What Is Happening in Sri Lanka and Why?

Sri Lanka is a small island nation off the southern coast of India. Sri Lanka is a multinational state, home to diverse cultures, languages, and ethnicities. It is an island nation that is home to lush forests, sandy beaches and is one of the most famous tourist attractions in the world. But a series of bad investments and decisions made by the government coupled by the COVID-19 pandemic have pushed the nation into a crippling economic crisis that does not seem to be ending any time soon.

The country has defaulted its foreign debts for the first time in its history as an independent nation. Its 22 million citizens are facing an extreme scarcity of food, fuel and other essentials with 12 hour power cuts every day. Inflation is at an all-time high of 17.5%, with prices of food items such as a kilogram of rice soaring to 500 Sri Lankan rupees when it would normally cost around 80 rupees. Amid shortages, one 400g packet of milk powder is reported to cost over 250 rupees, when it usually costs around 60 rupees. On April 1, President Gotabaya Rajapaksa declared a state of emergency. In less than a week, he withdrew it following massive protests by angry citizens over the government's handling of the crisis. The country relies on the import of many essential items including petrol, food items and medicines. Electricity generation has been impacted with only four hours of power a day. Printing industry has also taken a hit, driving publications to cut down on production, to even outright closure, and postponement of school examinations.

In order to obtain these items, countries keep foreign currencies in hand for trade. But due to extreme price hikes, Sri Lanka is facing a shortage of foreign exchange and it has brought their whole economy to a standstill, with ripple effects that have far reaching consequences.

Critics say the roots of the crisis, the worst in several decades, lie in economic mismanagement by successive governments that created and sustained a twin deficit – a budget shortfall alongside a current account deficit But the current crisis was accelerated by deep tax cuts promised by Rajapaksa during a 2019 election campaign that were enacted months before the COVID-19 pandemic, which wiped out parts of Sri Lanka’s economy. With the country’s lucrative tourism industry and foreign workers’ remittances sapped by the pandemic, credit ratings agencies moved to downgrade Sri Lanka and effectively locked it out of international capital markets.

In turn, Sri Lanka’s debt management programme, which depended on accessing those markets, derailed and foreign exchange reserves plummeted by almost 70 per cent in two years. Sri Lanka’s foreign currency reserves nosedived 70 per cent since January 2020 to around $2.3 billion by February, which is a fall of $779 million from December 2021. The COVID-19 pandemic that affected the tourism sector, ill-timed tax cuts, weak government finances and skyrocketing inflation, impacting foreign remittances are some of the main factors behind Sri Lanka's present economic crisis.

It faces debt payments of $4 billion in the rest of this year, one of which is of $1 billion in the form of a sovereign bond that matures in July. Moreover, the Chinese loans of over $5 billion it banked on, were mostly for low-return projects such as construction of ports, airports and coal power plants. Its reserves are enough to only pay for about a month’s worth of imports, indicating a fall in essential commodities such as fuel, food and medicines.

Sri Lanka’s debt burden has become unmanageable for the country if a proper bailout package is not given to the country from an international financial agency or group. Sri Lanka is obligated to repay debt of about $7 billion in 2022. One of the debts is of $1 billion in the form of an international sovereign bond that matures in July. India has reportedly assured Sri Lanka that it would extend the credit line to meet the imports of essential items such as rice, wheat, wheat flour, pulses, sugar and medicines. Besides the two $1 billion credit lines, India earlier this year extended a $400 million currency swap, and another $500 million credit line for buying fuels. This is in addition to the Chinese currency swap facility amounting to $1.5 billion in 2021.

What will happen now? Sri Lanka will now obtain a 17th IMF loan to tide over the present crisis, which will come with fresh conditions. A deflationary fiscal policy will be followed, which will further limit the prospects of economic revival. The country has also taken short term loans from Japan and Bangladesh. Things seem even bleaker, as the people of the nation have taken to the streets to protest against the current government and have called for the resignation of President Gotabaya Rajapaksa.

The only thing that can help the nation right now is the correct management of the funds coming into the country as loans and bailouts.

References:

Sinha, S. (2022, March 29). What is happening in Sri Lanka? Why does it not have money? India Today. https://www.indiatoday.in/world/story/sri-lanka-financial-economic-crisis-1930721-2022-03-29

What is happening in Sri Lanka and how did the economic crisis start? (2022, April 15). ET EnergyWorld. https://energy.economictimes.indiatimes.com/news/oil-and-gas/what-is-happening-in-sri-lanka-and-how-did-the-economic-crisis-start/90859188