Sri Lanka crisis flashes warning for other indebted economies

The president hasn’t yet directly addressed an announcement by the speaker of the parliament that Mr. Rajapaksa would resign on Wednesday. His only communication since massive protests overran his official residence was a statement from his office ordering officials to expedite the distribution of a shipment of natural gas due to arrive Sunday.

Sri Lanka’s financial and political crisis, driven by the country’s mix of high indebtedness, soaring inflation and poor economic management, now stands as a cautionary tale for a number of other debt-laden countries who are now increasingly vulnerable to the recent confluence of food shortages, inflation and rising U.S. interest rates.

Countries such as Zambia and Lebanon are already in the grip of crises and are seeking international help to provide loans or restructure their debts, while Pakistan’s new government, which came to power in April, says that it narrowly averted a debt default in recent weeks, driven by a soaring fuel-import bill. Foreign-exchange reserves held by the central bank dwindled to cover less than two months’ worth of exports, largely closing off Pakistan’s prospects of tapping international financial markets. China, a close ally, provided a $2.3 billion loan in June to shore up the foreign-currency reserves.

Islamabad is seeking a bailout from the International Monetary Fund. The country removed a $600 million-a-month gasoline subsidy in June, to stabilize government finances and enable ongoing talks with the IMF. It has raised the price of gasoline and electricity repeatedly in the past few weeks, to keep pace with the international price of oil.

In Laos, inflation hit an annual rate of 24% in June. A shortage of dollars is squeezing imports of gasoline and other essentials. The World Bank estimates Laos had foreign-exchange reserves of $1.3 billion at the end of 2021, enough to pay for just over two months of imports.

The World Bank recently cut its forecast for growth in developing economies to 3.4% this year from 4.6% previously, citing the effects of spiraling prices for food and energy and rapidly rising borrowing costs following interest-rate increases in the U.S.

Russia’s invasion of Ukraine has sent fuel and food prices soaring, while rising U.S. interest rates have seen many currencies hit multiyear lows, making fuel and other imports more expensive. That has presented countries that are also servicing high levels of debt with tough choices.

In Sri Lanka’s case, the coronavirus pandemic—which decimated foreign-currency earnings from tourism—and global inflation helped tip Sri Lanka’s economy over the edge, but its precarious financial position had taken root earlier, stemming from an accumulation of debt on infrastructure spending and sweeping tax cuts that drained government revenue, as well as a ban on chemical fertilizers that shrank crop output. The country defaulted on its debt in May, and an acute shortage of foreign currency has left it unable to secure energy supplies, leading to rolling blackouts and shortages at gas pumps. Food inflation soared to 80.1% last month.

For most Sri Lankans, daily life in recent months has revolved around spending hours in line for fuel or waiting for the electricity to come back on. But those wandering around the president’s residence on Sunday got a sobering glimpse of the lifestyles of the political elite who presided over the unfolding economic crisis.

Months of antigovernment demonstrations and public anger over the government’s handling of the economy had culminated on Saturday in thousands of protesters in the Sri Lankan capital, Colombo, storming and occupying the official residences of Mr. Rajapaksa and Prime Minister Ranil Wickremesinghe. Mr. Wickremesinghe said in a tweet that his stepping down would make way for Sri Lankan political party leaders to assemble an interim all-party government, ahead of holding fresh elections at a date yet to be decided.

The developments buoyed the moods of the presidential residence’s new occupants, who lounged on beds and upholstered chairs, played the piano and even found time for a mock International Monetary Fund debate across a sprawling conference table. Some, however, were left angered by the contrast with ordinary Sri Lankans who were struggling to make ends meet.

“We don’t have fuel, food, and cooking gas," said 60-year-old wharf clerk Wijitha Kumara. “But while we are suffering, Gotabaya has had a luxurious life."

Some governments around the world are scrambling to cushion the blow of food and energy inflation by launching new subsidies and boosting social-spending programs to stave off unrest and hunger amid the rising cost of daily living. Many countries are approving new handouts, even as they struggle with budget deficits and economies that are still reeling from the dislocations of the pandemic. Analysts have warned subsidies and new social spending could push their governments into deep financial trouble.

In Europe, governments from Germany to Greece, Spain and Portugal have in recent months announced tax rebates and energy subsidies. In Africa, Nigeria recently announced $9.6 billion to subsidize fuel prices, while Zambia is spending $200 million to extend a fuel subsidy, despite soaring debt in both countries. Meanwhile, Asian countries including the Philippines, Singapore and Indonesia are boosting social spending, often targeting lower-income families with direct cash assistance.

Sri Lanka’s political turmoil could slow its efforts to extract itself from its economic crisis. Mr. Wickremesinghe, the prime minister, is also the finance minister and the main point-person directing the country’s negotiations with the IMF for a possible multibillion-dollar bailout.

The global lender said on Sunday it was closely monitoring developments. “We hope for a resolution of the current situation that will allow for resumption of our dialogue on an IMF-supported program," it said.

On Sunday, calm had largely been restored to the streets of Colombo. A light security presence allowed protesters to saunter in and out of the president’s residence, a cavernous colonial-era building with whitewashed walls, without impediment.

Mr. Kumara, the wharf clerk, said he urged everyone around him not to damage any property, given that it was paid for with public money. And despite being saddened at seeing the lavish lifestyle Mr. Rajapaksa enjoyed, Mr. Kumara said he did allow himself the satisfaction of taking a selfie. “We do also have a feeling of being victorious against a bad ruler," he said.