Sri Lanka crisis shows why reserves matter

SRI Lanka has been thrust into the limelight after plunging into political and economic crisis. The country lacks a functioning government after the president fled from mass protests this week. Foreign exchange reserves have been depleted and the country is embroiled in a messy public debt default. There are lessons here for countries outside of Sri Lanka’s picturesque shores.

From an economic perspective, Sri Lanka’s turmoil is a textbook balance of payments crisis. The pandemic crippled its tourism-dependent economy due to a slump in international travel, weighing on a key source of external revenues. Meanwhile, rising imports and large debt servicing costs – a consequence of loose fiscal policy and heavy foreign exchange borrowing – caused a rapid decline in international reserves.

This precarious situation was compounded by this year’s surge in oil prices – a key commodity import – and rising United States interest rates. The central bank simply did not have the firepower to defend the Sri Lankan rupee against these global pressures and the currency has collapsed by more than 40 per cent against the dollar so far this year.