How did the Sri Lankan economic crisis take the shape of catastrophe?

 By Danish Yousuf
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Introduction

The Sri Lankan government declared an economic emergency last month after protests rocked the country over the deepening economic crisis.[1] The country has officially announced a default on all its external debt[2]. The island nation’s foreign reserves were at $1.93 billion at the end of March, with $4 billion in foreign debt payments due this year, including a $1 billion international sovereign bond due in July.[3] The impact of the meltdown is now being felt on the Indian shore. Reports suggest that at least 16 Sri Lankan nationals, all Tamils from the northwestern provinces of Jaffna and Mannar have arrived in Tamil Nadu[4]. Sri Lankan Tamils have been migrating to Tamil Nadu for decades, fleeing the island’s violence and war. However, this time they are migrating for a different reason, they are driven by hunger, not war. The Island, Lanka’s most prominent newspaper has stopped its print edition due to the non-availability of paper.[5]

Protests by opposition parties and citizen groups have taken place around the country, accusing the government of being responsible for the country’s economic crisis. President Gotabaya Rajapaksa earlier had requested a bailout from the International Monetary Fund (IMF)[6]. However, the IMF says that Sri Lanka’s 51 billion foreign debt is unsustainable[7]. After signing a $1 billion credit line, Sri Lanka has sought an additional  $1 billion credit line from India[8].

How did Sri Lanka land in this crisis situation?

 It was in August last year that Sri Lanka declared an economic emergency in the country because of rising food prices, together with shortages of essential products such as milk powder, sugar, and kerosene.[9] Since the outbreak of the pandemic, the World Bank estimates that half a million Sri Lankans have slipped into poverty.

Severe Tax Cuts

Many factors have been identified as being responsible for the current crisis. Experts at Verite Research, a Colombo-based think tank, on the other hand, believe that the situation can be traced back to a single event which is the tax cuts that happened in the aftermath of the 2019 presidential election.[10] Taxes were slashed in order to fulfill the promise of the presidential campaign manifesto, resulting in a 25% reduction in government revenue and a 35% reduction in the country’s tax base[11]. After these tax cuts were implemented a few months later, Sri Lanka’s credit rating was downgraded, thus denying it access to international financial markets. It was a blacklisting downgrade, as experts call it. As Sri Lanka continued to service its debt after losing access to international markets, its reserves decreased, and as the reserves decreased, the ratings decreased, and it was a downward spiral that Sri Lanka could not reverse. The current state of affairs is the culmination of that process, which has resulted in virtually zero reserves. If the credit downgrade had not occurred, Sri Lanka would have maintained its regular equilibrium of borrowing to repay its debt, and if the tax cuts had not occurred, which caused the revenue to fall so much that interest cost on revenue rose up to 70% [12] which is perhaps the highest in the world.

Tourism

The tourism industry is the country’s third highest foreign currency earner.[13] In April 2019, it was battered by Easter Sunday attacks and then by the coronavirus. Surprisingly, Sri Lanka had recovered and boosted its foreign reserves to 7.5 billion dollars by the end of 2019.[14] However, the Covid epidemic struck the country in early February 2020, placing tremendous strain on all businesses and affecting the government’s foreign exchange reserves.Two countries that are vital to its tourism market,  Russia and Ukraine are at war. This year, Russia and Ukraine were the first and third largest sources of visits.[15]  The tourism industry, which generated around 12% of the country’s GDP, at least 200,000 people have lost their employment[16].

Rapidly Rising Inflation

Food prices have been rising for several months, and inflation has just hit a new high of 25%.[17] It’s mostly due to the depletion of foreign exchange reserves and a poor harvest. The  Sri Lankan government abruptly banned the import of foreign fertilisers and pesticides last year in an attempt to become the first 100 percent organic nation[18]. Despite the fact that the decision was ultimately reversed, the prohibition had a disastrous effect on agricultural production, which relies significantly on agrochemicals, resulting in a spike in food costs.

Diminishing Foreign Exchange Reserves

Most of the country’s foreign exchange earnings come from the Middle East, from the apparel industry. In February 2020, the country’s total textile sector exports were 679.8 million dollars[19]. However, since March 2020, the export percentage has been declining. Sri Lanka’s garment exports dropped 27.6% in 2019 compared to the previous year. The pandemic triggered a rare confluence of supply and demand-side disruptions, resulting in this shift. Despite a little improvement in the second part of the year, the industry is still dealing with daily pandemic-related interruptions. These ramifications are particularly concerning for the industry’s over 350,000 employees[20].

Foreign Debt

Sri Lanka has one of the highest external debt ratios in the world, thanks to heavy government expenditure, slow growth, and massive foreign debt of 35 billion dollars. S&P, Moody’s, and Fitch Ratings have all lowered Sri Lanka’s rating three notches since December 2018[21]. Sri Lanka’s bonds are assessed as having a very high risk of default based on these ratings. Sri Lanka has never been in a more vulnerable position in terms of debt repayment in the previous 70 years than it is now. The extensive research published by Verite Research revealed that the major driver of Sri Lanka’s debt growth over time has been the inability to pay interest on prior loans.

Political Crisis

To some extent, the Rajapaksa family has to shoulder some of the blame for this crisis. They control the principal government positions, distributed among members of a single political family. In 2019, Gotabaya Rajapaksa was elected President, and very soon he appointed his brother, Mahinda Rajapaksa, as Prime Minister. Later two of the brothers of the President were appointed to the cabinet and several others in government (in the cabinet as well as other positions in government). It is quite visible that the concentration of powers is centred in one family. This concentration of power has been through constitutional means as well. The  20th Constitutional Amendment in 2020 paved the way for greater powers in the presidency. Sri Lanka today has the most powerful executive presidency in history.

Conclusion

Although the IMF has assured assistance, it alone would not be able to fix the country’s difficulties, however,  the IMF would lay the foundation for Sri Lanka to seek aid from other countries. In the middle of this economic crisis for Sri Lanka, India is affected by both instability in the country and the future of projects it has recently signed with Sri Lanka. India has extended a series of credit lines for food and fuel which are proving very helpful. A consensus is required among different political groups in the country on the basic principles required to deal with the crisis. Sri Lanka needs to diversify its economy; tourism and textiles alone won’t sustain the country for long. The Country’s economy has to be restructured as per contemporary needs.

[1]Sri Lanka declares a state of emergency after violent protests erupt over the economic crisis. The Economic Times. Accessed on 02 April 2020. https://economictimes.indiatimes.com/news/international/world-news/sri-lanka-declares-state-of-emergency-after-violent-protests-erupt-over-economic-crisis/videoshow/90604077.cms

[2]Sri Lanka Announces Defaulting On All Its External Debt. NDTV. Accessed on 12 April 2022. https://www.ndtv.com/world-news/sri-lanka-announces-defaulting-on-all-its-external-debt-news-agency-afp-2880723

[3] Srinivasan. M.,Sri Lanka suspends foreign debt payments temporarily. The Hindu. Accessed on 12 April 2022. https://www.thehindu.com/news/international/sri-lanka-external-debt-imf/article65313684.ece

[4] Janardhan. A., Explained: The new refugees from Sri Lanka, driven by hunger, not war. Indian Express. Accessed on 23 March 2022. https://indianexpress.com/article/explained/tamil-nadu-sri-lankan-refugees-economic-crisis-explained-7834849/

[5] Sri Lanka daily halts weekend edition amid economic crisis. The Hindu. Accessed on 26 March 2022. https://www.thehindu.com/news/international/sri-lanka-daily-the-island-halts-weekend-edition-amid-economic-crisis/article65258936.ece

[6] Cash-strapped Sri Lanka seeks IMF bailout. The Hindu. Accessed on 21 March 2022. https://www.france24.com/en/live-news/20220316-cash-strapped-sri-lanka-seeks-imf-bailout

[7] Sri Lanka hikes rates as economy risks collapse. The Economic Times. Accessed on 12 March 2022. 

https://economictimes.indiatimes.com/news/international/business/sri-lanka-hikes-rates-as-economy-risks-collapse/articleshow/89988400.cms

[8]Sri Lanka secures $1bn credit line from India as IMF signals help. Aljazeera. Accessed on 22 March 2022. https://www.aljazeera.com/news/2022/3/18/sri-lanka-secures-1bn-credit-line-from-india-as-imf-signals-help

[9]Sri Lanka declares economic emergency to contain food prices as the forex crisis worsens. The Hindu. Accessed on 07 March 2022. https://www.thehindu.com/news/international/sri-lanka-declares-economic-emergency-to-contain-food-prices-as-forex-crisis-worsens/article36226141.ece

[10]Analysis: Shocks and missteps: how Sri Lanka’s economy ended in crisis. Reuters. Accessed on 03 March 2022. https://www.reuters.com/world/asia-pacific/shocks-missteps-how-sri-lankas-economy-ended-crisis-2022-02-25/

[11] Sri Lanka on the brink of bankruptcy after worst economic crisis in history. The Week. Accessed on 07 April 2022. https://www.theweek.in/theweek/cover/2022/03/24/sri-lanka-on-the-brink-of-bankruptcy-after-worst-economic-crisis-in-history.html

[12]Haider. S.How can India help Sri Lanka? The Hindu. Accessed on 12 April 2022. https://www.thehindu.com/news/international/worldview-with-suhasini-haidar-how-can-india-help-sri-lanka/article65303369.ece

[13]Sri Lanka sees a tourism boom with highest holidaymakers from India. The Business Standard. Accessed on 06 April 2022. https://www.business-standard.com/article/current-affairs/sri-lanka-sees-a-tourism-boom-with-highest-holidaymakers-from-india-122010400470_1.html

[14]Why Sri Lanka’s economy is Drowning. The Times of India. Accessed on 23 February 2022. https://timesofindia.indiatimes.com/world/south-asia/why-sri-lankas-economy-is-drowning/articleshow/86035789.cms

[15] Ranil on what needs to be done. The Island. Accessed on 22 March 2022. https://island.lk/ranil-on-what-needs-to-be-done/

[16] Yokoyama. K., How can Sri Lanka recover from COVID-19? Asian Development Bank. Accessed on 02 April 2022 https://www.adb.org/news/op-ed/how-can-sri-lanka-recover-covid-19-promoting-integrated-rural-development-kenichi

[17] Refugees, inflation and power cuts: How Sri Lanka walked itself into a mess. India Today. Accessed on 03 April 2022. https://www.indiatoday.in/world/story/sri-lanka-economic-crisis-economy-news-1931473-2022-03-30

[18]Srinivasan. M., Sri Lanka eyeing green agriculture. The Hindu. Accessed on 01 December 2021 https://www.thehindu.com/news/international/sri-lanka-eyeing-green-agriculture/article37030627.ece

[19]Yousuf. D., Sri Lanka’s Economic Crisis and Its Impact on India. CLAWS. Accessed on 04 April 2022.  https://www.claws.in/publication/sri-lankas-economic-crisis-and-its-impact-on-india/

[20] Ibid.

[21]Charting a Path for Debt Sustainability in Sri Lanka. Verite Research. Accessed on 13 March 2022. https://www.veriteresearch.org/wp-content/uploads/2021/10/VR_RR_ENG_Oct2021_Charting-A-Path-for-Debt-Sustainability-in-Sri-Lanka-2.pdf