Sri Lanka declared the country was suspending payment on most foreign debt from April 12, 2022, kindling the Indian Ocean island's first sovereign default event and ending an unblemished record of repaying external debt despite experiencing milder currency crises in the past. By April Sri Lanka was suffering the worst monetary crisis in its history with a steeply falling rupee, high inflation and forex shortages which triggered shortfalls of fuel, power and medicine. Widespread public protests led to a political crisis. In March, the International Monetary Fund released a report saying publicly for the first time that the country's debt was unsustainable and required re-structuring. Authorities had advertised for financial and legal advisors to help negotiate with creditors shortly before the suspension was announced.
Overview
Sri Lanka has seen external instability from around late 2014 suffering two currency crises and low growth with the rupee falling from 131 to 182 to the US dollar by 2018. Foreign debt rose from 30% of gross domestic product in 2014 to 41.3% in 2019 while total debt went up from 76% to 86% as growth slowed amid Sovereign bond borrowings also expanded. In December 2019, Sri Lanka's newly elected government cut taxes in a fiscal stimulus, sharply lowering state revenues and followed up in the first quarter of 2020 with policy rate cuts which were enforced by large scale money printing, unleashing unprecedented volumes of liquidity in to money markets. The Coronavirus pandemic hit the country and a lockdown started in March 2020. Though Sri Lanka drew praise for its handling of the pandemic and swift vaccination of the population, money printing worsened with unusually large central bank financing of the government triggering the worst balance of payments crisis in the country's history. Then central bank Governor W D Lakshman was said to have been following Modern Monetary Theory. Sri Lanka's sovereign rating was progressively downgraded and the country was locked out of capital markets and was unable to roll-over maturing sovereign bonds.
The IMF in its 2021 Article IV Consultations report concluded that Sri Lanka's public debt was unsustainable. "The country has started experiencing a combined debt and BoP crisis...", the report asid. "Staff assesses that Sri Lanka's public debt is unsustainable." The report warned that continued central bank financing will worsen inflation and could lead to an external trade collapse and even higher inflation. "[T]he country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits. And continued reliance on central bank financing would eventually lead to a de-anchoring of inflation expectations." An attempt to float the currency in March 2022 did not succeed and forex shortages continued to persist with the rupee falling from 202 to below to 300 the dollar. Forex shortages had triggered power, fuel and medicine shortages leading to widespread protests. On April 3 the Cabinet of ministers resigned. Sri Lanka's newly appointed Central Bank Governor Nandalal Weerasinghe sharply raised policy rates on April 8 allowing interest rates to go up and reduce money printing. By end March foreign reserves were down to US$1.9bn and there were concerns over their actual usability since about US$1.5bn which had come from a Renminbi swap from China. On April 12, the Finance Ministry announced a halt to payments of most foreign debt, ahead of restructuring.On February 3, 2023, China provided Sri Lanka with an offer of extending its debt and requested other major debt leaders to do the same.