Sri Lanka's $51 Billion Default: How a Country Ran Out of Dollars

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On 12 April 2022, Sri Lanka's finance ministry announced it would stop paying its foreign debts, about $51 billion in all. It was the first default in the country's history. The ministry called it a "last resort in order to prevent further deterioration of the republic's financial position."

What followed was one of the worst economic crises in modern South Asia: queues for fuel that lasted days, power cuts, shortages of medicine and food, inflation near 70 percent, and a president who fled the country. Then, slowly, a recovery. This story is about how a middle income country with famous beaches and tea ran out of dollars, and what it took to get them back.

Why dollars matter

Sri Lanka imports most of its fuel, much of its medicine and many of its basic goods. All of that has to be paid for in dollars or other foreign currencies. The country earns those dollars from exports like clothes and tea, from tourism and from Sri Lankans working abroad who send money home.

When dollars coming in fall far below dollars going out, the central bank uses its reserves to fill the gap. When reserves run out, the country can no longer pay for imports or service its foreign loans. That is what happened.

How the reserves drained

Several blows landed close together. The US Congressional Research Service summarised them in July 2022.

Tourism, a big source of dollars, collapsed during the Covid pandemic. Remittances from Sri Lankans abroad fell to less than half of their 2019 level. A tax cut reduced government revenue, widening the budget gap.

Then came a policy shock. The government banned chemical fertilisers and pesticides almost overnight, with no transition period. Combined with fuel shortages, the CRS reported, farm yields fell by an estimated 20 to 70 percent in the season ending March 2022. A country that had fed itself now needed more imports, just as it had fewer dollars to pay for them.

Finally, the war in Ukraine pushed global fuel and food prices up in early 2022. In March 2022 Sri Lanka's reserves fell 16 percent to $1.94 billion, nowhere near enough to cover its imports and debt payments. Bonds due that July traded at a record low of about 46 cents on the dollar, a sign that investors expected not to be paid in full.

The default and the crisis

The April 2022 default stopped the outflow of dollars to foreign creditors, but daily life kept getting harder. Inflation passed 50 percent in June 2022. On 9 July 2022 protesters stormed the presidential palace and the prime minister's residence in Colombo. President Gotabaya Rajapaksa fled to the Maldives and then Singapore, and resigned.

Inflation peaked at 69.8 percent in September 2022. Over the full year the economy shrank by 8.7 percent, according to the IMF.

The road back

Recovery came with hard conditions. On 20 March 2023 the IMF approved a four year programme worth about $3 billion. In return, Sri Lanka raised taxes, cut energy subsidies, let its currency float and rebuilt its reserves. Fuel and electricity prices had already been raised more than threefold before the deal.

The next step was to reach agreement with everyone it owed money to. Talks with foreign governments and with private bondholders took nearly two years. On 20 December 2024, Sri Lanka completed the exchange of $12.55 billion of defaulted international bonds for new ones and officially exited default. The government expected the deal to save about $9.5 billion in debt payments over the IMF programme. Fitch raised Sri Lanka's rating out of default the same week.

By January 2025 prices were actually falling, by 4.0 percent from a year earlier, the steepest drop since 1960, helped by cuts in electricity and fuel prices.

What the ledger teaches

Sri Lanka's crisis was not caused by one bad decision. It was caused by several shocks arriving when the country had no cushion left. Low reserves, high foreign debt and sudden policy changes made a bad year into a collapse.

For Pakistan and the rest of South Asia, the lesson is uncomfortable and familiar. Countries that rely on borrowed dollars to pay for imports are safe only as long as lenders keep lending. Reserves are the cushion. When they are thin, any shock can become a crisis.

Questions to ask about any country's finances

• How many months of imports can its reserves pay for?
• How much foreign debt falls due this year, and who is it owed to?
• Where do its dollars come from, and could any source stop suddenly?
• Are big policy changes tested before they are made, or announced overnight?

The ledger

Munshi's noteA country, like a shop, can be profitable on paper and still close if it runs out of the one currency its suppliers accept.

Sources

1. Gulf News (Bloomberg), 12 April 2022Sri Lanka defaults on entire $51 billion external debt
2. US Congressional Research Service, July 2022Sri Lanka in Crisis
3. Bloomberg, 30 September 2022Sri Lanka inflation accelerates to 69.8% in September
4. Counterpoint (IMF press release), 21 March 2023IMF Executive Board approves US$3 billion Extended Fund Facility for Sri Lanka
5. Sunday Observer, 22 December 2024Sri Lanka exits debt default
6. Channels TV (AFP), 31 January 2025Sri Lanka records highest deflation in 65 years

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