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Street protests are erupting across Sri Lanka as the island nation stares at an economic meltdown. President Gotabaya Rajapaksa has been left to deal with the crisis by himself as more than 40 MPs have left the coalition government, including the country’s finance minister.
Stuck in an economic as well as political crisis, Sri Lanka is facing bankruptcy owing to the faulty decisions taken by consecutive governments. Inflation in Sri Lanka hit 15.1% in February 2022, and there is little hope that the country will be able to get out of the ditch without external help.
What is the Sri Lanka economic crisis?
A 2019 Asian Development Bank paper says that Sri Lanka is a classic twin deficits economy. “Twin deficits signal that a country’s national expenditure exceeds its national income, and that its production of tradable goods and services is inadequate.”
Sri Lanka is looking at a severe shortage of foreign currency, food and fuel, even as debilitating power cuts and soaring inflation. The problem runs much deeper though as the country faces foreign debt repayments but has no means to fill its coffers.
In 2019, the Rajapaksa government cut taxes in the country to keep up with election promises. S&P Global Ratings and Fitch Ratings were quick to downgrade the country saying the tax cuts undermined the country’s fiscal and debt sustainability.
Soon after, the pandemic hit the country and brought normal life to a standstill, wrecking Sri Lanka’s lucrative travel and tourism industry which contributes more than 10% to the GDP. The country’s economy contracted by a record 3.6% in 2020.
In a surprise move, the country banned the use of fertilizers in agriculture in 2021, taking a toll on tea and rice production. Tea is Sri Lanka’s biggest export item and brings in $1.25 billion each year, making up 10% of the country’s export income. The drop in tea production could cost Sri Lanka $425 mn in revenue. Rice, a staple food of Sri Lankans, saw domestic production fall by 20%, raising concerns about food security. The problem is not limited to low production, as several labourers are at risk of unemployment due to the collapse of tea farms.
The pandemic brought foreign remittances and tourism to a standstill and hit the foreign reserves of the country. This, along with the lack of ample produce to earn foreign exchange has led to Sri Lanka economic crisis.
As of February 2012, Sri Lanka is left with only $2.31 billion in its foreign exchange reserves.
The challenge of foreign debt
Oil prices are sky high due to the Ukraine crisis, and Sri Lanka barely has any money left to buy commodities from foreign countries. With no income stream in sight, the country is also facing debt repayments of around $7 billion in 2022, reports Al-Jazeera.
World Bank estimates peg Sri Lanka international sovereign bond repayments of about $15 bn, with a total long-term debt of $45 bn. The next big hurdle is the repayment of $1 bn in July, and the country is at the risk of defaulting on the payment.
Initially, the Rajapaksa government was reluctant to ask the IMF for help, but the $81 bn economy finally gave in earlier this month as global oil prices hover at record highs. Sri Lanka has now initiated deliberations with the IMF and may announce a possible loan program soon.
In the run-up to asking for IMF’s help, the island nation devalued its currency, the Sri Lankan rupee, by up to 15% to boost currency reserves and help negotiate debt restructuring. The Lankan rupee ended Tuesday’s trading at 297.375 against the US dollar.
The devaluation is also expected to increase remittances, a major source of foreign currency. Remittances to Sri Lanka dropped to a mere $204.9 mn in February, down 64.5% compared to the previous year, per Ceylon Today.
Sri Lanka has also sought help from China and India. India has extended a credit line of $1 bn to the country, and talks are ongoing for another $1 bn. Chinese debt is also piling on the country, as it seeks a $1.5 billion credit facility and a separate loan of up to $1 billion.
China’s interests in Sri Lanka
China accounts for more than 10% of Sri Lanka’s total foreign debt obligation. Amid the crisis, China has taken a large stake in the $14 bn Port City of Colombo (PCC).
Hong Kong businesses such as banks, financial service providers, logistics firms as well as trading houses have been looking to set up bases in PCC to bypass Beijing’s tightening grip on Hong Kong. However, they would be eventually moving into the special economic zone that China has funded to the tune of $1.4 bn as part of the Belt and Road Initiative (BRI), says Nikkei.
