.6 billion from tourism in 2019 before the pandemic slashed that to less than a fifth two years later, official data show.

The central government’s foreign-owned debt stood at $US32 billion as of November. Optimism that the government will soon manage to reach a deal with the IMF has already spurred a rally in the country’s dollar bonds. An offshore bond due 2030 rallied to 49 cents to the dollar from a record low of 38.9 cents on March 9, while one-year default probability has dropped to 18.2 per cent from as much as 31.3 per cent in late December, according to data compiled by Bloomberg.

The nation’s international bonds need to be restructured by July as Sri Lanka doesn’t have the necessary resources to pay the $US1 billion due that month, Citigroup said in a February note.

Besides raising borrowing costs and devaluing the rupee, Central Bank of Sri Lanka Governor Ajith Nivard Cabraal also urged restrictions on non-essential imports of around 300 items from electronic appliances to apples and increases in fuel prices and power tariffs.

The pain is real

“The government seems to be reacting positively and that would help steer the economy to calmer waters in this time of unprecedented global challenges,” Cabraal said by phone last week.

Yet for ordinary Sri Lankans, the pain is real. Civic groups have held vigils highlighting rising costs, while the main opposition party organised a mass rally in the capital city of Colombo on March 15, demanding the resignation of President Rajapaksa. The protests pose no immediate threat to his government, which commands almost two-thirds majority in parliament.

Sugath Chaminda, 44, said he spent about 10 hours to refuel his auto rickshaw, after being turned away by numerous petrol pumps that had run dry. He then spent more time hunting for a cylinder of cooking gas, which was also in short supply.

“I don’t know what the government is doing to have brought us to this situation,” he said in Colombo.

Inflation surge

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Some of the inflation surge is also self-inflicted. Last year, the government banned imports of chemical fertilisers in an ambitious plan to promote organic farming. That caused a shortage of nutrients, leading to crop failure and protests, prompting the government to reverse the decision in November.

Sri Lanka has also approached China and India for bilateral credit lines to avoid an IMF bailout, but negotiations have been complicated by the war in Ukraine. In the past, policymakers have generally considered some of the IMF’s conditions as burdensome, leading to reluctance to engage with the agency.

Rajapaksa said on Wednesday his government has weighed the advantages and disadvantages of working with the IMF, which has urged a “credible and coherent strategy” to restore macroeconomic stability and debt sustainability.

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A restructuring is necessary as the debt levels are too high, said Kenneth Akintewe, head of Asian sovereign debt at abrdn in Singapore.

“The country doesn’t have a history of defaults, but that also means they don’t have experience with going through the restructuring process,” he said. “Added to that, the relationship with the IMF has been a fractured one. This leaves room for missteps along the way.”