The new prime minister, Ranil Wickremesinghe, is appealing for foreign help to bail out the government, which has almost run out of foreign currency reserves..
Sri Lanka has seen weeks of protests because of rising food prices and acute shortages of fuel.
Why did Sri Lanka default on its debt?
Sri Lanka’s government has failed to pay $78m (£63m) in debt interest payments, causing two of the world’s biggest credit rating agencies to declare it had defaulted.
A default can seriously damage investors’ confidence in a country, making it harder for it to borrow money on international markets and threatening the value of its currency.
Sri Lanka owes $50bn (£40bn) to foreign creditors but says it cannot pay them. It is asking for a loan from the International Monetary Fund (IMF).
Prime Minister Wickremesinghe has said the nation also urgently needs $75m (£60.8m) of foreign currency in the next few days to pay for essential imports such as fuel.
How is this affecting people?
For months, Sri Lanka has lacked the foreign currency to buy all that it needs from abroad. Shortages of food and fuel have caused prices to soar. Inflation is now running at 30%.
There have been power cuts, and a lack of medicines has brought the health system to the verge of collapse.
People started protesting out on the streets of the capital, Colombo ,in early April and the protests have spread across the rest of the island.
Why is Sri Lanka’s economy in crisis?
Sri Lanka’s foreign currency reserves have virtually run dry, and it can no longer afford to pay for imports of staple foods and fuel.
The government blames the Covid pandemic, which affected Sri Lanka’s tourist trade – one of its biggest foreign currency earners. It also says tourists have been frightened off by a series of deadly bomb attacks on churches in 2019.
However, many experts say economic mismanagement is to blame.
At the end of its civil war in 2009, Sri Lanka chose to focus more on providing goods to the domestic market instead of trying to break into foreign ones. So income from exports remained low, while the bill for imports kept growing.
Sri Lanka now imports $3bn (£2.3bn) more than it exports every year, and that is why it has run out of foreign currency reserves.
At the end of 2019, Sri Lanka had $7.6bn (£5.8bn) in foreign currency reserves.
By March 2020 its reserves had dwindled to $1.93bn (£1.5bn). and recently the government said it this figure had fallen to just $50m (£40.5m) .
The government also has also racked up huge debts with countries including China, to fund what critics have called unnecessary infrastructure projects.
Much of the popular anger for the economic crisis which followed has been directed at President Gotabaya Rajapaksa and his brother, Mahinda, who he appointed to be prime minister, but then dismissed in May, in the face of widespread protests.
President Rajapaksa has been criticised for big tax cuts he introduced in 2019, after coming to power. Finance Minister Ali Sabry has said these lost the government more than $1.4bn (£1.13bn) a year in revenue.
When Sri Lanka’s foreign currency shortages became a serious problem in early 2021, the government tried to limit the outflow by banning imports of chemical fertiliser, telling farmers to use locally sourced organic fertilisers instead.
This led to widespread crop failure. Sri Lanka had to supplement its food stocks from abroad, which made its foreign currency shortage even worse.
An IMF report in March this year said the fertiliser ban (reversed in November 2021) had also hurt tea and rubber exports, leading to “potentially substantial” losses.
Does the government have a plan to solve the crisis?
Prime Minister Ranil Wickremesinghe has said the government is now so short of funds that it will be printing money to pay employees’ salaries. He warns this will lead to further price hikes, with inflation rising to 40%.
He also says state-owned Sri Lankan Airlines could be privatised.
How much foreign debt must Sri Lanka repay?
Sri Lanka’s government has racked up $51bn (£39bn) in foreign debt.
This year, it will be required to pay $7bn (£5.4bn) to service these debts, with similar amounts for years to come. The government is seeking emergency bridging loans of $3bn from the International Monetary Fund (IMF) so it can pay.
The IMF has said the government must raise interest rates and taxes as a condition of any loan.
The World Bank has agreed to lend Sri Lanka $600m.
India has committed $1.9bn and may lend an additional $1.5bn for imports. It has also sent 65,000 tonnes of fertiliser and 400,000 tonnes of fuel, with more fuel shipments expected later in May.
The G7 group of leading industrial countries – Canada, France, Germany, Italy, Japan, UK and the US – have said they will provide help to Sri Lanka in securing debt relief.
Sri Lanka owes $6.5bn to China and the two are in talks on how to restructure the debt.
