Sovereign debt, the money a country borrows from international lenders, is an important source of financing for governments to invest in growth and development. Many countries rely on foreign borrowing, but if the debt becomes unsustainable, it can lead to economic crises and increased poverty. In 2023, the United Nations (U.N.) warned that some governments are now spending more on servicing debt than on essential sectors such as health and education.

Global public debt has risen rapidly, with almost 40% of the developing world in serious debt. As a result, many developing countries face a difficult choice between paying their debts and investing in public services such as health care, education and infrastructure. The situation requires greater transparency, stronger tools to ensure debt sustainability and faster debt restructuring agreements between governments, private creditors and international financial institutions.

Sri Lanka’s Debt Crisis

Sri Lanka, a lower-middle-income developing country, experienced a severe economic crisis in 2022 when the government failed to repay its foreign debt for the first time in its history. Before this, Sri Lanka had maintained a perfect record of external debt repayment since gaining independence in 1948. The default triggered the worst economic crisis the country had ever faced. 

Prices increased dramatically and there were shortages of essential goods, including fuel, food and medicine. Fuel shortages meant buses, trains and medical vehicles struggled to operate, while gas and diesel prices rose sharply. Schools had to close and many people had to work from home to conserve fuel. The country also experienced long power cuts and widespread inflation, including food inflation that reached 95%. 

Additionally, taxes on goods were doubled, electricity prices increased and fuel subsidies were removed. As a result, poverty in Sri Lanka doubled, reaching 26% of the population, with millions of people pushed into hardship.

What Caused the Crisis?

One of the key causes of Sri Lanka’s crisis was a shortage of foreign currency. The country imported about $3 billion more goods each year than it exported, which gradually drained its foreign exchange reserves. By the end of 2019, Sri Lanka had about $7.6 billion in foreign reserves, but this rapidly fell to around $250 million, leaving the country unable to repay its sovereign debt. 

Government policy decisions also worsened the situation. In 2019, large tax cuts introduced by the government reduced public revenue by more than $1.4 billion per year. This weakened the country’s finances and made it more difficult to service its debt. 

How the Government Responded

To address Sri Lanka’s crisis, the government proposed using funds from workers’ retirement savings to help repay the country’s debt. The government also sought international support. The International Monetary Fund (IMF) determined that Sri Lanka’s debt was unsustainable and agreed to provide a $3 billion loan while helping design an economic recovery program. 

The government also sought financial assistance from other partners to mitigate the crisis’s impact on citizens, with its major creditors, including China and India, agreeing to extend the repayment timeline. As part of the recovery plan, Sri Lanka also introduced tax increases on products such as fuel and food. Furthermore, it announced plans to raise funds by restructuring state-owned enterprises and privatizing the national airline. 

In 2024, Sri Lanka’s national debt was formally restructured after negotiations with creditors. However, challenges remain. In 2025, a cyclone caused further devastation, prompting people to call for a suspension of the country’s debt repayments. 

What Happens Next?

By 2024, Sri Lanka’s economy had stabilized faster than expected, surpassing the performances of other debt-defaulting countries. Inflation fell to single digits, but stabilization alone is not enough. The country has often failed to introduce deeper structural reforms after past crises. For long-term recovery, it will need strong political commitment to implement policies that encourage sustainable growth.

Many experts argue that Sri Lanka will need debt relief or cancellation to recover fully. People need decent jobs, wages, rights, social protection, inclusion and equality. The outcome will also serve as an important test for international organizations such as the IMF in how they manage sovereign debt crises and it will demonstrate the urgent need to reform how debt crises are managed. 

– Jeanne Pellet

Jeanne is based in London, UK and focuses on Business and Technology for The Borgen Project.

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