The Economic Crisis in Sri Lanka

Introduction

The nation of 2.2 crore people is now grappling with unprecedented economic turmoil since its independence from Britain in 1948. Sri Lanka’s foreign currency reserves have virtually run dry, and it can no longer afford to pay for imports of staple foods and fuel. Government is already knee-deep in foreign debt of $51 billion.

Currently, the Island nation has now run out of money, and prices for everything have skyrocketed. The inflation rate spiraled to 40% in April 2022. Following credit rating downgrades in 2020, Lanka lost access to foreign commercial borrowing. It is collapsing under the weight of its debt burden owing to a serious Balance of Payment problem along with rupee depreciation.

Political contest

Sri Lanka is a presidential representative democratic republic where the president is both the head of state and head of the government. The politics of the island reflect the historical and political differences between the ethnic groups- the Sinhala majority (predominantly Buddhists) and the Tamil and Muslim minorities. The rising ethnic tension led to the formation of LTTE (Liberation Tigers of Tamil Eelam) in 1976 which stood for the Tamils in the north and eastern parts of the island. The continuous political conflicts led to the Civil war which lasted until 2009 when all the Tamil tiger guerrillas had been killed and at least 1 lakhs deaths were reported. Since then, the Rajapaksa brothers have dominated politics here for the last 20 years.  The warning signs were there from the moment the powerful Rajapaksa clan regained control of the country following a sweeping election victory in November 2019. They rushed to restore the populist authoritarianism combined nationalism to Sinhalese but that strategy backfired. They played soft dictatorship and dozens of relatives held top posts in the government.

Current events

Not long ago, angry protesters of Sri Lanka set fire to the homes of party officials and stormed PM’s residence raising slogans and demonstrations to remove President and PM. They accused Rajapaksa of triggering the crisis through corruption and misrule. There are daily power cuts, long queues for cooking gas, and fuel for vehicles and finally, people are bearing the brunt of the worst economic crisis ever had.Political instability grew with the resignation of 26 cabinet ministers in April. After the long protests, PM resigned, and a new PM, Ranil Wickramasinghe from the opposition party took the charge. Following this, nine ministers had taken the oath at the president’s office. The state of emergency has been lifted nearly two weeks after it was imposed after anti-government protests.  Also, the cabinet is planning to go for its 21st constitutional amendment that annuls the 20A which gave unlimited powers to the President

Reasons for the free fall of the economy

  • Massive external debt since 2010

For a long time, the government has been spending more than it takes in, paving the way to unmanageable debts which accounted for $7 billion due this year. At the end of its civil war in 2009, Sri Lanka chose to focus more on providing goods to the domestic market instead of trying to break into foreign ones. So income from exports remained low, while the bill for imports kept growing. The post-conflict reconstruction effort was also marked by heavy investments in infrastructure, but less in tradeable goods. This development required loans that indebted an economy fragile from years of war. In April, the government itself admitted that it cannot make the debt payments anymore. It owes most of the debt money to China, Japan, and other international agencies. Public debt now stands at 119% of its GDP.

  • Rapidly depleting forex reserve

Sri Lankan exports comprising rubber, tea, textiles, and spice trade form around 23% of its GDP is badly hit by the pandemic. The nation is running short of forex due to heavy imports for essential goods like sugar, pharmaceuticals, and pulses and low remittances which fell 48% in March 2022. With just 2- billion reserves, it is unable to import even essential commodities.

  • The decline in the tourism sector

Tourism which accounted for 10% of the island’s GDP, took a massive hit after the pandemic-induced lockdowns coupled with the Easter bombings. It led to a fall in revenue from $7.5 billion in 2019 to $2.5 billion last year.

  • Economic mismanagement

High level of corruption and nepotism by the successive governments- Mahinda Rajapaksa (2005-15),Maitripala Sirisena (2015-19), and the current president Gotabaya Rajapaksa and their populist measures like huge infrastructure projects (Hambantota port), deep tax cuts in 2019 have turned the situation disastrous. Tax cuts reduced the value-added tax from 15% to 8% and as a result, the tax revenue dropped to 8.5% of GDP. Expenditures were 2.4 times more than the revenue earned in 2021, according to Finance Ministry. To make the matter worse, a complete ban on chemical fertilizers to promote 100% organic farming had severely affected the agricultural production resulting in a food emergency in September 2021.An IMF report in March this year stated the fertilizer ban had also hurt tea and rubber exports, leading to “potentially substantial” losses.

  • Russia-Ukraine war

Lanka exports tea to these warring nations and imports almost half of its wheat and sunflower oil from them. The surge in the price of crude petroleum (a 14-year high) had increased the import bills. Moreover, the war had dented the arrival of tourists from there. To add fuel to the fire, Global Inflation supercharged by the Ukraine war accelerated the pre-existing economic and currency slump, devastating already limited forex reserves – leaving Sri Lanka, struggling to import essential goods and make timely repayments.

Lessons from the crisis

It depicts how flawed economic policy and political turmoil can affect an economy’s prospects and security.

In Sri Lanka, 500,000 people have sunk back into poverty over the last two years. Three years back, the World Bank categorized Sri Lanka as an upper-middle-income country with a per capita income of $3,850. But now it has since fallen back to lower-middle-income status. Also, Lonely Planet named Sri Lanka the best destination to visit in 2019. But at present, the situation went upside down.

Ceylon once was lauded for its welfare program that is subsidized rice. But remember that welfare is financed by borrowing rather than taxes and the onus is on future generations who have to pay for it.

Globalization and liberalization are not a panacea. According to the theory of comparative advantage, a country needs to specialize in its production and rely only on foreign trade for goods that it does not produce. Sri Lanka’s over-reliance on China as a development partner proved wrong as it made up 10% of its overall debt.

Latest developments

India was the first country to lend its assistance to currency starved Sri Lanka providing a credit line of $500 million for diesel shipment and a $1 billion credit line for essentials. To bolster the reserves, a $400 million currency swaps agreement is also done. Recently, another humanitarian relief of $2 billion in the form of milk powder, rice, and medicines is also provided. The country has also approached IMF for debt restructuring (changing loan terms easier)and a possible bailout(financial assistance if agreed to terms and conditions). The World bank also gave $160 million for urgent fuel purchases. Meanwhile, Sri Lanka has also sought the assistance of friendly countries for its economic uplift. Sri Lanka owes $6.5bn to China and the two are in talks on how to restructure the debt. The G7 group of leading industrial countries – Canada, France, Germany, Italy, Japan, the UK, and the US – have said they will provide help to Sri Lanka in securing debt relief.

Ways ahead

It seems Sri Lanka will receive more loans to help it tide this economic storm. Whatever it does, Sri Lanka needs to prop up its economy so that it can produce at least as much as it imports. Many economists believe this isn’t going to be easy but there is no other alternative. This is a perfect example of how important economic output is.

Conclusion

This political instability can make spillover effects on India as well in the form of the rise of rebel groups, and the refugee crisis. Also, the crisis should be used as an opportunity for India to solve the longstanding trust deficit in bilateral ties, the threat of Chinese influence, fishermen disputes, etc.

India and Sri Lanka’s relationship is about 2500 years old. There are deep cultural and racial links between the two countries. Being the harbinger of the Neighborhood first policy, India must take every steps carefully to protect Sri Lanka from its downturn and preserve its strategic interests in the Indo-pacific region.

 

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