President Gotabaya Rajapaksa addresses the nation after being sworn in on November 18, 2019. Photo: AFP

With the Russia-Ukraine war pushing global oil prices as high as US$140 a barrel on March 7, the financial fate of importing nations already battered by the Covid-19 pandemic hang in a precarious new balance.

And nowhere is a potential default more imminent than in cash-strapped Sri Lanka. The Sri Lankan rupee fell by some 30% earlier this month, a depreciation that drove crucial commodity prices including oil sky-high.

That’s a reflection of the market’s view of the island nation’s deteriorating finances, with total foreign exchange reserves down to just over $2 billion, with actual accessible reserves at a paltry $800 million, according to reports.

The government will face a moment of financial truth this year with some $7 billion in overseas loan repayments due. Around $1 billion comes due in July. The situation has become so dire that Columbo has approached the International Monetary Fund for a bailout package.

The IMF has proposed a broad economic restructuring program, which the Rajapaksa government is expected to discuss and possibly approve by April. The appeal to the IMF came after loans and currency swap arrangements with China and India failed to stem the financial rot.  

Hints of the default to come were witnessed two weeks ago when two ships carrying oil and diesel arrived in Colombo but could not be brought in because the Sri Lankan government did not have enough money to pay for them.

Before he was fired last week, Udaya Gammanpila, Sri Lanka’s energy minister, said that Colombo was virtually out of rupees or dollars to pay for fuel shipments.

In an interview with Reuters, K.D.R. Olga, the secretary of the energy ministry, said Sri Lanka is “facing a very challenging situation” as the Russia-Ukraine war and spike in global fuel prices caught it off-hand.

Fuel shortages have led to a massive rise in oil and diesel prices in Sri Lanka, which threatens to spark inflation across the wider economy.

On Friday, March 11, Sri Lanka’s Ceylon Petroleum Corp increased oil prices by 77 rupees in one day, jumping from 177 rupees to 254 rupees a liter. The price of diesel was increased to 176 rupees from 121 rupees per liter.

A general view of the Chinese-managed terminal of the Colombo port is seen from the Galle Face promenade in Colombo on February 2. Sri Lanka’s government said on February 2 it was pulling out of an agreement with Japan and India to develop a deep-sea container terminal that was viewed as an attempt to counter Beijing’s growing, debt-fueled influence. Photo: AFP / Ishara S. Kodikara

Sri Lanka’s central bank has also proposed to increase electricity rates amid growing outages caused by the oil shortage, as well as water prices.

The Russia-Ukraine war is impacting Colombo in at least two other areas: tourism and tea exports. Ironically, perhaps, Russia and Ukraine are the two largest sources of tourists in Sri Lanka.

In the first two months of 2022, almost 28,000 tourists arrived in Sri Lanka from Russia alone, contributing millions to the Sri Lankan foreign exchange reserves.

A total of 13,062 Ukrainian tourists arrived in Sri Lanka in the same period, according to the data provided by Sri Lanka’s Tourism Board in its monthly report of February 2022.

The report said that a Russian tourist spent, on average, $162.94 per day in 2018, while a Ukrainian spent $162.24 in the same year.

With the war raging in Ukraine, the arrival of tourists from both countries is expected to fall off drastically. The report mentions that the “implication of this crisis will be far-reaching for Sri Lanka tourism, likely for a prolonged period of time.”

The report said Sri Lanka is already receiving cancellations from Russian tourists and that no new bookings have been received since the start of the war three weeks ago.

Another source of foreign exchange earnings hit by the war is tea exports. Until recently, Russia was the largest importer of Ceylon, or Sri Lankan, tea. The collapse of the Russian ruble due to Western sanctions is making it difficult for Russians to pay their import bills.

As one Sri Lankan businessmen recently confirmed to various local media that Russian buyers have already warned of affordability issues because of the rubel’s depreciation. Over the past week, Sri Lanka’s rupee has appreciated against the ruble by over 25%.

The Russia-Ukraine war has thus caught Sri Lanka’s two major industries out of the blue at a time. Basil Rajapaksa, Sri Lanka’s current finance minister and President Gotabaya Rajapaksa’s younger brother, had recently said he hoped both industries would boost national revenues in 2022.

With Sri Lanka lacking any viable internal sources of revenue generation, Colombo desperately needs external help, including from the IMF, to avoid a national default.

In January 2022, Sri Lanka appealed to China to restructure its debts owed for various infrastructure projects under the Belt and Road Initiative. Reports say China has yet to approve Sri Lanka’s request, however.

Another potential external option for Sri Lanka is India. While India, like China, extended a helping hand last year through loans and currency swap deals, it is now reluctant to approve another loan.

Like the IMF, New Delhi has asked Colombo to provide a roadmap for economic recovery and ways to generate revenue to repay any new loans.

Basil Rajapaksa has thus canceled two planned visits to New Delhi due to Colombo’s inability amid the new energy crisis to develop a credible roadmap.

A Sri Lankan vegetable vendor counts cash after sales at a market in Colombo on November 9, 2016, ahead of the national budget. Sri Lanka is expected to raise capital gains taxes in a bid to reduce the deficit in the annual budget for calendar 2017 to be announced November 10, 2016. Photo: AFP

What could this mean for the Rajapaksa regime?

The financial collapse is a political nightmare for a government that came to power in 2019 promising economic stability through strongman rule.

Until now, the Rajapaksa regime was reluctant to approach the IMF because of the political backlash it would likely unleash. Most Sinhala Buddhist nationalists, who make up the core of ruling Sri Lanka Podujana Peramuna (SLPP), see the IMF as a “neo-imperial arm” of the West.

If the Rajapaksa regime accepts the IMF’s demands, it could alienate a significant chunk of its constituency, which could be the beginning of the end of the SLPP’s rule. If it doesn’t, the Ukraine-Russia war could be the last straw that breaks the nation’s finances.