research paper on sri lanka economic crisis

Lifestyle changes during the economic crisis: a Sri Lankans survey

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• Published: 31 July 2023

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• Piumika Sooriyaarachchi   ORCID: orcid.org/0000-0001-9570-2344 1 , 2 &
• Ranil Jayawardena   ORCID: orcid.org/0000-0002-7352-9365 3 , 4  

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The economic crisis in Sri Lanka has caused millions of people to descend into poverty, compromising their rights to health, education and standard of living. This study aimed to examine how the economic crisis has affected Sri Lankans’ lifestyles.

Subject and methods

An online cross-sectional survey was conducted in July 2022, using an e-questionnaire based on Google Forms. The questionnaire assessed respondents’ socio-demographics and lifestyle-related behaviours before and during the economic crisis. Descriptive statistics and multivariable logistic regression analysis were used.

A total of 1214 respondents, aged ≥ 18 years were included in this survey. During the crisis, there was a nearly 80% and 60% decline in alcohol consumption and smoking, respectively. Although many respondents (57.6%) used private vehicles as their primary mode of transportation before the crisis, this has decreased significantly (18.2%) during the crisis. Furthermore, 65.3% reported that their walking time has increased during this time. Respondents who lived in Colombo were significantly more likely to report increased walking time compared to people from other districts (OR 1.540; 95% CI, 1.081–2.193; P  = 0.017). Also, those with the lowest monthly incomes reported a twofold increase in walking time during the crisis as those with the highest monthly incomes (OR = 2.224, 95% CI = 1.329–3.723, P  = 0.002). Cooking methods used before and after the economic crisis differ significantly, with many respondents relying on gas (pre 92.8%; post 15.5%) as their primary cooking fuel before the crisis and now moving to firewood (pre 3.7%; post 46.5%). More than two-thirds (75.2%) of respondents were thinking of migrating to another country alone or with their families because of the country’s current situation.

The everyday activities of Sri Lankans have been significantly affected by the country’s economic crisis.

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Introduction

Sri Lanka is currently facing the worst economic crisis since its independence in 1948. According to reports, the crisis started in 2019 because of several interrelated, compounding events, including tax cuts, money creation, a national policy to switch to organic or biological farming, the 2019 Easter bombings, and the COVID-19 pandemic’s effects in Sri Lanka (Bhowmick 2022 ; Fowsar et al. 2021 ). Additionally, Russia was Sri Lanka’s second-largest tea export market; traditionally, Russians and Ukrainians have made up most of the nation’s non-South Asian visitors (Pereira et al. 2022).

The economic crisis in Sri Lanka is pushing millions of people into poverty and compromising their rights to health, education and quality of life. The country is currently experiencing a severe economic crisis, which has resulted in a shortage of commodities such as food, fuel, cooking gas, medicine (Jayawardena et al. 2023 ) and other necessities. People’s daily routines have been drastically altered because of the economic crisis, including changes to their eating, cooking and commuting habits, as well as other behaviours (Sooriyaarachchi & Jayawardena 2023 ). Food inflation (year on year) increased to 46.6% in April 2022 from 30.2% in March 2022, while non-food inflation (year on year) increased to 22.0% in April 2022 from 13.4% in March 2022 (Lanka 2022 ).

International literature has extensively addressed the effects of the financial crisis on social and economic life (Nolan 2014 ; Quail 2010 ). The reduction in income and the rise in unemployment are widely recognized as the basic and immediate consequence of the financial crisis, which is causing a significant portion of the population to live in extreme poverty (Zavras et al. 2013 ). Unemployment and reduced income are associated with mental disorders (Marmot and Bell 2009 ), addiction issues, substance abuse (Compton et al. 2014 ), smoking and alcohol use (de Goeij et al. 2015 ). Further, low socio-economic status often leads to the adoption of coping mechanisms such as the increased purchase of cheap food with low nutritional value (Brinkman et al. 2010 ) and poor disease management (Suhrcke et al. 2011 ). Furthermore, it is well-established that a lower socioeconomic position is linked to greater morbidity and mortality rates (Lund Jensen et al. 2017 ). A survey of older adults from 20 Mediterranean islands found that after the economic crisis started, there was a trend towards less healthful behaviours, including more depressive symptoms and unhealthier dietary habits (Foscolou et al. 2017 ). In contrast, research has demonstrated that in developed nations, economic downturns are linked to healthier lifestyle choices, such as a rise in physical activity, a rise in fruit and vegetable consumption, and a reduction in obesity (Ariizumi and Schirle 2012 ; Gerdtham and Ruhm 2006 ; Ruhm 2000 ). In addition, studies on the effect of economic crises on alcohol and cigarette use have yielded quite a range of outcomes (Ahmad and Franz 2008 ; Bruggink et al. 2016 ).

Food preparation methods have changed in response to previous economic downturns. For instance, during Russia’s economic collapse in 1998, low-income households increased the amount of food they produced at home with staple foods to lower the cost per calorie of food (Dore et al. 2003 ). According to a survey done in Greece, people’s transportation preferences have shifted in favour of sustainable transport forms of transportation during the country’s economic crisis (Papagiannakis et al. 2018 ). Owing to financial constraints, they preferred the use of public transportation, bicycle or walking instead of private vehicles (Galanis et al. 2017 ).

These altered lifestyle habits unintentionally provided by the economic crisis can result in more significant, long-lasting socio-cultural changes. Therefore, this study aimed to investigate the changes in lifestyle behaviours among Sri Lankans during the economic crisis.

Methodology

Using Google Forms, a three-week countrywide online cross-sectional survey was conducted among adult Sri Lankan citizens in July 2022. Online social media channels were used to disseminate the link to the survey and volunteers were requested to take part. The specific recruitment strategy for the online survey is described in detail elsewhere. The survey was conducted in compliance with the guidelines outlined in the Helsinki Declaration (Association 2014 ). Ethical permission for the study was obtained from the Ethics Review Committee, Nawaloka Hospitals Research and Education Foundation, Colombo, Sri Lanka. The informed consent form was attached at the start of the electronic questionnaire, and participants completed it voluntarily and anonymously.

Questionnaire

The questionnaire was made available in English, Sinhala and Tamil languages, and included both multiple-choice and open-ended questions. It consisted of two main sections with questions regarding (i) Socio-demographic and socio-economic background and (ii) changes in lifestyle behaviours during and before the economic crisis.

The first section included questions on respondents’ gender, age, district, residential area (inner city, suburban and rural), ethnicity (Sinhalese, Sri Lankan Tamil, Indian Tamil, Moors and Others), education status (secondary education or below, tertiary education, degree/diploma or above), number of family members, children (having children or no), employment status, monthly income and main source of monthly income.

The second section consisted of questions on lifestyle habits. To study the changes in food consumption and food substitution, respondents were asked to list the foods they used to eat before the economic crisis but no longer do during the economic crisis. They were also asked to mention any food items they may have substituted for the main course during the economic downturn. Participants were asked to categorize their changes as (i) increase, (ii) decrease and (iii) no change to study how addictive behaviours, such as smoking and drinking alcohol, have changed over the crisis time. They were asked to choose their primary mode of transportation before and during the crisis from a given list of six answers to determine the changes in the mode of transportation: (i) walking, (ii) cycling, (iii) motorbike, (iv) private vehicle, (v) public transport and (vi) hired vehicles. To determine the change in walking time before and during, the participants were required to choose one from three options: (i) increase, (ii) decrease and (iii) no change. Further, the changes in cooking methods were investigated by asking the respondents about their most common mode of cooking before and during the economic crisis. The following options were offered to choose from: (i) using gas, (ii) hot plates and electric cookers, (iii) using firewood, (iv) kerosene oil stove and (v) other methods. Additionally, the respondents were also questioned regarding their plans to immigrate to another nation due to the nation’s current state. The following options were offered: (i) yes, only myself (ii) yes, with my family (iii) no.

Statistical analysis

The demographic characteristics of the study sample were investigated using descriptive statistics. For categorical variables, frequency and percentages were used to evaluate the general distribution, whereas continuous variables were evaluated using means and standard deviations. In addition, univariate and multivariate logistic regression analyses were carried out to identify the sociodemographic variables that affected the change in lifestyle behaviours. Odds ratios (OR) and 95% confidence intervals (CI) were used to express the findings of logistic regression analysis. Statistical significance was accepted as P  < 0.05. The IBM SPSS statistics version 23.0 was used for all analyses (IBM, Chicago, IL, USA).

After removing incomplete and duplicate records, a total of 1214 valid respondents, aged ≥ 18 years were included in the final analysis. General characteristics of the population are reported in Table  1 . The survey population was primarily female (60%) and had a mean age (± SD) of 35.08 (± 9.54) years. Many participants were Sinhalese (93%) and represented the Colombo district (42.7%). When compared to inner-city and suburban regions, which each had 27.4% and 34.0% of responses, rural areas made up 38.6% of the total. Most participants (84.1%) had at least a professional degree and were either working permanently (67.3%) or temporarily (10.9%). Full-time students accounted for 8.6% of the sample, while unemployed and retired accounted for 10.7% and 2.6%, respectively. More than half of respondents (54.1%) had families of three to four members, with the average family size being 4.11 (± 1.29). Only 36.2% of respondents had children; of those, 58.6% had only one child and 32% had two children. Approximately 84% of respondents reported having a monthly income; of those, 22.5% made less than 50,000 LKR per month and 17% made more than 200,000 LKR per month. Most of the respondents mentioned government (34.3%) or public sector (37.2%) jobs as their main primary source of income.

Fish, cheese and bread were among the most often listed food items by respondents in response to the question concerning food products that were commonly used before the economic crisis but are no longer used during the economic crisis. In addition, the most prevalent food substitutes for main meals were boiled jack fruit, bread fruit, manioc and instant noodles.

Figure  1 shows the changes in smoking and alcohol use during the economic crisis. Alcohol use was reported by only 21.6% of the respondents. Among them, 79.4% reported that their drinking had decreased throughout the economic crisis, 19.5% reported no change in consumption, and only 1.1% reported higher consumption than before. In the population, there were extremely few respondents who reported smoking (5.8%). Out of them 64.3% and 27.1% reported that the smoking frequency was decreased and unchanged, respectively, while 8.6% declared their smoking has increased during this period.

Change in addictive behaviours during the economic crisis

There was a significant difference in the use of transportation methods before and during the economic crisis ( P  < 0.001) (Fig.  2 ). Before the financial crisis, 57.6% of respondents indicated that private vehicles were the most popular form of transportation. However, during the economic crisis, only 18.2% of people were using their private vehicles. The majority of the respondents (49.6%) mentioned public transport as their main transportation method during the economic crisis. Although only 1.3% of respondents reported walking prior to the crisis, this number has increased to 12.7% during the crisis. In addition, 65.3% of respondents reported longer walking times during the crisis, and only 24.3% and 10.4% reported no change or longer walking times, respectively.

Modes of transportation before and during the economic crisis

Table 2 demonstrates the results of univariate and multivariate logistic regression analysis for an increased walking time by socio-demographic variables. According to the univariate analysis, the respondent’s age and average monthly income were significantly associated with increased walking times. In the multinomial regression models adjusted for all the variables, the respondents from the Colombo district reported significantly increased walking time compared to respondents from other districts (OR = 1.540; 95% CI = 1.081–2.193; P  = 0.017). Additionally, compared to those who made more than 200,000 LKR per month, those who earned less than 50,000 LKR per month reported a more than twofold increase in their walking time (OR = 2.224; 95% CI = 1.329–3.723; P  = 0.002).

Furthermore, before the economic crisis, 92.8% of the respondents used gas for preparing their meals. The use of firewood, electric cookers and others before the crisis was 3.7%, 3.2% and 0.2%, respectively. However, during the economic crisis, the use of gas for cooking has drastically reduced to 15.5%. There was a significant increase in the use of firewood and electric cookers during the crisis period which was reported by 46.5% and 31.2% of respondents, respectively. Additionally, 6.8% reported use of various other methods for cooking.

When asked about their desire to immigrate, 55% of the respondents stated that they had made the decision to immigrate with their families, while 20.3% had thought about immigrating alone. In addition, 24.8% of respondents stated that they have not considered moving abroad because of other obligations.

This population-based study provides an overview of how the living habits of Sri Lankan citizens have altered during the ongoing economic crisis. According to our understanding, this study was one of the first to look at how the economic crisis affected Sri Lankans’ lifestyles. Although the survey questionnaire was shared across the country regardless of the geographic area via social media, Colombo has the highest representation. This distribution pattern could be due to several reasons such as communication facilities as well as the interest to participate. Similar representation patterns have been observed in the online surveys conducted in Sri Lanka during the COVID-19 lockdown period (Sooriyaarachchi et al. 2022 , 2021 ). Also, more than 80% of the respondents had a degree or higher-level educational qualifications. The results of surveys can always be related to respondents’ educational backgrounds. The greater response rate could be attributed to educated respondents’ interest in this topic.

Public health issues such as smoking, alcohol consumption and alcohol-related illnesses can be influenced either favourably or unfavourably by economic crises. Smoking and alcohol use were both extremely rare in the current survey population, with prevalence rates of 5.8% and 21.6%, respectively. This might be a result of the sample consisting of 60% female responders who do not smoke or drink. In Sri Lanka it was reported that the current prevalence of smoking and alcohol intake among females over the age of 18 is 0.1% and 1.2%, respectively (Katulanda et al. 2014 , 2011 ). It has also been noticed that drinking is positively associated with a lower level of education and an older age, although this survey sample was primarily made up of relatively young and educated persons (Katulanda et al. 2014 ). However, as per the results, both alcohol consumption and smoking rates have drastically reduced during the economic crisis. There is conflicting scientific research regarding how economic crises affect alcohol intake and alcohol-related health issues. Following the beginning of the economic and social change in Russia and other Eastern European nations in the early 1990s, alcohol use surged, and this was accompanied by an increase in mortality and accidents (Baker et al. 2011 ; Men et al. 2003 ). Contrary to the transition in Eastern Europe, Finland’s economic crisis during this period resulted in mass unemployment, but it also coincided with a decline in alcohol intake and alcohol-related mortality (Herttua et al. 2007 ; Valkonen et al. 2000 ). According to a Brazilian study, all age groups exhibited a decline in smoking rates during the economic crisis, though with varying patterns (Souza et al. 2021 ). Numerous factors, including tighter financial restrictions brought on by income decrease during a recession or price increases for tobacco or alcoholic beverages, could account for the decreased use among the respondents.

There was a significant increase in demand for public transportation during the economic crisis, even though many of the respondents had previously utilized private vehicles for transportation. The government’s lack of foreign exchange to import fuel created severe fuel and energy shortages making long queues at petrol stations and also a black market for fuel, putting more pressure on people (Shehan et al. 2022 ). Essential services, including buses, trains and even medical vehicles, have been put on hold because of fuel scarcity. To conserve the remaining fuel, the government had to take harsh steps, such as closing schools and offices, implementing work-from-home policies, and temporarily banning the sale of gasoline and diesel for non-essential vehicles (Shehan et al. 2022 ). The shortfall has also caused prices to increase sharply. These could be the reasons for most of the respondents to switch to public transport during the economic crisis.

Additionally, an increase in cycling and walking was noted. A similar finding was observed in a study conducted in the city of Volos, Greece (Galanis et al. 2017 ). According to their findings, Greek citizens have switched to sustainable mobility options during the country’s years of economic hardship. People preferred using public transportation, bicycles or walking for their commutes rather than driving their cars because of the rising unemployment rate and the decline in personal income (Galanis et al. 2017 ). According to the regression analysis, respondents from the Colombo area and those with lower monthly incomes were significantly more likely to report increased walking. More people will choose walking over other forms of transportation, especially for short distances within cities, the safer and more convenient the walking environment becomes. Additionally, residents with lower salaries might have decided to walk to balance their expenses.

Further, there was a significant increase in the use of firewood and electric cookers during the economic crisis due to the scarcity of cooking gas. Some people attempted to switch to kerosene oil cookers, but the government lacked the funds to import it in addition to the scarce fuel and diesel. Moreover, those who purchased electric cookers were in for an unpleasant awakening when the government imposed lengthy power failures due to a lack of funds to buy fuel for generators.

According to study results, more than two-thirds of respondents have considered moving to another country either with their families or on their own. According to the International Red Cross, Sri Lanka’s economic crisis has led to an increase in cross-border migration activity through both regular and irregular channels (Societies 2022 ). Many Sri Lankans use unauthorized modes of transportation to travel to neighbouring nations such as India and Australia, which puts them in danger of being trafficked and detained. In addition, as people look for jobs abroad, there has been a rise in labour migration to the Middle East and Gulf nations. The Department of Immigration and Emigration reports that over 300,000 Sri Lankan passports were issued in the first half of 2022, compared to a total of 382,000 passports granted in the entire year of 2021 ( Department of Immigration and Emigration Sri Lanka ).

The primary drawback of the current study is the use of a self-reported questionnaire, which could result in actual data misreporting. Also, certain population categories have been overrepresented because of the online survey method. Owing to a higher proportion of survey respondents having a higher level of education, it is important to acknowledge that the study sample may not fully represent the general population. The significant percentage of participants with advanced education suggests that individuals with higher educational qualifications may hold distinct perspectives or have different experiences compared to those with lower educational backgrounds. Our online survey, however, was identical to others that have commonly been used. The fact that the survey was carried out at the peak time of the economic crisis was a strength of our study.

In general, the current economic crisis has altered the lifestyle behaviours of citizens. There was a reduction in alcohol intake and smoking during the crisis by nearly 80% and 60%, respectively. Prior to the crisis, many people travelled by private vehicles, although demand for public transportation and environmentally friendly modes of mobility such as walking and cycling increased throughout the crisis. Interestingly, compared to those residing in other districts and earning higher incomes, those with lower incomes and those who reside in the Colombo district reported longer walking times. Additionally, due to a lack of cooking gas, a significant increase in the use of electric and firewood stoves has been observed. The ongoing economic crisis has caused more than one-third of the population to consider moving.

Data availability

Data are available from the corresponding author upon reasonable request.

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Acknowledgements

The authors thank all who supported in distributing the questionnaire. We also express our heartiest gratitude to all the participants for their contribution to this study during this difficult time.

Open Access funding enabled and organized by CAUL and its Member Institutions The authors declare that they received no funding for conducting this study.

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Health and Wellness Unit, Faculty of Medicine, University of Colombo, Colombo, Sri Lanka

Piumika Sooriyaarachchi

Faculty of Health, School of Exercise and Nutrition Sciences, Queensland University of Technology (QUT), Brisbane, QLD, Australia

Department of Physiology, Faculty of Medicine, University of Colombo, Colombo, Sri Lanka

Ranil Jayawardena

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Contributions

PS and RJ conceived and designed the online survey questionnaire; distributed the questionnaire; PS analysed and interpreted the data; PS drafted the manuscript; RJ revised the manuscript. All authors read and approved the final manuscript.

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Correspondence to Piumika Sooriyaarachchi .

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Sooriyaarachchi, P., Jayawardena, R. Lifestyle changes during the economic crisis: a Sri Lankans survey. J Public Health (Berl.) (2023). https://doi.org/10.1007/s10389-023-02030-z

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Received : 15 February 2023

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DOI : https://doi.org/10.1007/s10389-023-02030-z

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Research Article

Impact of debt, reserves, and political stability on Sri Lanka’s financial crisis

Roles Conceptualization, Data curation, Formal analysis, Funding acquisition, Investigation, Methodology, Project administration, Resources, Software, Supervision, Validation, Visualization, Writing – original draft, Writing – review & editing

* E-mail: [email protected] , [email protected]

Affiliation Department of Business Management, SLIIT Business School, Sri Lanka Institute of Information Technology, Colombo, Sri Lanka

• Candauda Arachchige Saliya

• Published: November 17, 2023
• https://doi.org/10.1371/journal.pone.0294455
• Reader Comments

This study attempts to explore the impact of external debt ($Debt), foreign reserves ($Reserves), and political stability & absence of violence/terrorism (PS&AVT) on the current financial crisis in Sri Lanka. Using data from 1996 to 2022 obtained from the World Bank (WB) and the Central Bank of Sri Lanka (CBSL), a regression analysis is conducted, with a composite variable named "CRISIS," which accounts for interest rate, inflation, currency devaluation adjusted to GDP growth, as the dependent variable. The findings indicate that, collectively, these predictors significantly contribute to explaining the variance in the financial crisis, although their impact is relatively minor. While the direct influence of PS&AVT on the financial crisis is not statistically significant, it indirectly affects the crisis through its considerable impact on debt and reserves. Granger causality tests showed predictive value for $Debt and $Reserve in relation to CRISIS, but the reverse relationship was not significant. Regression analysis using the error term and scatter plots supports the absence of endogeneity issues in the model. These findings suggest that while external debt and foreign reserves are more directly related to financial crises, political stability and the absence of violence/terrorism can influence the crisis indirectly through their effects on debt accumulation and reserve levels. This study represents a pioneering effort in investigating the impact of external debt, foreign reserves, and political stability on the financial crises in Sri Lanka. By utilizing a comprehensive dataset and applying a regression analysis, it sheds light on the complex interactions between these variables and their influence on the country’s financial stability.

Citation: Saliya CA (2023) Impact of debt, reserves, and political stability on Sri Lanka’s financial crisis. PLoS ONE 18(11): e0294455. https://doi.org/10.1371/journal.pone.0294455

Editor: Ricky Chee Jiun Chia, Universiti Malaysia Sabah, MALAYSIA

Received: July 25, 2023; Accepted: October 31, 2023; Published: November 17, 2023

Copyright: © 2023 Candauda Arachchige Saliya. This is an open access article distributed under the terms of the Creative Commons Attribution License , which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.

Data Availability: All relevant data are within the paper and its Supporting Information files.

Funding: The author received no specific funding for this work.

Competing interests: The author has declared that no competing interests exist.

Introduction

In the field of economics, understanding the intricate relationships between key macroeconomic variables such as inflation, interest rates, exchange rates, debt, foreign reserves and economic growth is essential for effective policy formulation and decision-making. The Covid-19 pandemic has sparked renewed interest in sovereign debt crises, as demands for debt relief for developing nations have emerged. Therefore, it is crucial to contextualize recent research findings in this field within the broader economic landscape, particularly in light of the growing concerns surrounding sovereign debt crises in various nations, including Sri Lanka. A report from the International Debt Statistics (IDS) 2021 reveals that prior to the pandemic, many countries already had high levels of debt to the tune of $8.1 trillion. Many of these countries, including Sri Lanka, have debt to GDP ratios surpassed 100%. These Figures underscore the ominous reality that debt burdens had become increasingly unsustainable, despite two decades of debt relief initiatives led by the World Bank in collaboration with the IMF and the international community [ 1 ].

Sri Lanka is currently experiencing a grave political and financial crisis, which has resulted in millions of people being unable to afford basic necessities such as food and medicine [ 2 , 3 ]. The nationwide protests against the escalating cost-of-living crisis climaxed with the storming of the presidential palace on 9 th July 2022 and the resignation of both the President and his brother Prime Minister. To mitigate the crisis, the Sri Lankan government has again sought assistance from the International Monetary Fund (IMF). In May 2022, the island nation defaulted on US$51 billion of external debt ($Debt) for the first time in Sri Lankan history. In 2022 alone, Sri Lanka faced debt obligations amounting to US$6 billion, while its foreign reserves ($Reserves) were only US$ 1.9 billion [ 4 ]. It is important to note that US$1.5 billion of this amount is tied up in a swap arrangement with China, which cannot be utilized for dollar payments [ 5 ]. Sri Lanka’s foreign debt depresses income and stimulates price level and have raised interest rates [ 6 ].

Further, the situation has reached such a critical state that experts predict a rise in acute malnutrition from 13 percent to 20 percent, while the number of severely malnourished children is expected to double from 35,000 to 70,000 [ 7 ]. Import restrictions on fertilizer and agrochemicals resulted in a reduction not only in domestic essential crops but also in export earnings on products such as tea, which accounts for 11% of national export income. This was further aggravated by a pegged exchange rate to the US dollar, which discouraged all sorts of exporters and inward remittances while drained off $Reserves.

With the government’s stark admission of Sri Lanka’s financial bankruptcy, the country found itself engaging in negotiations from the standpoint of a financially beleaguered nation. The President candidly acknowledged that this journey would be hard and strenuous [ 8 ].

Henceforth, a potential intricate interplay may have emerged similar to the global financial crisis of 2008, affecting numerous economies, including Sri Lanka. The escalation of government debt levels has multifaceted consequences, impacting both government deficits and shaping investor sentiment. On one side, the upsurge in government deficits heightens the necessity for borrowing, subsequently exerting upward pressure on interest rates. This, in turn, can trigger a "crowding-out" phenomenon, dampening private investment and potentially impeding overall economic growth [ 9 ]. Conversely, the heightened risk aversion among investors may favor bonds issued by countries perceived to have a lower default risk. Simultaneously, as economic growth dwindles and government revenues decline, governments face the imperative to increase their debt levels to sustain welfare programs. The convergence of these economic challenges in Sri Lanka and the pioneering research on inflation, interest rates, and economic growth in elsewhere forms a backdrop against which I explore the multifaceted dynamics of the situation and the vital role of policymakers in navigating these complex waters [ 10 ].

Literature review

After analyzing and evaluating the current and future debt levels of 68 countries that hosted the China-funded projects, the Center for Global Development (CGD) has identified ten countries (Sri Lanka, Kyrgyzstan, Djibouti, the Maldives, Laos, Mongolia, Pakistan, Montenegro, Angola, and Tajikistan) as ‘at risk of debt distress’ [ 11 ]. However, against many predictions by industry experts, after imposing very painful conditions, IMF granted US$2.9 billion in September 2022 and approved further US$3 billion in March 2023, both under the terms of 48-months as per the Extended Fund Facility (EFF) arrangements [ 12 , 13 ] (IMF 2022; 2023). The Sri Lankan Rupee depreciated against US$ by approximately 555% on an annualized basis, dropping from LKR 200.92 in February to LKR 294.00 in March 2022 and continued depreciating until hitting its lowest point at LKR 368.50 in November 2022. However, since then, The Sri Lankan Rupee has appreciated and recorded as LKR 305.00 on 24 th May 2023, which is an annualized appreciation of 33.7% [ 4 , 14 ].

Further studies of similar experiences faced by the countries elsewhere revealed that, to arrest such crises, they had established peace immediately [ 15 – 19 ] and then implemented structural reforms towards liberalisation of markets [ 20 – 25 ]. The success of all other short-term solutions such as debt restructuring, selling state assets and controlling imports etc. seem inevitably to depend on a stable socio-political climate and policies conducive for foreign direct investments.

A long-standing stern debate prevails between left and right camps in the political arena as well as in the academia on structural reforms towards liberalization conditioned by the IMF. The main arguments of “the left camp are that liberal policies could stimulate corruption and discrimination, obstruct inclusion, empower the elite-class to accumulate wealth disproportionately, increase inequalities and also could bring adverse effects to certain traditions and sociocultural values of people” [ 26 – 31 ]. In contrast, “right wing argues that liberal policies stimulate economic development by removing certain traditional barriers, enable nations to create more wealth which will trickle down to everyone else, hence improve living standards in general by translating individual greed into collective good and also it would ensure law and order towards justice and diversity” [ 32 , 33 ] (Bourguignon 2018; UN 2010).

Bhowmick [ 34 ] points out that the nature of borrowing and $Debt obligations are the key contributors to Sri Lanka’s current economic crisis. Good governance can be defined as the process by which governments make decisions, implement policies, and manage public resources [ 35 ]. High-cost foreign debt could trigger crises when the WGI in a country are weak [ 28 ] and there is widespread agreement that the country’s high levels of $Debt are a major contributing factor [ 36 ]. This has been aggravated by external factors such as the COVID-19 pandemic and Russia-Ukraine war which have hit the country’s tourism industry hard, as well as internal factors such as corruption and mismanagement of public funds [ 12 ].

External debt ($Debt) and foreign reserves ($Reserves)

Although $Debt can contribute to increase $Reserves, it can cause serious difficulties, especially during crisis periods. It is widely accepted that the current financial crisis in Sri Lanka is attributed to the burden of international debt stimulated by deteriorating of $Reserves [ 5 , 34 ]. While some argue that international loans, including those from the IMF, can be beneficial [ 8 , 37 ], others contend that current IMF facilities may cause stress as they lack longer tenures, are not interest-free, lead to social-unrest, undermine sovereignty, perpetuate poverty and inequality, create dependency and present moral hazard among policymakers [ 5 , 38 – 43 ].

The Fig 1 shows the accumulation of $Debt compared to $Reserves in Sri Lanka from 1997 to 2022, highlighting the concurrent weakening trend of Sri Lankan Rupee. As at end 2022, Sri Lanka’s total public debt was US$ equivalent 83.6 billion (including arrears) comprised of US$ 45.5 billion of foreign currency stock and US$ 38 billion of local currency stock of Central Government debt, including US$ 3.7 billion of guaranteed state-owned enterprises (SOEs) loans and US$ 3.1 billion of CBSL debt [ 4 , 14 ].

• PPT PowerPoint slide
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Sources: Author’s illustration based on data from The CBSL, The World Bank and Macrotrends.

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Sri Lanka’s $Debt was 69.7% of its Gross Domestic Product (GDP: LKR 23,700 billion or US$ 65.38 billion) and its total debt amounted to a staggering 128% of its GDP [ 4 , 12 , 44 ]. This high level of debt has led Sri Lanka to focus its economic strategies on sectors that bring in foreign currency, primarily export industries. These industries include the production of clothes for US and European markets (which account for 52% of all Sri Lankan exports), tea, coffee, and spices for export, and tourism development [ 14 ].

The available $Reserves dropped to an unprecedented $20 million in April 2022, though official $Reserves were reported at around US$1.6 billion. This Figure includes a restrictive amount of US$1.4 billion with the People’s Bank of China that cannot be utilized to finance imports until Sri Lanka accumulates $Reserves equivalent to three months’ worth of imports (US$5.1 billion) [ 45 ]. Higher $Reserves reduce the perceived country risk, while higher $Debt increases it. However, there are also studies (for example [ 46 ]) that claim that $Reserves have a negative impact on $Debt, suggesting that countries with higher $Reserves tend to have lower levels of $Debt irrespective of their GDP per capita standing; high-income country (such as oil-exporting countries) or low-income country.

Reflections of economic crisis

A rich body of research and academic literature spanning a significant historical timeline extensively examines the multifaceted factors that either contribute to or emerge as consequences of financial and economic crises across diverse economies. These factors encompass, among others, interest rates, inflation, exchange rate depreciation, economic contractions marked by negative GDP growth, various forms of deficits such as budget, trade, and balance of payments deficits, monetary expansion (money printing), government debt accumulation, and foreign reserve management (see [ 7 , 20 , 26 , 46 – 48 ]). This comprehensive body of research provides crucial insights into the dynamics of financial and economic crises, enhancing our understanding of their causes and implications.

Debt and economic growth.

Theoretically, both neoclassical and endogenous growth models [ 49 , 50 ] suggest that high levels of public debt will always reduce the rate of economic growth. Additional channels in support of a negative effect of public debt on long-term growth include: (i) the “debt overhang” hypothesis [ 51 ] (ii) the “constraint” hypothesis (iii) the ‘crowding out’ effect.

The assertion that high levels of public debt impede GDP growth (a negative components of the composite DV-CRISIS) finds support in a growing body of empirical evidence, which illustrates a non-linear, negative relationship between public debt and economic growth in both advanced and emerging market economies [ 49 , 50 , 52 – 55 ], Gomez-Puig and Sosvilla-Rivero [ 56 ] provide evidence of a "diabolic loop" between low economic growth and high public debt levels and public debt has a detrimental impact on economic growth, particularly beyond specific debt thresholds unique to country. Findings of Panizza et al., [ 57 ] (2014) also aligns with this growing empirical literature suggesting a negative non-linear correlation between public debt and economic growth.

Some studies (for example, [ 58 , 59 ]), unveil a bilateral causal relationship between debt and growth appears to be relatively weak. However, there is limited evidence of a robust, long-term causal effect when employing bivariate Granger causality tests [ 58 ]. According to Baum et al. [ 59 ], the short-run impact of debt on GDP growth is significantly positive but diminishes and loses significance beyond specific debt-to-GDP ratios, which vary between countries. Notably, when debt-to-GDP ratios exceed certain thresholds (e.g., above 95%), additional debt exerts a negative impact on economic activity.

Therefore, causal effects in either direction between debt and growth cannot be rejected across the board, it highlights the necessity of considering country-specific dynamics and nonlinear properties when conducting such analyses [ 58 , 59 ].

Interest rate, inflation and exchange rate.

Swift accumulation of debt, particularly when it culminates in a debt crisis, can potentially trigger a currency crisis. After a sovereign default, creditors may decline to extend loans and withdraw their investments due to concerns about a recession, exerting downward pressure on the exchange rate [ 60 ]. Additionally, Marques et al. [ 61 ] suggest that although debt surprises raise long-term inflation expectations in emerging market economies in a persistent way, but not in advanced economies. However, as noted by Podkaminer [ 62 ], the prevailing belief that increasing public debt inevitably results in future inflation lacks empirical support. Meanwhile, Romero and Marin [ 63 ] have found that find that for countries whose public debt is already high, further increases in public debt are inflationary.

Political stability.

Studies have shown that political stability has a significant impact on a country’s debt accumulation [ 26 , 64 ]. They argued that political instability can increase borrowing costs and reduce investor confidence, ultimately leading to higher debt. On the other hand, some other studies [ 26 , 28 ] found that political stability is negatively related to debt. They argued that political stability can improve macroeconomic stability and reduce borrowing costs, leading to lower debt. However, Mehmood et al [ 65 ] argue that the impact of political stability on debt may be mediated by the level of institutional quality. They found that political stability has a positive impact on debt in countries with low institutional quality, but a negative impact on debt in countries with high institutional quality. Several studies have investigated the impact of political stability on reserves. For instance, a study by Mofady and Malawi [ 66 ] examined the impact of political instability on reserves in Jordan and found that political instability has a significant positive impact on reserves, suggesting that countries with higher political stability are likely to have higher foreign reserve levels.

Previous studies have shown that governance and political stability positively affects debt and reserves, indicating that better governance can contribute to higher levels of debt and reserves [ 34 ]. On the other hand, certain studies have shown that good governance, particularly in areas such as political stability, control of corruption, and regulatory quality, can significantly influence a country’s debt and reserves [ 26 , 28 ].

All of these factors are intricately intertwined, collectively contributing to the onset of a financial crisis, which, in turn, often triggers an economic crisis marked by a contraction in the economy."

Theoretical framework

This study builds on previous research by using updated data to examine the relationship between $Debt, $Reserves and Political Stability and Absence of Violence/Terrorism (PS&AVT) focusing on Sri Lanka. The PS&AVT is one of the World Governance Indicators (WGIs) which have been used in numerous studies in finance and economics field [ 67 – 70 ]. These WGIs measure perceptions of the likelihood of existence of them by an aggregate indicator, in units of a standard normal distribution. Estimate gives the country’s score on the aggregate indicator, in units of a standard normal distribution, i.e., ranging from approximately -2.5 to 2.5 [ 71 ]. For example, PS&AVT measures perceptions of the likelihood of political instability and/or politically motivated violence, including terrorism. These aggregate indicators combine the views of a large number of enterprise, citizen and expert survey respondents in industrial and developing countries. They are based on over 30 individual data sources produced by a variety of survey institutes, think tanks, non-governmental organizations, international organizations, and private sector firms [ 35 ].

CRISIS: The dependent variable.

An economic crisis is typically characterized by several key indicators, including high interest rates and inflation, currency devaluation or exchange rate instability, elevated unemployment rates, and negative GDP growth. These factors often coincide and contribute to a challenging economic environment [ 72 ]. The dependent variable ’CRISIS’ (financial crisis) is constructed using a proxy that combines four key indicators of a country’s financial and economic situation: interest rate, inflation, currency devaluation and GDP growth because (unemployment level excluded in this study as it is more focused on a financial crisis):

• High interest rates can be indicative of tight monetary policy, which may lead to reduced borrowing and investment, potentially impacting economic growth. Additionally, high interest rates can increase borrowing costs for individuals and businesses, leading to financial stress and potential economic downturns.
• High inflation erodes the purchasing power of individuals and reduces consumer confidence. It can lead to higher production costs, decreased investment, and economic instability. Rapid or sustained increases in the inflation rate can be a sign of underlying economic imbalances and potential crisis.
• Exchange rate depreciation: The value of a country’s currency may decline rapidly during an economic crisis, leading to a crash or instability in the foreign exchange market. This can make imports more expensive, impacting businesses and consumers, and may affect the balance of trade.
• GDP growth rate: A negative or low GDP growth rate suggests a slowdown or contraction in economic activity. It may indicate declining business investment, decreased consumer spending, or reduced export demand. A sustained period of low or negative GDP growth can signal an economic crisis, as it reflects a significant downturn in overall economic performance.

By combining these factors, the equation "CRISIS = Interest rate + Inflation rate+ annual currency devaluation—GDP growth rate" provides a simple way to capture the interaction and cumulative impact of interest rates, inflation, currency devaluation and GDP growth on the overall financial crisis. Higher the value, severe the crisis. It considers both monetary and real economic factors that can contribute to financial instability and helps provide a comprehensive measure of the crisis situation.

https://doi.org/10.1371/journal.pone.0294455.t001

CRISIS index Vs specialized indices.

This CRISIS index is not meant to substitute specialized indices, such as the Financial Stress Index (FSI), Sovereign Risk Index, and Economic Vulnerability Index (EVI) which offer a more comprehensive assessment of risk and vulnerability by considering a broader range of factors beyond economic variables. They utilize rigorous methodologies, undergo validation, and provide targeted analysis of specific risks. In contrast, this CRISIS index is characterized by its simplicity, understandability, and easy applicability. It provides a quick snapshot of economic conditions, has broad applicability, and can potentially act as an early warning signal. The graphical presentation in Fig 2 shows the reflection of the CRISIS index on its components and demonstrates a fair representation of a crisis situation.

Source: Author’s illustration based on data from the CBSL and the World Bank.

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Hence, the following research hypotheses are constructed:

• H1: External debt ($Debt) positively influences the CRISIS in Sri Lanka.
• H2: Foreign reserves ($Reserves) negatively influence the CRISIS in Sri Lanka.
• H3: PS&AVT negatively influences the CRISIS in Sri Lanka.

To examine the indirect effects of PS&AVT on the CRISIS through $Debt and $Reserves, the following hypotheses are tested:

• H4: PS&AVT is positively associated with $Debt.
• H5: PS&AVT is positively associated with $Reserves.

These hypotheses examine the impact of external debt ($Debt) and foreign reserves ($Reserves) on the CRISIS, as well as the role of Political Stability and Absence of Violence/Terrorism (PS&AVT) in the form of indirect effects considering the associations between PS&AVT and $Debt, as well as PS&AVT and $Reserves. This comprehensive approach seeks to provide a deeper understanding of the causes and dynamics of the economic crisis in Sri Lanka.

Afterwards, I explore the potential causes of these positive or negative influences by critically analyzing various reports, expert opinions, and scholarly works. This investigation aims to identify specific policy decisions or actions that have played a pivotal role in triggering the economic crisis in Sri Lanka.

This wholistic approach can be illustrated in Fig 3 .

https://doi.org/10.1371/journal.pone.0294455.g003

Materials and methods

The method employed for data collection and analysis in this study is a flexible-integrated mixed method [ 27 ] approach that utilizes secondary data from 1996 to 2022 obtained from the World Bank Database and the Central Bank of Sri Lanka, and other authentic reports. To capture the lag effect of the independent variables on the CRISIS, the regressions were conducted with one year lag, so that, for example, the PS&AVT score, $Debt and $Reserves of 2021 are regressed on the Crisis of 2022. Therefore, for example, H1, H2 and H3 regression equation would be as follows.

The regression was conducted using SPSS. Afterwards, the findings of the quantitative tests were critically analyzed with the reports of institutions such as IMF, UN entities, Reuters, Policy Institutions, The World Bank and the Central Bank of Sri Lanka (CBSL) and publicly available opinions expressed by industry experts and scholars in the field.

The dependent variable CRISIS in this analysis is constructed by combining the risk-free interest rate (1-year T-Bill), inflation (annual change of the Colombo Consumer Price Index-CCPI), annual devaluation of Sri Lankan Rupee (LKR) against US$ and GDP growth rate. In 2022, the value of the CRISIS variable is computed as 83.99 which is the highest observed in the 26-year period since 1996. According to the graph in Fig 2 , this CRISIS index fairly reflects crisis situations in Sri Lanka.

Various statistical techniques were employed to assess bidirectional causality between the independent variable and the dependent variable. These techniques encompassed Granger causality tests and regressing lagged dependent variable on independent variables which provided insights into causal relationships, and regressing with the residuals (error term), combined with scatter-plots, to address potential endogeneity concerns.

Basic characteristics

The variable CRISIS has a mean of approximately 16.17 and a standard deviation of approximately 15.30. The positive skewness (3.682) indicates a right-skewed distribution with potentially extremely high values as expected in crisis times. The high kurtosis (15.787) suggests a sharper peak and heavier tails compared to a normal distribution. All other variables demonstrate a relatively normal distribution, with skewness values ranging from 0.004 to 0.529 and kurtosis values ranging from -1.413 to -1.774 ( Table 1 ).

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The correlation coefficient between $Debt and $Reserves is 0.784, and the correlation coefficient between $Debt and PS&AVT is 0.880, both of which are statistically significant at the 0.01 level. These findings suggest that there are significant relationships between the variables, with $Debt and PS&AVT showing stronger associations with CRISIS compared to $Reserves. However, the correlation between CRISS and PS&AVT is negative but very minimal (-.054) and not significant ( Table 2 ).

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Regressions

The ANOVA results demonstrate that the regression model, as a whole, is statistically significant. The F-statistic of 4.825 (p< 0.010) suggests that the predictor variables (PS&AVT, $Reserves, $Debt) collectively make a significant contribution to explaining the variance in the dependent variable (CRISIS). The Durbin-Watson statistic has a value of 1.716, indicating a lack of significant autocorrelation in the residuals of the regression model ( Table 3 ).

https://doi.org/10.1371/journal.pone.0294455.t004

The predictor variables $Debt and $Reserves show statistically significant relationships with the dependent variable CRISIS. Specifically, for every one unit increase in $Debt, CRISIS is expected to increase by approximately trivial 9.673E-10 units (p = 0.004). Similarly, for every one unit increase in $Reserves, CRISIS is expected to decrease by approximately minor -6.203E-9 units (p = 0.001).

However, the predictor variable PS&AVT does not exhibit a statistically significant direct relationship with CRISIS (p = 0.384). Therefore, the results suggest that changes in PS&AVT do not have a meaningful direct impact on the value of CRISIS ( Table 3 ).

Political Stability and absence of violence/Terrorism on CRISIS did not show any significant impact. The regression analysis reveals that PS&AVT accounts for approximately 55.5% of the variance in $Reserves (R Square = 0.555). The coefficient for PS&AVT indicates that a one-unit increase in PS&AVT would result in an increase of approximately 2815632325 $Reserves. This relationship is statistically significant (p < 0.000). However, the presence of positive autocorrelation in the residuals (Durbin-Watson = 0.578) suggests the need for further investigation ( Table 4 ).

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PS&AVT on Debt ( Table 5 ): The regression analysis reveals that PS&AV explains approximately 77.5% of the variance in $Debt (R Square = 0.775). The coefficient for PS&AVT of 23,767,977,200.367 indicates that a one-unit increase in PS&AV is associated with approximately $23,767,977,200.367 in $Debt. This relationship is statistically significant (p < 0.000). The ANOVA results confirm the overall significance of the regression model (p < 0.001).

https://doi.org/10.1371/journal.pone.0294455.t006

Simultaneity causality

Simultaneous causality issues occur when two or more variables in a model are interrelated and influence each other simultaneously, making it challenging to establish the direction of causality between them. Simultaneity bias can complicate efforts to estimate the true causal relationships between variables accurately. To address these issues of bidirectional causality and endogeneity, researchers often employ methods such as Granger causality testing, regression models incorporating lagged dependent variables and error terms (residuals), as well as scatter-plot charts. These tools help disentangle the complex relationships between variables and provide insights into the direction of causality.

Therefore, as additional support, the study incorporated a lagged CRISIS (t-1) variable to examine the reverse direction of the impact, revealing that the relationships were not statistically significant (see Table 6 ).

https://doi.org/10.1371/journal.pone.0294455.t007

Granger causality.

The results of Granger causality Wald tests for potential $Debt Granger-Causes CRISIS show a statistically significant relationship (F(1, 20) = 16.416, p = 0.0006) suggesting that changes in $Debt Granger-cause changes in CRISIS, indicating that $Debt can serve as a predictive factor for variations in CRISIS. Testing Whether CRISIS Granger-Causes $Debt, the relationship was not found to be statistically significant (F(2, 20) = 0.40674, p = 0.6712). Thus, there is no strong evidence to support the notion that changes in CRISIS Granger-cause changes in $Debt. CRISIS does not appear to be a statistically significant predictor of variations in $Debt.

In relation to $Reserves, the results of the Granger causality Wald tests show a statistically significant relationship (F(2, 20) = 5.0459, p = 0.0168) suggesting that changes in the variable $Reserves Granger-cause changes in CRISIS. In other words, $Reserves can serve as a predictive factor for variations in CRISIS. Contrarily, test results for CRISIS Granger-Causes $Reserves was not found to be statistically significant (F(2, 20) = 1.5134, p = 0.2443), so no strong evidence to support the notion that changes in CRISIS Granger-cause changes in $Reserves.

The results of the Granger causality Wald tests for the causal relationships between the variable CRISIS and PS/AV show that the relationship is not statistically significant (F(2, 20) = 3.1128, p = 0.0665). Therefore, there is no strong evidence to support the idea that changes in PS/AV Granger-cause changes in CRISIS. In other words, PS/AV does not appear to be a statistically significant predictor of variations in CRISIS. Also, the relationship was not found to be statistically significant (F(2, 20) = 0.57654, p = 0.5709) for CRISIS Granger-Causes PS/AV suggesting that changes in CRISIS do not Granger-cause changes in PS/AV ( Table 7 ).

https://doi.org/10.1371/journal.pone.0294455.t008

Endogeneity.

Endogeneity is primarily a concern related to the independent variables in a regression analysis. It arises when one or more independent variables are correlated with the error term in the regression model, violating the assumption of exogeneity. Endogeneity can arise as a result of measurement error, reverse casualty/simultaneity, omitted variable or unobserved variables, omitted selection, lagged dependent variables. These are the main reasons why X and e might be correlated or main causes of failure of exogeneity [ 73 ].

Therefore, another regression analysis was conducted, incorporating the lagged CRISIS variable (t-1), an additional independent variable, as a control Variable. The results demonstrate that this inclusion does not alter the significance of the impact of any of the independent variables (t-1), except for PS & AV (t-1), on CRISIS (t), thereby providing additional support for the absence of endogeneity issue related to the majority of the independent variables (see Table 8 ).

https://doi.org/10.1371/journal.pone.0294455.t009

Further, according to the results of regression on the error term (Residuals) of the original regression the independent variables do not have a significant impact on the error term (RESIDUAL) in the original regression model ( Table 3 ) and it does not explain much variance in the error term (R 2 = 0) and none of the independent variables are statistically significant predictors of the error term (p>.05). This suggests that there may not be strong bidirectional causality or endogeneity between these variables in the specified model ( Table 9 ).

https://doi.org/10.1371/journal.pone.0294455.t010

The scatter plots depicting the relationships between the independent variables and the residuals provide additional evidence that supports the absence of endogeneity ( Fig 4 ).

•(p < .05), ••(p < .01), •••(p < .001).

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When $Debt and $Reserves are regressed together on CRISIS, they exhibit a moderately strong positive correlation although the magnitude is very small. The regression model is statistically significant (F =., p 0.00), highlighting the significant role of foreign reserves and external debt in explaining CRISIS. Increase in $Reserves is associated with a decrease in CRISIS and increase in $Debt is associated with increase in CRISIS. The PS&AVT shows positive strong association with $Reserves, means that PS&AVT indirectly influence negatively on CRISIS via foreign reserves. Similarly, the PS&AVT, as a predictor of $Debt, influences positively of $Debt, and therefore, indirectly influence negatively on CRISIS through external debt ( Fig 5 ).

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The Granger causality Wald tests revealed a significant causal relationship from $Reserves to CRISIS indicating that $Reserves can be used to predict changes in CRISIS. However, the reverse relationship, where CRISIS Granger-causes changes in $Reserves was not found to be statistically significant. The causal relationship from $Debt to CRISIS was significant, suggesting that $Debt can be used to predict changes in CRISIS. However, the reverse relationship, where CRISIS Granger-causes changes in $Debt was not found to be statistically significant. Also, there is no significant causal relationship between PV/AV and CRISIS. Changes in PS/AV are not found to predict changes in CRISIS. Likewise, CRISIS does not appear to significantly predict changes in PS/AV.

In terms of endogeneity, regression analysis on the error term (residuals) of the original regression model revealed that the independent variables in the original model did not exert a statistically significant impact on the error term (RESIDUAL). Furthermore, this analysis demonstrated that the independent variables did not account for a substantial proportion of variance in the error term, as evidenced by an R-squared (R2) value of 0. Importantly, none of the independent variables emerged as statistically significant predictors of the error term, with all p-values exceeding 0.05. The scatter plots depicting the relationships between the independent variables and the residuals provide additional evidence that supports the absence of endogeneity. These findings collectively indicate that the original regression model does not appear to suffer from endogeneity issues related to a significant correlation between the independent variables and the error term.

When examining the change of the estimates of the six World Governing Indicators (WGI) over a span of 20 years, with data points taken at five-year intervals, PS&AVT shows the highest level of variation ( Fig 6 ).

Source: Author’s illustration based on data from the World Bank.

https://doi.org/10.1371/journal.pone.0294455.g006

A vicious cycle

The servicing of a large debt increases the expenditure of the government and leads to further deficits and borrowing. The cyclic relationship of the two leads to serious difficulties in containing either and results in economic instability and may even lead to a national financial crisis as happened in Sri Lanka in 2022 ( Fig 7 ).

https://doi.org/10.1371/journal.pone.0294455.g007

Political stability

Starting in mid-January 2022, the availability of fuel experienced a significant decline, leading to the duration of daily blackouts of over 10 hours. Items that were previously considered essential, such as medicines and drugs, became scarce and elusive luxuries. Furthermore, the fuel crisis has posed a substantial threat to food supplies, primarily due to the shortage of diesel. This scarcity has hindered the operation of vehicles responsible for transporting essential commodities like vegetables, fruits, and fish.

In February, a significant number of Sri Lankans from all corners of the country took to the streets in unprecedented numbers, demanding the resignation of the president and his government. This mounting pressure culminated in a demonstration on 31 March, held directly in front of the president’s personal residence. In mid-April, Galleface belt in Colombo became the site of a large gathering, where protestors established a makeshift community known as Gotagogama, (Gota go village) amplifying the public’s demand for the president’s departure. After a three-month struggle, Gotabaya Rajapaksa became the first president in Sri Lanka’s to be ousted by a popular uprising. The protests can be seen as a reaction not only to the politics of nepotism but specifically to a type of nepotism that has resulted in the unraveling of the system [ 7 ]. He further predicts that “…so long as the Rajapaksas remain in power, on the frontlines or from the sidelines, instability will continue. That may debar Sri Lanka from tapping into much needed funds, which Colombo needs to get out of the crisis” [ 7 , p. 5].

Mismanagement

The financial crisis in Sri Lanka is an intricate and multifaceted issue, characterized by a convergence of various factors that have collectively contributed to its occurrence. At its core, the crisis can be attributed to a combination of weaknesses in the country’s financial systems, coupled with ill-suited fiscal and monetary policies. Additionally, sudden shifts and fluctuations in the global markets have further complicated the situation, exacerbating the existing vulnerabilities.

One pivotal aspect that cannot be overlooked is the mismanagement of borrowed funds, which has significantly contributed to the already burdensome debt load. Irresponsible handling of these funds has resulted in a snowballing effect, making the debt increasingly unsustainable and burdening the nation’s economy with escalating interest payments and repayment obligations. The misallocation of borrowed funds into non-productive ventures has hindered economic growth and stifled the potential for long-term financial stability.

The repercussions of the financial crisis extend beyond the realm of economics. They have permeated into various sectors of society, triggering widespread unrest, uprisings, and political instability. The frustrations arising from financial distress have fueled social discontent, leading to demonstrations, strikes, and protests, further complicating the country’s political landscape [ 74 ].

As the crisis deepened, it tested the resilience of institutions, governance, and public trust. The government’s ability to effectively manage the situation was put to the test, and in some instances, inadequate responses and delays worsened the crisis’s impact. Political instability, arising from both internal and external pressures, added another layer of complexity to the situation, hindering the implementation of comprehensive and sustainable solutions.

Conclusions

The statistical analysis conducted in this study indicates a strong association between political stability, external debt and foreign reserves. These independent variables explain a high proportion of the variance in crisis which represented by a proxy consist of interest rate, inflation, currency devaluation adjusted to GDP growth. Granger causality tests showed predictive value for $Debt and $Reserve in relation to CRISIS, but the reverse relationship was not significant. Regression analysis using the error term and scatter plots supports the absence of endogeneity issues in the model.

This study advances our knowledge of the factors contributing to financial crises in Sri Lanka by revealing the intricate connections between external debt ($Debt), foreign reserves ($Reserves), political stability & the absence of violence/terrorism (PS & AV). It emphasizes that while the variable PS & AV may not have a direct impact on financial crises, its influence through $Debt and $Reserves should not be underestimated. The research contributes to the field by offering a more holistic and nuanced perspective on the dynamics of financial stability in the country.

The crisis in Sri Lanka is a complex issue with multiple factors contributing to its occurrence. It can be attributed to a combination of factors, including weak financial systems, inappropriate fiscal and monetary policies, and sudden changes in global markets. However, the mismanagement of externally borrowed funds (Debt) has played a significant role in exacerbating the already unsustainable debt burden. These factors have not only led to financial instability but have also contributed to wider unrest, uprisings, and political instability and violence (PS & AV). Therefore, it can be argued that the mismanagement of Debt, and political instability may have contributed significantly to the financial crisis in Sri Lanka. The study acknowledges certain limitations, such as the use of secondary data, potential omitted variable bias, and the focus solely on the case of Sri Lanka. These limitations should be considered when interpreting and generalizing the findings.

The research findings can be valuable for policymakers and politicians, providing insights into the significant impact of different independent variables on the crisis. The study emphasizes the importance of continued research into the complex factors contributing to financial crises and the consideration of different sets of independent variables when formulating policy.

Supporting information

S1 dataset..

https://doi.org/10.1371/journal.pone.0294455.s001

https://doi.org/10.1371/journal.pone.0294455.s002

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Sri Lanka’s Financial Crisis: Origins, Impact, and Next Steps

Sri Lankans organize a protest against the Rajapaksa government.

By Raghav Nath, MBA ’22

Sri Lanka finds itself in a financial crisis that has led to a rise in external debt, depleted foreign exchange reserves, a currency in freefall, and high, double-digit inflation. I will look at some of the factors that have contributed to the nation’s economic downfall, including consolidation of political power, hyper-populist policies, and an ill-thought push towards organic agriculture. Further, I will evaluate the impact that the situation has had on the nation in the form of political instability, shortages of essential items, galloping inflation, and disgruntled citizens.

How did Sri Lanka get here?

Sri Lanka has had economic trouble for the greater part of the last decade. It received a bailout from the International Monetary Fund (IMF), in 2009 and again in 2016, on the condition that it would control its debt and reduce it to 5 percent of its GDP by 2021. The situation worsened due to the twin impacts of the 2019 Easter bombings and Covid-19 on tourism, one of Sri Lanka’s main industries, accounting for approximately 10 percent of its GDP. Below are some of the key events and policy shifts that led Sri Lanka into the economic turmoil it faces today.

• Consolidation of political power | The Gotabaya Rajapaksa government first came to power in 2019, forming a caretaker government until the 2020 parliamentary elections, when Rajapaksa won a landslide victory as president, and his party, Sri Lanka Podujana Peramuna (SLPP), secured 145 out of 225 seats. This landslide victory allowed Rajapaksa to appoint members of his family to key posts including that of a prime minister and finance minister. Rajapaksa also initiated constitutional reforms that gave the incumbent government the ability to hire and fire judges and other members of the judiciary, further consolidating power and paving the way for major policy changes.
• Hyper-populist policies | The Rajapaksa government enacted populist policies, including massive tax breaks, that had an adverse effect on government revenue. The Goods and Services (GST) tax rate was slashed in half from 15 percent to 8 percent. Additionally, the government also cut the income tax by increasing the taxable income band by 600 percent from 500,000 Sri Lankan Rupees (SLR) to 3,000,000 SLR. This resulted in a 33.5 percent decrease in the number of tax payers. The loss of revenue to the Sri Lankan government was estimated at 2 percent of GDP. The reduced revenue to the government hindered its path towards lowering its percent of debt of the GDP and instead increased it, resulting in even higher interest payments.
• Organic agricultural methods | The government in Sri Lanka ordered a shift to organic methods of farming. They did this in a relatively short amount of time and in a very stringent manner, without rolling out support and help for the farmers to assist them in the change. What followed was a sharp reduction in output in agricultural items such as rubber and tea. Due to reduced output, Sri Lanka had to stop exporting these items and instead import them to ensure enough quantity to sustain domestic demand. This led to a negative impact on its balance of payments and increased debt that further weakened its currency, which in turn made these imports even more expensive. Sri Lanka was caught in a vicious cycle of rising debt and rising interest payments due to the mismanagement of its economy.

What impact has the crisis had on Sri Lanka?

The economic crisis has had a crippling effect on the country, with shortages of essential goods, high inflation, and more, leading to mass protests and resignations from the president’s cabinet.

• Shortages of essential goods | Sri Lanka has faced acute shortages of essential items such as fuel and medicines as it struggles to import goods due to its precarious foreign exchange reserves and mounting debt. This has had a compounding impact on the island nation as tourists have stayed away from the country amidst the fallout from the situation. Since tourism accounts for approximately 10 percent of Sri Lanka’s GDP, the failure to see an uptick in tourism following the easing of the Covid-19 pandemic has hit the country hard.
• High inflation | The country has struggled with high inflation owing to the vicious debt trap that it has found itself in. As a result, the interest payments on sovereign debt and the cost of imports have been rising steadily. The increase in inflation has hit every stratum of society hard, but has hit those with the lowest incomes the hardest.

What steps can Sri Lanka take to alleviate the situation?

Resumption of imports that help tackle the shortages of essential goods seems to be of the utmost importance. Without essential medicines, fuels, and food grains, any attempt to return to a state of normalcy will be futile. However, this will only be possible after it refinances its debt and gets a bailout either from its neighboring countries or the IMF. Without this, it will not be able to afford imports.

Sri Lanka estimates that it needs USD 1.5 billion to tide over the crisis immediately and resume its imports of essential items. An IMF bailout that mandates resumption of non-organic ways of farming, cutting back populist tax regimes, and increasing government revenue through more efficient tax collection will not only help the country in the short term but will also lay the foundation to build its future.

About Raghav Nath, MBA ’22

Raghav Nath is a second-year student in the Two-Year MBA program at the Samuel Curtis Johnson Graduate School of Management . He grew up in India and takes a keen interest in South Asian geopolitics. Nath is passionate about fintech and the application of technology to increase financial inclusion in the emerging economies. Upon graduation, he will be joining Fireblocks, a cryptocurrency infrastructure provider, to help promote the adoption of cryptocurrency by institutions.

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A View Inside Sri Lanka's Deepening Economic Crisis

Gayani Tillekeratne, who leads DGHI's research partnership in Sri Lanka, describes what it's like to work amid power outages and protests.

A quiet street in Galle, Sri Lanka, during a COVID-19 lockdown in spring 2020. (Photo courtesy of Champica Bodinayake)

By Michael Penn

Published April 11, 2022 under Around DGHI

In Sri Lanka, tensions over a deepening economic crisis boiled over during the last few days of March, as protesters flaunted government-imposed curfews to voice frustration with the government’s handling of the economy. Residents reported shortages of food and fuel, and on April 5 the United Nations Human Rights Office issued a warning about potential abuses in the government’s efforts to curtail protests.

Gayani Tillekeratne, M.D., an assistant professor of medicine and global health, watched the events unfold from the University of Ruhuna in Galle, Sri Lanka, where she co-directs the  Ruhuna-Duke Centre for Infectious Diseases . A native Sri Lankan who lived in the country until she was nine, she now spends six months a year there, collaborating with clinicians and researchers at the University of Ruhuna to improve surveillance and treatment of emerging infectious diseases.

We reached out to Tillekeratne to ask about the situation in Sri Lanka and how it is affecting her and her colleagues. This email exchange took place between April 8-10 and has been edited for length and clarity.

First and foremost, are you and your colleagues safe and secure? 

Thank you for checking. My colleagues and I are all safe. Most of the protests have been centered in the capital, Colombo. However, there are protests happening daily throughout the country, including in Galle where Duke’s collaborative site is based. The protests have been largely peaceful, although police have used water and tear gas to break up a few of the protests. And there have been protests throughout the world by the Sri Lankan diaspora in solidarity — in London, Melbourne and Los Angeles, to name just a few.

Can you describe what’s happening there? 

Sri Lanka is facing its worst economic crisis since obtaining independence in 1948. The country has overcome many challenges including a 26-year civil war, the tsunami of 2004 (the impetus for the Duke-Ruhuna collaboration), the Easter Sunday terrorist bombings in 2019, and more recently the COVID-19 pandemic. However, many people in the country are saying that these are some of the most challenging times they have faced.

Due to a combination of excessive borrowing in past years for massive infrastructure projects, unsustainable tax cuts, corruption and the downturn in tourism since 2019, the country is facing a severe lack of foreign reserves. Sri Lanka now has nearly US$7 billion of debt payments this year, with only about US$2 billion in reserves.

The government does not have adequate finances to purchase basic commodities such as petrol, diesel and cooking gas for the public. People are standing in long lines for limited supplies. Due to a lack of diesel fuel to run power plants, there have been daily electricity cuts which have lasted up to 12 to 15 hours a day, though this has improved in recent days. Inflation has spiked and the prices of basic items such as bread, rice, and produce have also risen, causing difficulties for those who were economically disadvantaged.

Sri Lanka relies heavily on imports for food, medicines and fuel, and so there is a fear that basic goods will become unaffordable or unavailable in the future. The power cuts are having a negative effect on the economy and affecting all sectors including education, health care, public transportation and now tourism.

“ The protests are also against what has been seen as an infringement on the rights of the people to protest peacefully and to speak freely. All social classes, races and religions have been affected and have taken the streets together.

What do the protesters want?

Sri Lankans are protesting the rise in prices, lack of basic goods and fuel, and the power outages. They are asking for a change in government because the president, prime minister and multiple other members in high political positions are all members of the same family. There is suspicion of widespread corruption within this family that has contributed to the current economic crisis.

In addition, when the protests were first starting, the government briefly instituted a national curfew, issued emergency powers usually reserved for national threats such as terrorist acts, and shut down social media channels. The protests are also against what has been seen as an infringement on the rights of the people to protest peacefully and to speak freely. All social classes, races and religions have been affected and have taken the streets together. The resulting unity has been an unexpected and very positive outcome of the current economic crisis.

What are you and your colleagues most concerned about now? 

We are mostly concerned that there does not seem to be a clear plan or solution from the government yet. Without swift and major change, the prices of basic commodities will continue to rise, which will make life very difficult for everyone. Importing basic goods will become more expensive or impossible, leading to shortages of essential items such as medications. This is already starting to be felt within the country. Power cuts will continue to negatively impact any chance of economic recovery.

Can you describe the goals of your research there? 

Broadly, the goals of our infectious diseases research program in Sri Lanka are to improve the diagnosis and management of known and emerging infectious diseases. Over the last 15 years, we have conducted large surveillance programs to identify the epidemiology of acute febrile and respiratory illnesses such as dengue, leptospirosis and influenza. We are now working to develop point-of-care diagnostic tests to improve detection of these infections and to predict which patients may progress to more severe disease.

We would like to develop practical, cost-effective algorithms using readily available data and low-cost tests to improve patient care, reduce unnecessary antibiotic use and decrease unnecessary admissions/ costs to the health system. Other important goals of our program include building local capacity by developing laboratory infrastructure, training students and personnel in research skills, and liaising with the public health system to provide real-time data. Our work has recently been consolidated under a new Centre for Infectious Diseases at Ruhuna.

Researchers in a molecular diagnostics...

Has your work been affected by shortages or power outages?

Initially, when the power outages lasted for 12 or more hours, it was difficult to be highly productive as laptops and phones could not last the duration of the outages. The power cuts are now more manageable – around six hours a day, divided into two blocks. Laboratory testing for our studies has been delayed due to inability to run equipment for the entire day. Our freezers, which hold biological samples from the last decade of studies, have been strained, and we have had to frequently replace the backup carbon dioxide cylinders to cool them.

Are there wider health impacts from the crisis?

Due to the heat, the power outages have been difficult to tolerate for the very young and the very old. Routine surgeries in some hospitals have been canceled. The economic crisis is expected to result in shortages of basic medications and supplies for the public hospitals in upcoming weeks, which will have important ramifications for the overall health of the people.

Duke has such strong connections with Sri Lanka. What is your message for colleagues in the U.S. and elsewhere who are watching the news there with concern? 

At the moment, it is difficult to predict how things will evolve. If the political system and economy stabilize due to a financial solution, life and work could return to relative normalcy. However, it is likely that at least the upcoming months will be challenging in the country. It will be important to continue to support our Sri Lankan colleagues, whether through donations of money or medical supplies or just moral support.

• Infectious diseases
• L Gayani Tillekeratne

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What must Sri Lanka do to avoid a second default in the near future?

Saturday, 18 May 2024 00:03 -     - {{hitsCtrl.values.hits}}

A second default by Sri Lanka could be more devastating than Sri Lanka’s first default in 2022 

What will a second default look like?

A second default by Sri Lanka could be more devastating than Sri Lanka’s first default in 2022. In case of a second default Sri Lanka will have to go once again to the lender of last resort, the International Monetary Fund as a bankrupt nation. The conditions by the IMF if we default the second time will be much harsher and rightly so. The bilateral creditors and bondholders will also not be as kind if Sri Lanka goes for a second default. With harsher terms by the IMF, bilateral creditors and bondholders, Sri Lanka if it defaults again will have very little space to breathe. 

With seven million Sri Lankans (one third of the population) categorised as poor after our first default in 2022, the people have already been hit by a wave of austerity measures and their buffer to take another hit is not there anymore. A second default, will result in greater pressure on the Government at the time of the second default to sell state owned enterprises which can even lead to a firesale of resources. So, careful planning is needed to avoid a second default.

What should Sri Lanka do to avoid a second default?

Favourable debt restructuring – Firstly, in the short term, we need to negotiate a good deal with the creditors to get a larger debt relief. As Sri Lankan employees whose EPF funds were invested in Government treasury bonds which were considered safe and had already lost half the value of their money due to inflation were restructured, it is more than fair to ask for a larger haircut from the ISB bondholders. As multilateral debt is not restructured, Sri Lanka needs to negotiate a favourable debt deal with the bilaterals and especially with the bondholders who bought bonds with higher interest rates due to the risk premium which they knew before buying. 

Improving credit ratings – Secondly, we need to improve our credit ratings with better GDP growth, better debt management, good fiscal and monetary policies and political stability so our borrowing costs are cheaper. For example, Japan’s debt to GDP ratio is over 250% which is much higher than Sri Lanka’s which is around 115%. But Japan’s interest rate for a government 10 year bond is just 0.88%. Japan’s Government revenue to GDP was 37% in 2022. So, only 6% of Japan’s Government revenue goes for interest payments even though its debt to GDP ratio is over 250%. But Sri Lanka spent 70% of its Government revenue on interest payments in 2022 even though its debt to GDP is only at 115% because our Government revenue is extremely low (around 8% of GDP in 2022) and our credit ratings are poor making our borrowing costs much higher. Bringing down borrowing costs can make Sri Lanka’s debt more sustainable even if the total principal debt remains the same.  Economic growth – Sri Lanka needs economic growth especially driven by the tradable sectors. For our economy to expand, we need to have more free trade agreements and improve our ease of doing business to attract export driven manufacturing and services investments. A number of other reforms are needed, like governance related reforms, land and labour reforms and digitisation to improve efficiency in government services. As I have argued in a paper I wrote for the IMF in 2022 which was voted one of the most read IMF articles in 2022, economic growth and innovation are directly related. Economies grow either with population increase, resources increase or with increasing productivity per person.  As Sri Lanka’s population is aging and Sri Lanka has limited natural resources, it needs to innovate and improve its productivity and efficiency. Sri Lanka needs to spend much more on its education sector. States like Tamil Nadu and Karnataka in India are successful compared to the rest of India because they focused on education much earlier than other states. Sri Lanka needs to spend much more on its education sector, especially STEM education. For Sri Lanka to increase productivity and efficiency, it needs to innovate and research and development investment is needed. As far as R&D goes, Sri Lanka spends a very low amount compared to the global average.  Greater economic partnership with India – A great opportunity for economic growth is greater economic integration with India. Sri Lankans look at Singapore and Dubai as examples of economic success but both Singapore and Dubai became economic powerhouses because they became the gateway to their regions. Singapore is the gateway to the ASEAN region and Dubai is the gateway to the oil rich Gulf region. India is the fastest growing major economy in the world and is set to be a $10 trillion dollar economy in the near future. Tamil Nadu, the state in India which is closest geographically, is the second most industrialised state in India and Tamil Nadu itself is expected to have a $1 trillion economy by 2034 according to Deloitte. Greater economic partnership with India can drive economic growth for Sri Lanka in the long term and it can attract greater Indian investment into Sri Lanka. 

Conclusion 

Sri Lanka needs to have long term planning and political consensus to ensure it does not default for the second time. A favourable debt restructuring is needed, borrowing costs need to be brought down by improving its credit ratings, economic growth driven by exports and greater integration with the regional economies can ensure a stable future for Sri Lanka.

(The writer is an Economist. He is a Consultant on Economic Policy at the Asian Development Bank. He is an Expert Member of the World Economic Forum and a regular Columnist for the International Monetary Fund on public finance management. He was a member of the Deloitte Global Economist Network. The views expressed in this article are strictly the writer’s own personal opinions.)

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Sri Lanka’s road to recovery is long and must stay course

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The economic recovery partially remains hindered by slow growth in exports and low foreign direct investment (FDI), with export growth projected at a modest 5.27 percent from 2024 to 2028 and FDI below 3 percent of GDP.  The country faces a significant challenge with a decade-long period of low productivity growth, averaging 1.4 percent annually, underlying major structural weaknesses in the economy, principally almost endemic policy inconsistency. To foster sustainable economic growth, Sri Lanka must seek and enter new markets through export, enhancing trade deals while addressing the domestic constraints to unlock its FDI and export potential.  Fifteen months after the crisis in Sri Lanka, it’s important to assess the progress made in terms of recovery and stability of the recovery. Efforts likely include rebuilding infrastructure, enhancing export supply chain capacity, restoring political stability, addressing economic challenges and fostering social cohesion. 

The ongoing international support and domestic initiatives are crucial for long-term recovery. Sri Lanka’s economic growth hinges on efficiently utilising labour and capital to boost productivity growth, also on international support. If Sri Lanka can do more with the key trading partners, Sri Lanka can enhance economic growth, leading to greater efficient resource allocation and productivity gains. However, this would require diplomacy of a very high order, experience and strong management from the top leadership to get the best for the country. 

Recovery 

Sri Lanka’s recovery could be attributed to several factors: strong leadership of the incumbent and role in orchestrating recovery efforts and mobilising international resources. Continued Support from the international community in terms of financial assistance, technical assistance and expertise can accelerate and sustain the recovery processes. 

Sri Lanka’s diverse economy, including tourism, agriculture and manufacturing, may have provided a foundation for our nation’s resilience and the community successfully adapting to difficult economic conditions. 

The resilience and cooperation of local communities, a critical supply chain component in rebuilding efforts, can significantly contribute to the pace of recovery. Combining these factors with effective coordination, transparency and collaboration among stakeholders can expedite the recovery process in Sri Lanka. 

The government also needs to run an effective administration to run down costs, improve the productivity of the public sector and deal with the elevated poverty levels and income inequality.

The Sri Lankan economy is clearly showing signs of recovery from a severe economic crisis, as acknowledged at several levels internationally, with impressive foreign exchange improvements from a US $ 4 billion International Monetary Fund reform programme, increased tourism income, improved remittances and other funding sources, allowing for the lifting of import restrictions on essential goods and reduced inflation. 

But a significant challenge remains in managing the country’s large sovereign debt and inequities of the partial coverage domestic debt optimisation programme that unfairly burdens the ordinary people and salaried participants in the economy, whilst excluding the financial services sector.  

Successful completion of the foreign debt restructuring process could potentially reduce Sri Lanka’s debt burden by approximately US $ 17 billion. Sri Lanka’s future depends on trade and investment, whilst the West remains Sri Lanka’s largest revenue generator for exports, the technological and demographic dividend of a faster-growing Asia offers the greatest prospects for Sri Lanka’s FDI and exports. These regions are likely to be among the major winners in the new geopolitically aligned trade equation, while not underestimating the world’s second largest economy China, due to its sheer market size and economic power.  

Cumulative Asian trade is forecast to grow US $ 1.5 trillion in the next 10 years, due to the region’s emergence as a critical destination for companies seeking to decrease their over dependence on China. Sri Lanka has strong complementarities with ASEAN’s relatively complex and advanced economic structures.  

An agreement with ASEAN, which would provide a larger market under a single administrative arrangement, would be a game changer for Sri Lanka, embellished with fully functioning bilateral trade arrangements with Asian powerhouses.

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A Crisis of Beliefs

Nicola Gennaioli

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Economics & Finance

A Crisis of Beliefs: Investor Psychology and Financial Fragility

• Nicola Gennaioli and Andrei Shleifer

How investor expectations move markets and the economy

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The collapse of Lehman Brothers in September 2008 caught markets and regulators by surprise. Although the government rushed to rescue other financial institutions from a similar fate after Lehman, it could not prevent the deepest recession in postwar history. A Crisis of Beliefs makes us rethink the financial crisis and the nature of economic risk. In this authoritative and comprehensive book, two of today’s most insightful economists reveal how our beliefs shape financial markets, lead to expansions of credit and leverage, and expose the economy to major risks. Nicola Gennaioli and Andrei Shleifer carefully walk readers through the unraveling of Lehman Brothers and the ensuing meltdown of the US financial system, and then present new evidence to illustrate the destabilizing role played by the beliefs of home buyers, investors, and regulators. Using the latest research in psychology and behavioral economics, they present a new theory of belief formation that explains why the financial crisis came as such a shock to so many people—and how financial and economic instability persist. A must-read for anyone seeking insights into financial markets, A Crisis of Beliefs shows how even the smartest market participants and regulators did not fully appreciate the extent of economic risk, and offers a new framework for understanding today’s unpredictable financial waters.

Awards and Recognition

• One of Bloomberg's Best Books of 2018 (Cass Sunstein)
• One of Barron's Book Picks from Industry Leaders in 2018 (Robert Shiller)

"There is evidence from behavioral economics that people are not entirely logical, and do not actually rely fully on logic or standard statistical techniques. This behavioral economic perspective is embraced by Nicola Gennaioli of Bocconi University and Andrei Shleifer of Harvard University in their remarkable new book, A Crisis of Beliefs ."—Robert J. Shiller, New York Times

"Economists are at last catching up with the seminal work of the late Hyman Minsky. In a book written for academics, but of wider relevance, the authors conclude that, first, investors make mistakes; second, those mistakes are systematic, predictable and incompatible with the view, that expectations are 'rational'; and, third, a new perspective, called 'diagnostic expectations', rooted in human psychology, does a good job of explaining these mistakes. Moreover, they argue, surveys indicate when expectations are becoming riskily euphoric and so should help predict crises."—Martin Wolf, Financial Times

"An ‘as smart as you would expect’ take on the hypothesis that investor over-extrapolation of recent price trends can cause financial crises, including our recent financial crisis."—Tyler Cowen, Marginal Revolution

"Something is wrong with the economics profession if events like those of 2008 do not change its thinking. Those wanting to be in the vanguard of the new thinking should be reading A Crisis of Beliefs ."—Lawrence Summers, WashingtonPost.com's Wonkblog

"A decade after the financial crisis of 2008 and its aftermath, economists are still grappling with its nature and significance. An important recent contribution is A Crisis of Beliefs . . . . They make a convincing case for taking seriously the evidence provided by surveys and anecdotes that characterize the beliefs held at the time by households, investors, and policy makers."—Arnold Kling, EconLib

"For a decade now, people have been looking for a silver lining to the disasters of 2008-2018, hoping that this period will bring about a more productive integration of finance, behavioral economics, and macroeconomic orthodoxy. So far, they have been searching in vain. But with the publication of A Crisis of Beliefs , there is hope yet."—J. Bradford Delong, Project Syndicate

"What caused the financial crisis of 2008? What’s likely to cause future crises? Gennaioli and Shleifer offer an original, compelling and intriguing answer: investor psychology. . . . Gennaioli and Shleifer offer a parsimonious account of boom-bust cycles — one that relies mostly on what goes on in people’s minds."—Cass Sunstein, Bloomberg

"A rich, elaborate and ambitious book."—Simone Raudino, The European Legacy

“ A Crisis of Beliefs offers a brilliant new analysis of the root cause of financial meltdowns and credit cycles more generally: market participants’ mistaken beliefs. Gennaioli and Shleifer show how survey evidence that ferrets out expectational errors can provide early warning signals of impending market corrections and a powerful new tool to prevent future financial crises. This book leads the way beyond rational expectations.”—Janet Yellen, Distinguished Fellow in Residence, Brookings Institution, and former Chair of the Federal Reserve, 2014–2018

“This brilliant book builds on a psychological idea to offer both an alternative to rational expectations and an interpretation of the financial crisis. It will be a milestone in the history of behavioral economics.”—Daniel Kahneman, winner of the 2002 Nobel Prize in economics, author of Thinking, Fast and Slow

“Economists have long needed a theory of why we are so often caught totally off guard by financial crises—here it is. This is a book that shakes our economic presumptions to the very core.”—Robert J. Shiller, winner of the 2013 Nobel Prize in economics, author of Irrational Exuberance

“The financial crisis brought home the inadequacy of analyses that assume people always correctly assess the risks they face. Gennaioli and Shleifer go further, offering a psychologically grounded theory of the kinds of errors that most typically occur, and explaining the consequences. This book is a tour de force, taking behavioral economics out of the lab and putting it to work in the real world.”—Michael Woodford, Columbia University, author of Interest and Prices

“This fantastic book puts forth an empirically motivated, rigorously modeled, and psychologically grounded theory of behavioral biases in expectations formation. Written by two of today’s leading economists, A Crisis of Beliefs will be on the shelves of policymakers around the world.”—Amir Sufi, coauthor of House of Debt

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