Back in January, I wrote about how the Sri Lankan government was destroying the country through irrational Covid and monetary policy. Prior to Covid-hysteria, the living standards in Sri Lanka were on the rise. The country had become a top tourist destination.
Today the Sri Lankan people have had enough. Thousands of Sri Lankans gathered in protest this past weekend calling for the president's resignation. Just a few weeks ago, protestors were storming the President’s private residence.
Rajapaksa won the presidency in 2019 with wide approval. His party went on to secure a two-thirds majority in the parliament within a year. This wide support even allowed Rajapaksa to appoint his brother, Mahinda Rajapaksa, as Prime Minister with little objection.
But, the tables have turned and now the grapes of wrath have come to harvest. “Rajapaksa” is now a dirty word.
Death by Debt
Sri Lanka is $51 billion in foreign debt. That may sound like nothing compared to the debt of the US government, but Sri Lanka doesn’t have the luxury of a reserve currency that allows them to export their inflationary effects to the world.
The Sri Lankan rupee (LKR) is exclusive to Sri Lanka. Contrast that to the US US dollar (USD) which is used by many countries as the dominant currency. The expansion of the USD supply across the world hides the impact of devaluation at home. Much of the printed dollars are sent abroad in exchange for imports. This causes the receiving countries (those dependent on export) to devalue their local currency to avoid their export prices from rising.
But, the rupee doesn’t command this type of dominance. So, when the Sri Lankan government prints money to finance itself, the inflationary effects are realized locally with acute pain. Sri Lanka is a small country with a relatively small population of ~21.5 million people. The value of the Sri Lankan rupee has plummeted in relation to USD. This was sparked by the central bank devaluing the currency by 15% on March 8th.
Like any commodity, the value of a currency is based on supply and demand. Increasing the supply of currency results in more money chasing the same amount of goods (or fewer). The result of the devaluation is realized by a general rise in prices. It is not that things get more expensive, it is that the currency gets less valuable. Those that have built up savings in an inflated currency quickly learn that the value of their savings has been stolen.
The effects of monetary inflation are detrimental. The resulting price inflation in Sri Lanka hit an annual 18.7 percent in March. But the rate of increase is also alarming. Consumer prices shot up over 3.0 percent from February to March. When the effects of monetary inflation begin to ignite, wildfires light up the world.
The Economic Ladder Has Crumbled
The Sri Lankan people are experiencing shortages of food, fuel and you name it. The government is literally turning the lights off to save money.
In the face of raging price inflation, the central bank has doubled its key interest rates, raising each by 700 basis points. The Sri Lankan government has also recently announced it is suspending payments on its foreign debt. I think this is probably the right decision at this point. The country is heavily dependent on imports. You must feed yourself before your creditors if you have any chance of surviving.
Unfortunately, the Sri Lankan people are learning that there is nothing magical about government debt. That debt eventually gets imposed on the people when the creditors come to collect. Debtors of the world should heed Sri Lanka as a warning.
And Sri Lankans are learning that money does not in fact grow on trees. Promoters of inflationary monetary policy better grasp the real effects of what they advocate before the world turns to turmoil. It may already be too late.