How a Country Goes Bankrupt: The Anatomy of Sri Lanka's 2022 Collapse

In 2022, Sri Lanka simply ran out of money. Not the way a household does, but in the far stranger way that entire nations can: unable to buy fuel, food, or medicine from the outside world, and unable to pay debts it had promised to repay. It was the country's first-ever default — and it is the clearest lesson you will find in how a nation goes broke.

There is a moment, in the story of any national economic collapse, that feels impossible. For Sri Lanka in 2022, it was the sight of a middle-income country — long held up as a development success, with good health and literacy and a thriving tourist trade — grinding to a halt. Cars queued for days outside petrol stations that had no petrol. Hospitals ran short of medicine. The power went off for hours at a time. Inflation tore past 70 percent. People died waiting in lines for essentials. And in July, after months of mass protests, the president fled the country and resigned.

How does this happen? How does an entire nation go bankrupt? It is one of the most misunderstood events in economics, precisely because a country is not like a person or a company. Understanding what happened to Sri Lanka — a story every Sri Lankan lived through — is the best possible way to understand the machinery of a sovereign debt crisis, because Sri Lanka managed to get almost every ingredient of one in place at the same time.

What "bankrupt" means for a country

Start with the crucial difference. When a person or a business runs out of money, they can be declared bankrupt, their assets seized, their debts settled by a court. None of that applies to a country. A nation cannot be liquidated, and no court can seize a country. So what does it actually mean for a country to "go bankrupt"?

The answer comes down to one thing: foreign currency. A government can always print more of its own currency — Sri Lanka can print rupees, just as the United States can print dollars. But it cannot print the currencies of other countries, and it needs those foreign currencies, above all US dollars, for two vital purposes. First, to pay for imports: a country buys fuel, food, machinery, and medicine from abroad, and foreign sellers want to be paid in hard currency, not local rupees. Second, to repay foreign debt: when a government borrows from international lenders, those loans usually have to be repaid in dollars.

A country's stockpile of these hard currencies is called its foreign exchange reserves. When those reserves run dry, the machinery seizes up. The government can no longer buy enough imports, so shortages of fuel, food, and medicine appear. And it can no longer make its foreign debt repayments, which means it must default — formally failing to pay what it owes. That is what "national bankruptcy" really is: not an empty bank vault, but an empty reserve of the foreign money a country needs to function in the world. In April 2022, Sri Lanka's reserves had collapsed to a fraction of what it owed, and it defaulted on its foreign debt for the first time in its history.

The important question is how the reserves ran dry — and here the story becomes a cautionary tale in slow motion.

Ingredient one: too little coming in

A country earns foreign currency the way a household earns income: by selling things. Sri Lanka's main earners of dollars were its exports (like tea and garments), money sent home by Sri Lankans working abroad (remittances), and, crucially, tourism — the foreign visitors who arrive with foreign money.

Two blows struck those earnings in quick succession. In 2019, a series of terrorist bombings devastated the tourist industry, frightening away the visitors a fragile economy depended on. Then, before it could recover, the COVID-19 pandemic arrived in 2020 and shut down global tourism almost entirely, while also disrupting the flow of remittances. Two of the country's biggest sources of foreign currency were choked off at once.

Underlying this was a deeper, self-inflicted weakness: the government simply didn't collect enough revenue. Sri Lanka already had one of the lowest tax takes in the world, and in 2019 a set of sweeping tax cuts slashed government income even further. State revenue fell from around 12 percent of the economy in 2019 to roughly 8 percent by 2022 — a level at which a government cannot fund itself, let alone weather a storm. A country with thin revenues and shrinking foreign earnings has almost no cushion when trouble comes.

Ingredient two: too much going out

While its income was collapsing, Sri Lanka's obligations were not. For years, the country had borrowed heavily on international markets and from foreign governments to fund large infrastructure projects and to cover the losses of inefficient state-owned enterprises. That debt came due regardless of the pandemic, and repaying it drained precious dollars out of the country just when it could least afford it.

Two further policy decisions turned a difficult situation into a catastrophe. The first involved the currency. For a long period, the central bank worked to hold the Sri Lankan rupee at an artificially strong, fixed rate against the dollar. This made imports feel cheap — which encouraged buying more from abroad — but it hurt exporters and, critically, it burned through reserves as the central bank spent dollars to defend the rupee's value. Propping up an overvalued currency is like keeping the price of something fixed while the world moves on; eventually the effort exhausts your resources.

The second decision has become infamous. In 2021, the government abruptly banned the import of chemical fertilizers, aiming to force the entire country's agriculture to become organic essentially overnight. The stated goal included saving the foreign currency spent importing fertilizer. The result was a disaster. Deprived of the fertilizers their crops depended on, farmers saw yields collapse; agricultural output fell sharply. A country that had grown much of its own food suddenly had to import more of it — spending even more of the scarce dollars the policy was meant to save, while also damaging its vital tea exports. The ban was later reversed, but the damage was done.

The collapse

Put those ingredients together and you have a reserve of foreign currency being drained from every direction at once: less coming in from tourism, remittances, and taxes; more going out on debt repayments, defended currency, and extra imports. There was one escape route — going early to the International Monetary Fund, the international lender of last resort, for help. But the government resisted seeking IMF assistance for a long time, even after its debt had been judged unsustainable, hoping to avoid the difficult conditions such a bailout requires. Delay only let the reserves drain further.

By early 2022, the tank was effectively empty. The reserves left were nowhere near enough to cover the billions in debt repayments due that year, and the country defaulted. With no dollars to pay for imports, the shortages became severe and then desperate: fuel, cooking gas, medicine, and food all ran short. The economy shrank by more than seven percent in a single year. Inflation exploded. And the human consequences spilled into the streets, as huge popular protests — remembered as the "Aragalaya," the struggle — brought the country to a standstill and ultimately drove the president from office. This is what the abstract phrase "sovereign default" looks like on the ground: not a line in a ledger, but a nation unable to function.

The long road back

A sovereign default is a beginning as much as an end, because the country still exists and still has to recover. Sri Lanka's path back illustrates the second half of the lesson: how a bankrupt nation claws its way out.

The first step was the bailout the government had long avoided. Sri Lanka secured a multi-year rescue package from the IMF — on the order of three billion dollars — but the money came with hard conditions: raising taxes, cutting subsidies, pricing utilities to cover their real cost, and reforming loss-making state enterprises. This is the painful medicine of recovery, known as austerity: a government that overspent and under-collected must do the reverse, which is deeply unpopular precisely because it squeezes people who are already suffering.

The second step was debt restructuring. A country that cannot pay its debts must negotiate with those it owes — international bondholders and other governments, including major creditors like Japan, China, and India — to reduce or reschedule what it owes, stretching repayments out over more years and easing the immediate burden. After lengthy negotiations, Sri Lanka reached agreements to restructure tens of billions of dollars of debt, a critical turning point that gave the economy room to breathe.

The results of this hard adjustment have been striking. After shrinking sharply, the economy returned to growth, expanding around five percent in 2024. Inflation, which had raged past 70 percent, fell dramatically, even turning negative. Foreign reserves more than doubled from their empty state, and the government achieved its first budget surplus, before interest payments, in over a decade. A resurgence in tourism helped refill the coffers. Politically, too, the country turned a page, with voters electing a new government that has, so far, maintained the reforms. Sri Lanka's recovery has been faster than many expected.

The lesson in the wreckage

It would be comforting to blame Sri Lanka's collapse on a single villain — one bad policy, or simply bad luck. The truth is more instructive, and more sobering: the crisis was the product of many things going wrong at once and compounding one another. Chronic under-taxation, heavy foreign borrowing, an overvalued currency, a dependence on fragile foreign earnings, external shocks like bombings and a pandemic, a catastrophic fertilizer experiment, and a fateful reluctance to seek help early — each alone was survivable, but together they emptied the country's reserves and pushed it over the edge.

That is how a country really goes bankrupt. Not suddenly, and rarely for one reason, but slowly, as a series of choices and misfortunes drain away the foreign currency a nation needs to pay its debts and buy from the world — until, one day, the tank is empty and everything stops. Sri Lanka's ordeal, and its hard-won recovery, is a live textbook on both halves of that process, written in the experience of a whole population. And its clearest warning is that the vulnerabilities build quietly, long before the queues appear at the petrol stations.

Sources and further reading

• IMF working papers and program documents on Sri Lanka's 2022 sovereign default, its Extended Fund Facility (~$3 billion, from 2023), and the collapse in government revenue (from ~12% of GDP in 2019 to ~8% by 2022).
• Analyses (Cornell, Asia Pacific Foundation, ODI, Australian Institute of International Affairs) on the causes — the 2019 tax cuts and Easter bombings, the COVID-19 hit to tourism and remittances, heavy external debt, the defended overvalued exchange rate, and the 2021 chemical-fertilizer ban.
• Reporting on the reserves falling to roughly $1.9 billion by March 2022 against several billion dollars in repayments due, the April 2022 default, ~7% GDP contraction, inflation above 70%, shortages, the "Aragalaya" protests, and President Gotabaya Rajapaksa's resignation.
• Coverage of the recovery: debt restructuring (tens of billions, including deals with bondholders and creditors Japan, China, and India), ~5% GDP growth in 2024, falling/negative inflation, doubled reserves, the first primary surplus in over a decade, and the 2024 change of government.