Sri Lanka economy shrinks amid political chaos, inflation

Sri Lanka’s economy fell back into contraction last quarter as the country battled its worst economic problems since independence, with emergency aid to stabilise the island nation proving elusive.

Gross domestic product declined 1.6 per cent in the quarter ended March from a year earlier, the Department of Census and Statistics said in a statement on Tuesday. That’s shallower than a 3.6 per cent contraction seen by economists in a Bloomberg survey and compares with a revised 2 per cent expansion in the previous quarter.

The department attributed the decline to the “adverse effects” of inflation, foreign exchange devaluation and dollar deficit.

The contraction likely marks the beginning of a painful and long recession for the country, whose Prime Minister Ranil Wickremesinghe last week said the economy had “completely collapsed”. The crisis follows years of debt-fueled growth and populist fiscal policies, with the Covid-19 pandemic’s hit to the dollar-earning tourism industry serving as the last straw.

Absence of foreign exchange to pay for imports of food to fuel led to red-hot inflation, the fastest in Asia, triggering protests against the government led by the Rajapaksa clan that eventually led to the resignation of Mahinda Rajapaksa as premier. While the months-long protests hurt business activity in parts of the country, the government on Monday imposed new curbs, which includes a call to residents to stay home until July 10 to conserve fuel.

That will depress activity further, while raising the risk of more unrest given lingering shortages of essential goods.

“The key will be how we weather the storm,” said Sanjeewa Fernando, a strategist at CT CLSA Securities Pvt. “Unless the fuel crisis especially is resolved soon, I don’t see a turnaround.”

Sri Lanka is in talks with the International Monetary Fund for aid to tide over the crisis, with at least $6 billion needed in the coming months to prop up reserves, pay for ballooning import bills and stabilise the local currency. The central bank has raised interest rates by 800 basis points since the beginning of the year to combat price gains that touched 39 per cent.