Lessons from the economic crisis in Sri Lanka

Dr Subhash Chandra Pandey (11 July 2022)

Sri Lanka is facing its worst economic crisis since independence in 1948. It plunged into deep political crisis as protesters stormed Presidential palace after setting ablaze PM’s private home. Months of raging public anger against rising prices and shortages of food, fuel, medicines and other essentials culminated in these scary scenes of anarchy.

After Sri Lanka emerged from a 26-year long civil war in 2009, it showed healthy GDP growth of 8-9% pa till 2012 but then growth rate almost halved after 2013 as global commodity prices fell and trade deficits rose.

The island country of 2.2 crore people is heavily dependent on foreign exchange earnings by way of tourism, remittances from overseas workers and tea /rubber/apparel exports.

Country’s tourism-dependent economy was badly hit after Easter bomb blasts of April 2019 in churches in Colombo and later the Covid led to serious drop in tourist arrivals.

The problem was further compounded by build-up of huge government debt, rising oil prices and a ban on import of chemical fertilisers (due to shortage of foreign exchange to finance imports) last year that devastated agriculture.

President Gotabaya Rajapaksa had promised lower tax rates and subsidies for farmers during 2019 election campaign and quick implementation of these ill-advised promises exacerbated fiscal deficit. Big tax cuts introduced in 2019 led to government losing more than $1.4bn a year.

In 2021, all fertiliser imports were completely banned and it was declared that Sri Lanka would become a 100% organic farming nation overnight. This overnight shift to organic fertilisers heavily impacted food production. In part, the ban was imposed to save dollars needed for fertiliser imports ! and dollars were needed for servicing foreign debt, notably to China!

When Sri Lanka’s foreign currency shortages became a serious problem in early 2021, the government tried to limit them by banning imports of chemical fertiliser. The fertiliser ban (reversed in November 2021) also seriously hurt tea and rubber exports.
The government has incurred huge foreign debts to fund what critics call unviable infrastructure projects.

Sri Lanka’s total external debt is estimated to be about $51bn and annually needs over $6bn for debt servicing. In contrast, Sri Lanka had $7.6bn in foreign currency reserves by end of 2019. By March 2020, reserves fell to $1.93bn. Recently the government said it had just $50m left.

Sri Lanka earned about $4bn from tourism in 2019 which dropped by 90% due to the pandemic! Its foreign exchange reserves dropped to just about $1.6bn by the end of November, only enough to pay for just a few weeks of imports. The government was forced to restrict import of essential commodities including food in a desperate bid to save dollars.

High global oil / food prices and cost of shipping especially after Russia Ukraine conflict tripped Sri Lanka totally off balance.

Debt to GDP ratio rose from 94% in 2019 to 119% in 2021. Over 10% fiscal deficit in 2020-21 in covid-hit, import dependent and heavily indebted economy resulted in over 15% inflation and serious shortages of food and fuel. A few days’ petrol/diesel left, not enough to even run essential services.

Amidst depreciating currency and rapidly depleting forex reserves an economic emergency as declared to contain rising food prices.
After taking a $2.6 billion loan from the IMF in 2009, it again approached the IMF in 2016 for another US$1.5 billion loan.

Some ill-informed, rather irresponsible and politically motivated commentators have been (rather gleefully!) quick to suggest that India may also witness such scenes soon. Such fear mongering is absolutely baseless.

India had indeed landed in a somewhat precarious economic crisis in 1991 when at one point we had less than 1 billion US dollars in our reserves; just enough to pay for 15 days of imports!

We were on verge of default on international loans but we rose to the occasion. We were quick to rise on our feet. We pledged gold to raise emergency loan followed by IMF loans and have since travelled a lot of distance on the path to progress.

India’s foreign exchange reserves stood at $588 billion on July 1. No doubt all emerging economies are under pressure. Our forex reserve dipped by $5 billion in the week ending July 1 prompting RBI to launch fresh remedial measures. However, our granaries are overflowing and we are slowly switching energy mix and decarbonising economy to slowly reduce dependence on imported crude oil and foreign debt is less than 5% of total public debt.

India is trying to help Sri Lanka by extending credit lines, selling food and fuel on credit and also outright aid. India has signalled its willingness to go beyond the $4bn in loans, currency swaps and aid already provided to Sri Lanka when about $5bn are needed in the next six months to cover basic necessities for people struggling with long queues worsening shortages and power cuts.

So any suggestion that India is in the same boat as Sri Lanka is patently mischievous political propaganda. India is indeed part of the rescue team.


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