Sri Lanka Economic Crisis

An Overview of the Sri Lanka Economic Crisis: Causes, Impact and the Aftermath

Sri Lanka just defaulted payment on a multibillion-pound foreign loan, intensifying the country’s greatest economic crisis since independence in 1948. Ranil Wickremesinghe, the new Prime Minister, is pleading for international assistance to save the Government, which is almost on the edge of running out of foreign currency reserves. It is the Sri Lanka Economic Crisis, an economic catastrophe!

Protests have erupted in Sri Lanka for weeks due to soaring food costs and severe fuel shortages. The Sri Lanka Economic Crisis, which began in 2019, is still underway. It is the country’s worst economic downturn since its 1948 independence. As a result, there has been extraordinary inflation, a near-depletion of foreign exchange reserves, shortage of medical supplies, and an increase in the price of basic foodstuffs.

Multiple compounding variables led to the crisis:

  • Tax Cuts
  • Money Creation
  • A statewide programme to convert to organic or biological farming
  • Drastic occurrences like the Easter bombings in 2019, and
  • Impact of the COVID-19 pandemic

In addition, Sri Lankan protests erupted in 2022 due to the consequent economic woes.

A Nation in Crisis

Sri Lanka was slated for sovereign default since the country’s residual foreign exchange value reserves of the amount US$1.9 billion as of March 2022 will not cover the country’s international debt commitments for 2022, which totalled US$4 billion.

In July 2022, the Government must return $1 billion in International Sovereign Bonds. According to Bloomberg, Sri Lanka owes a total of US$8.6 billion in debt repayments by 2022, including both domestic and foreign debt. As a result, the Sri Lankan Government declared a default in April 2022, making it the foremost sovereign default in the history of Sri Lanka since independence in 1948. It is also the first sovereign default in the Asia-Pacific region in the twenty-first century.

What caused Sri Lanka Economic Crisis?

Fuel Shortage
Credit: The Conversation

According to two of the world’s largest credit rating agencies, Sri Lanka’s Government has defaulted after failing to pay $78 million in debt interest payments. A default can substantially harm a country’s investor trust, making it difficult for it to borrow money on international markets and jeopardizing the currency’s value.

Sri Lanka owes foreign creditors $50 billion but claims it cannot pay. So it has applied to the International Monetary Fund for a loan. Prime Minister Wickremesinghe has stated that the country requires $75 million in foreign currency to cover the critical imports such as petrol.

Cuts in taxes and money creation

Sri Lanka’s administration, led by President Gotabaya Rajapaksa, implemented significant tax cuts that impacted government revenue and fiscal policies, causing budget deficits to skyrocket.

High tax-free thresholds resulted in a 33.5% drop in registered taxpayers. VAT dropped down to 8% and corporate tax from 28% to 24%. In addition, there was the abolishment of the Pay As You Earn (PAYE) and the enactment of a 2% “nation-building tax” that funded infrastructure development. Rating agencies downgraded the sovereign credit rating as a result of the large loss of tax revenue, making it more difficult to take on further debt.

P. B. Jayasundera indicated in 2021 that President Rajapaksa was aware of the revenue loss but viewed it as an “investment,” with no intentions to raise taxes for another five years. However, the Central Bank began printing money in unprecedented volumes to finance government spending, against the International Monetary Fund’s advice to stop printing money and instead raise interest rates and taxes while cutting spending. The International Monetary Fund (IMF) cautioned that continuing to print money will result in an economic collapse.

The CBSL purportedly printed 119.08 billion rupees on April 6, 2022, making it the greatest reported amount printed by the CBSL in a single day for the year 2022. For the year 2022, the overall amount of money introduced to financial markets climbed to Rs. 432.76 billion.

External Debt

Between 2010 and 2020, Sri Lanka’s foreign debt more than doubled. Foreign debt was roughly 42% of GDP in 2019, but by 2021 it had risen to 119% of GDP. The Government is expected to pay US$4 billion to debtors by the end of 2022, but government reserves were US$2.3 billion in April 2022.

Various commentators blamed the financial issue on Mahinda Rajapaksa’s previous presidential administration, claiming that he led Sri Lanka into a Chinese “debt trap.” Sri Lanka borrowed much of it for large-scale infrastructure projects that proved unproductive. Some were the Hambantota port- leased to a Chinese business for 99 years when there was a failure of repayment of the loan. While China’s external debt was officially 10% of overall debt by April 2021, some officials claimed that China’s total lending was substantially higher after state-owned businesses and the central bank was factored in.

Sri Lanka’s existing funding sources, according to S&P Global Ratings, do not appear sufficient to satisfy its debt servicing demands, which are anticipated to be just over $4.0 billion in 2021. The Government declared an economic emergency in September 2021, as the situation was exacerbated by a declining national currency exchange rate, growing inflation resulting from high food prices, and pandemic tourist restrictions, which further reduced the country’s income.

Bankrupty Striken

It pushed Sri Lanka to the edge of bankruptcy, with foreign reserves decreasing to US$1.9 billion in March 2022, insufficient to cover US$4 billion in international debt commitments and a US$1 billion payment on an International Sovereign Bond (ISB) due in 2022. According to the National Consumer Price Index, the national inflation rate jumped to 17.5% in February 2022.

Despite mounting criticism from economic analysts and professionals who unanimously encouraged the Government to postpone the ISB payment to maintain foreign reserves, the Government repaid US$500 million in International Sovereign Bonds that were due in January 2022. On April 12, 2022, Sri Lanka stated that it would default on its $51 billion external debt.

Decreasing Foreign Remittances

Sri Lanka Rupee
Credit: Wise

Under Cabraal, the Central Bank of Sri Lanka attempted to keep the LKR fixed. It would continue to print money and impose stringent exchange controls, lowering the rupee’s market value. As a result, by February 2022, the unofficial market value of the LKR had surpassed 248 to the US dollar, despite the Government’s efforts to maintain the currency pegged at 200 LKR to the USD.

As a result, overseas workers continued to send money through unofficial methods, forcing Sri Lankan banks to run out of foreign currency and international remittances to plummet, with formal remittances dropping by 61% in January 2022.

Tourism

Sri Lanka’s tourism industry accounted for more than a tenth of the country’s GDP. However, the 2019 Easter bombings had a detrimental impact on the sector, and the COVID-19 epidemic hampered recovery.

Agribusiness Crisis

Sri Lanka has always been self-sufficient in rice production. The imports confined to Basmati and other speciality rice. However, president Gotabaya Rajapaksa declared in April 2021 that Sri Lanka would allow exclusively organic farming, prohibiting the use of artificial fertilizers and agrochemical-based fertilizers.

The decline in tea output due to the fertilizer restriction alone resulted in $425 million in economic losses and a 20% drop in rice production in the first six months alone, reversing previously obtained rice self-sufficiency and forcing the country to import rice for $450 million. The situation in the tea industry has been described as serious, with organic production costing ten times as much as conventional farming and yielding half as much.

Sri Lanka abandoned its goal to become the world’s first organic farming nation in November 2021, citing rising food prices and weeks of anti-plan protests. As such, restrictions lift up. However, there is still a prohibition on urea imports. Sri Lanka is attempting to implement necessary goods rationing during times of calm.

The Russo-Ukrainian War

The current hostile situation between Ukraine and Russia as a result of the Russo-Ukrainian War is being felt in Sri Lanka’s already sluggish economic conditions. The Russian invasion of Ukraine in 2022 has aggravated the Sri Lanka economic crisis. That is because Russia is Sri Lanka’s second-largest tea export market. Also, Sri Lanka’s tourism sector is strongly dependent on Russia and Ukraine, with the majority of tourist arrivals from there. As a result, the Ukrainian crisis has stopped Sri Lanka’s economic recovery, with both the tea and tourism sectors suffering significant losses.

Impact of Sri Lanka Economic Crisis

Shortage
Credit: NDTV

Sri Lanka has been without foreign money for months, preventing it from purchasing everything it requires from abroad. In addition, food and gasoline shortages have pushed up prices. The current rate of inflation is 30%.

There were power outages, and the health system was on the edge of collapsing due to a scarcity of drugs. People began protesting in the streets of Colombo, Sri Lanka’s capital, in early April. The protests have since expanded across the country.

Fuel and Electricity Shortages

Due to shortages, the Sri Lanka economic crisis has resulted in decreased usage of power, fuel, and cooking gas. To save electricity, Finance Minister Basil Rajapaksa has requested all government entities to turn down all street lights at least till the end of March 2022. As a result of cooking gas shortages, about 1000 bakeries have closed. In recent months, long lines have formed in front of gas stations. A rise in global oil prices exacerbated the fuel shortage.

The Government gave instructions to the military to station soldiers at gas and fuel filling stations on March 22. It stated to reduce tensions among people waiting in lines and to facilitate fuel delivery. Throughout March 2022, daily seven-hour power outages were seen. It increased to ten hours by the end of the month and then to fifteen hours in early April. Due to paper shortages and price increases, the newspapers The Island and Divaina ceased print publishing and shifted to e-papers. Hydroelectricity generation in Sri Lanka has also been impacted.

Inflation

Inflation was 17.5% in February 2022. Food inflation increased by 24.7% year over year, while non-food items increased by 11%. Local red chilis climbed by 60% year over year, local potatoes prices by 74.8%, and Nadu rice by 64%.

Education

Several Sri Lankan schools declared in March 2022 that their term/mid-year tests to postpone indefinitely due to paper shortages across the country. These were mostly caused by a lack of foreign reserves to import paper. The term test examinations were scheduled to take place island-wide on March 28, 2022. However, there was cancellation or postponement of tests due to a severe scarcity of printing paper and ink ribbons.

Health

Due to a scarcity of pharmaceuticals, scheduled procedures stopped at the Peradeniya Teaching Hospital on March 29. In addition, many other institutions halted routine procedures and restricted the number of laboratory tests performed.

The Medical Council of Sri Lanka warned on April 8 that unless supplies are replenished in a few weeks, there will be a catastrophic number of deaths. It would potentially exceed the combined death tolls of:

  • COVID-19,
  • the devastating 2004 tsunami,
  • and the Civil War.

Likewise, the Singapore Red Cross Society issued a warning. It described the medical crisis in Sri Lanka as an “exceptional humanitarian calamity.”

According to the Sri Lanka Medical Association, all hospitals now lack access to imported medical equipment and essential pharmaceuticals. Due to a shortage of new medical equipment, doctors are treating patients with old and used medical equipment.

Exports

Leading textile brands such as Zara, Mango, and H&M have shifted their focus from Sri Lanka to India to place their orders due to the ongoing economic turmoil in the country. As there was a detorioration of the economic and political situation in Sri Lanka, India witnessed a substantial increase in outside requests for tea goods.

How much foreign debt does Sri Lanka need to repay?

International Currency
Credit: CGTN

Sri Lanka’s Government owes $51 billion in foreign debt. It will have to pay $7 billion this year to settle these loans, with similar amounts due in the future. The Government is requesting $3 billion in emergency bridging loans from the International Monetary Fund to pay its bills. As a condition of any loan, the IMF has stated that the Government must boost interest rates and taxes.

Foreign Aid

Sri Lanka has received a $600 million loan from the World Bank. India has pledged $1.9 billion and may lend an additional $1.5 billion to finance imports. It has also shipped 65,000 tonnes of fertilizer and 400,000 tonnes of petrol. There are also more fuel shipments planned later this month.

The G7 group of major industrial countries – Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States – have stated that they will assist Sri Lanka in obtaining debt relief.┬áSri Lanka owes China $6.5 billion, and the two countries are discussing how to restructure the debt.

Diplomatic Scenes

Due to a lack of foreign reserves, the Sri Lankan High Commission in Nigeria and consulates in Germany and Cyprus closed down in January 2022. Due to a lack of dollar reserves, the Sri Lankan embassy in Iraq, the Sri Lankan embassy in Norway, and the Sri Lankan consulate in Australia were all shuttered in March 2022.

India offered a total of US$2.415 billion in January 2022 to help Sri Lanka. It is to overcome acute financial restrictions imposed by external debt payments and a shortage of US dollars for commerce. India issued a $400 million loan and deferred a $500 million Asian Clearing Union settlement. This is under the SAARC currency exchange agreement. In addition, it approved a new $500 million line of credit for the purchase of petroleum products.

Sri Lanka obtained a US$1 billion credit line from India on March 17, 2022. It is a lifeline to purchase critically required essential supplies such as food and medication. The Singapore government declared that it would give a relief package worth US$100,000. It would boost the Singapore Red Cross’s humanitarian public fundraising efforts for Sri Lanka’s most vulnerable communities.

Wayforward

One of the crucial ways Sri Lanka can overcome the Sri Lanka economic crisis is by rolling back the manure policy. The manure policy implemented by President Rajapaksa. Instead, it can invest in feasible methods like making artificial fertilizer less prone to environmental damage. The International Monetary Fund pledged its help to Sri Lanka’s debt-ridden Government. It would try to alleviate the present economic crisis by initiating early talks with a delegation. Sri Lanka termed it ‘fruitful.’

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