ECONOMIC CRISIS | COVID-19 | TOURISM | REMITTANCE | DEBT | ECONOMIC POLICY | SOVEREIGN RATING

Sri Lanka is facing its worst-ever economic crisis

Both mismanagement and external turmoil led to the current crisis

- By Karan Poudel |

Galle, Sri Lanka | Photo by Siarhei Palishchuk on Unsplash
Galle, Sri Lanka | Photo by Siarhei Palishchuk on Unsplash

IF YOU WANT TO KNOW what policy missteps can do to a country, look no further than Sri Lanka. The ongoing deepening economic crisis was years in the making. Tourism, a big source of foreign currency, was hit hard after terrorist attacks in 2019. It plummeted by nearly 20% from the previous year. That same year when Gotabaya Rajapaksa became president of Sri Lanka, he quickly got to work to heal the ailing debt-straddled economy. He slashed taxes hoping to promote local firms and started printing money and cut down interest rates.

But the measures he took only added miseries. Inflation skyrocketed, tax revenues shrunk and the budget deficit bulged. Then came covid-19 which hit tourism even harder than terrorist attacks and remittances–another prime source of dollars (it slumped to a 10-year low at $5.49 billion in 2021). This meant foreign-currency receipts collapsed, making it harder to buy essential imports. Foreign reserves dwindled from $7.6 billion at the end of 2019 to $1.93 billion by March 2020. 

To save dollars, the president took some heavy-handed actions. He banned the import of motor vehicles in 2020. And last year when fertilizer imports were briefly banned, the production of the country’s staple food, that is, rice was hit. China donated a million tons of rice to make up for the shortage, and Sri Lanka paid a premium to Myanmar for additional supplies of it, eating into its rapidly dwindling foreign currency.

The south asian island nation’s economic suffering is also the product of a toxic mix of humongous debt load and recent developments, the Covid-19 flare-up in China and the Ukraine war.

When Mahinda Rajapaksa was president between 2005 and 2015, the country of 22 million people borrowed expensive international debt to finance infrastructure projects, such as Hambantota Harbour port. But they are yet to generate returns. The next presidency of Maithripala Sirisena worked around the debt and somehow managed to accumulate foreign reserves to some $7.5 billion. And the current one burnt through them.

Sri Lanka has virtually run out of dollar reserves now: it had just $734 million in February. And it has had no access to international credit markets for two years since ratings agencies downgraded its debt. The government put prime real estate for sale and converted the dollars of its citizens in banks into rupee as foreign reserves depleted. In an unprecedented settlement, the central bank bartered tea leaves for Iranian oil bills of $251 million.

Yet Sri Lanka must pay $7 billion in debt and interest payments by the end of the year. A payment of a $1 billion international bond is due in July. And the country has borrowed half of its $35 billion debt from private bondholders in global credit markets. China and Japan are the country’s biggest creditors: together they account for some 20% of its total debt.

Sri Lanka's central bank, however, announced on April 12th that it would default on the $35 billion foreign currency debt repayments it owes foreign countries. Remaining scarce foreign reserves must be used for food and fuel imports, says the central bank. Before it used its foreign reserves to prop up the rupee and make debt payments, though.

India has provided $2.5 billion to Sri Lanka in loans, credit lines for fuel and food and currency swaps. It has postponed debt payments owed to the country. China is willing to ramp up the country’s foreign reserves by converting the rupee to renminbi. But whether the renminbi could be used for imports from other countries bar from China remains unclear. And official talks with the IMF will begin on April 18th for a possible bail-out.

Most recently, the Russian invasion of Ukraine and China’s Omicron outbreak have disrupted global supply chains and pushed up commodity prices yet again. This has impinged Sri Lanka’s already mismanaged economy. The latest Bloomberg survey of economists shows that prices will likely climb to about 20% in the second and third quarters of this year. This comes as no surprise. Consumer prices were already at a record 13-year high of 17.5% in February.

This economic fiasco came to a head when the central bankhaving pegged the rupee to the dollar for five monthsabandoned its peg on March 7th under the pressure of the government, the rupee plunged by more than 30% against the dollar. Because of this, the cost of imports became even dearer. Prices of medicines, like paracetamol, rose by 29%. The price of petrol and diesel hiked by 43.5% and 45.5% respectively. 

Things have turned even sourer of late. Shortage of fuel and cooking gas has dealt a heavy blow to Sri Lankans. They are now facing power cuts of up to 13 hours a day. Standing in long queues for gasoline and other essentials has become normal. Hospitals are running out of medicines. The country imports nearly 85% of its medical supplies. Food prices, which make up a greater share of Sri Lankans’ spending, are soaring in recent weeks, imperiling the finances of poor people. No longer able to bear the hardship, frustrated Sri Lankans took to the streets in thousands early in this monthdemanding the government to step down.

Yet among darker economic outlooks, there are some shafts of light. Sri Lanka’s willingness to talk to the IMF (it was reluctant before) and the appointment of P. Nandalal Weerasinghean admired economistas the new governor of the central bank and the default on its foreign debt to save its fast depleting foreign reserves for other important things may be the first step towards fixing its unaffordable crisis. In the meantime, Sri Lanka’s economic problems continue.

Karan Poudel is an Investment Writer/Editor at Ansu Group. He was a former writer-analyst at the_farsight.

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