Explained: Why Sri Lanka Is Battling Worst Economic Crisis Since Its Independence In 1948

The looming economic crisis in Sri Lanka has worsened the routine functioning of the country. Several reports are indicating spiked inflation, long queues of people outside petrol pumps, long hours of power cuts.

AFP/ File

A slump in GDP, a credit crunch, losses to tourism and a decline in foreign reserves have created a financial crunch. Sri Lanka is drowning in its worst economic crisis since independence. What are the factors that led the country¡¯s economy on the verge of collapsing? Is there any solution? If the IMF can rescue the country¡¯s crumbling economy?

What is the problem of Foreign Reserves or BOP?

Simply put, a balance of payments (BOP) arises when a country imports more than its exports. Also, a crisis deepens if the outflow of money is more than the inflow of money rests for a longer time.

The Sri Lankan economy is crumbling due to an acute shortage of foreign currency or a balance of payments (BOP) crisis and the fast depreciation of the Sri Lankan rupee against the dollar. As the country is heavily dependent on imports including petrol, diesel, food, sugar, lentils, paper, medicines etc. but reduced forex reserves have negatively impacted the imports.

File Photo

According to data provided by the Central Bank of Sri Lanka, the country¡¯s forex reserves dropped by 24.8 per cent to $2.36 billion in January 2022 and recently Prime Minister Mahinda Rajapaksa admitted that the country is expected to have a trade deficit of $10 billion.

Lockdown Hits Tourism Industry

The Covid-19 pandemic hit the economy of the island nation severely. The tourism industry has been bringing much of Sri Lanka's forex but Covid-19 induced restrictions brought a drop in tourism which contributed 10 % to its GDP. However, the 2019 serial bomb blasts in Colombo already impacted the tourism sector of the country.

The fall in Sri Lanka's FDI also contributed to declining of foreign reserves. It decreased from $548 million in 2020 to 1.6 billion in 2018. In fact, the major export destinations of the country (China, EU nations) had issues with trade during the pandemic which also fueled the crisis.

Failed Policy of Organic Farming

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In its aspiration to become the world¡¯s first 100-percent organic farming nation, the Sri Lankan government banned the import of agricultural chemicals and fertilisers last year. The island nation tried to reduce its dwindling foreign currency reserves but it emerged as a big blunder.

The ban on fertilisers resulted in crop failure and massive protests by farmers against the government. According to a report published in Aljazeera, over one-third of Sri Lanka¡¯s agricultural land was left fallow after the import ban last year. The country¡¯s economy was already in a spiral of debt and the scheme added to the crisis as Food inflation in Sri Lanka hit a record 21.5 percent in January 2022.

Correcting its failed policy, the government had to announce compensation for more than a million rice farmers who faced crop failure and 40,000 million rupees ($200m) to farmers whose harvests were destroyed due to the ban. The government also announced to spend another $149m on a price subsidy for rice farmers.

Despite the rolling back of its policy, the government failed to replenish the situation.

Sky-rocketing Inflation

AFP

As per the data released by the Sri Lanka government, the country recorded 15.1% inflation in February 2022 and now has reached 25.7%. The price of the cylinder rose to Rs 1359 each and the soaring prices of food items, medicines are also affecting the citizens.

The budget deficit was also expected at 10.7% of GDP in 2022 after an 8.9% of GDP deficit in 2021.

Impact of the economic crisis

The severity of the crisis is such that the country had to cancel school exams due to the shortage of paper. The department of education of the Western Province stated that "School principals cannot hold the tests as printers are unable to secure foreign exchange to import necessary paper and ink."

The government also announced Nationwide 7.5-hour daily power cuts. It was considered to be the longest power cut announced in Sri Lanka in 26 years.

According to a report published in Indian Express, a shipment of 40,000 tonnes of fuel had to wait at the Colombo port for four days because the government struggled to find funds. And, then the Bank of Ceylon released $35.5 billion for the payment.

Will IMF be able to rescue the collapsing economy?

Sri Lanka was already facing several economic challenges and Covid-19 fueled the situation to its worst. According to the International Monetary Fund (IMF), ¡°on the eve of the pandemic, the country was highly vulnerable to external shocks owing to inadequate external buffers and high risks to public debt sustainability, exacerbated by the Easter Sunday terrorist attacks in 2019 and major policy changes including large tax cuts at late 2019.¡±

Reuters

Earlier, Sri Lanka was abstaining from taking loans from the International Monetary Fund but had finally reached out to the institution. The reports indicated that the rescue plan is to be discussed next month between both parties.

Gerry Rice, IMF spokesman stated, "The (Sri Lankan) authorities have also indicated that they are actively considering an IMF-supported program.¡±

The IMF analyzed Sri Lanka's economy in a staff report and concluded that ¡°the debt is unsustainable is now known.¡± The country's money is depreciating against the international currencies. The IMF program mostly involves a tight reserve money program to stop inflation and block the validation of domestic prices as the currency weakens.

¡°Debt restructuring will also reduce the corrective interest rate and the need to immediately deploy more savings for debt repayment and leave space for a reasonable growth path.¡± the report added.

How India is Helping Sri Lanka?

AP

India has come out to help its neighbour, Sri Lanka, by providing a line of credit of 1 billion dollars to help in maintaining their food prices and fuel costs. India had also signed off on a $400-million credit swap facility with Sri Lanka.

The Ministry of Finance said, ¡°Agreement was signed between SBI and Government of Sri Lanka for a $1 billion credit facility for procurement of food, medicine and other essential items to Sri Lanka.¡±

Earlier this month, India had sent 40,000 tonnes of fuel to the country to cope with its crisis.

India is helping Sri Lanka to counter the rising influence of China over the country.

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