22% of the country is currently classed as food insecure. Inflation rates are over 70%. There is $51 billion in foreign debt. These are all tragic impacts of the economic crisis that Sri Lanka is currently in, historically the worst economic crisis since the country gained independence in 1948. This is a severe crisis that has been ongoing since 2019, due to many reasons such as a weak government body, loans and heavy imports, all factors we will consider in this article.
What caused the Sri Lankan economic crisis?
Tourism:
Tourism is a valuable income earner for Sri Lanka, being the third largest foreign exchange earner, accounting for 12% of the country’s GDP of $ 84 Billion (as of 2019). Sri Lanka is a popular holiday destination for various reasons such as tropical climate all year round, a range of diverse and rare animals on the island as well as the culture and the history of Buddhism in the country. But in the recent years, demand for this service from tourists that come into the country has fallen noticeably due to two events that have occurred in the recent years.
On 21st April 2019, 3 luxury hotels and 3 churches in Colombo, were victims of a coordinated terrorist suicide bombings. This event was dubbed the Easter bombings and claimed the lives of 269 people, which included 45 foreign nationals, and left 500 injured. As a result of these bombings, many were left in fear of using facilities such as churches and hotels, and this deterred other tourists from coming to the island due to fears that terrorists would again coordinate an attack.
In the following year of 2020, the country faced a greater worldwide problem of Covid-19 as lockdown was announced in mid-2020, again with a lockdown being announced in August of 2021. As of September 2021, 462,767 Covid-19 cases were recorded in the country and 10,140 people died. Due to flights into Sri Lanka being restricted, and many scared to leave their homes in fear of contracting the virus, this halted the tourism sector in the Sri Lankan economy, leaving many unemployed and weakening the workforce as many became ill as a result of the virus or dying due to Covid-19.
These two events reduced the number of consumers that entered Sri Lanka due to fears regarding their health and lives, reducing the tourism sector in the economy, therefore likely reducing the GDP of the country. We also need to consider the other businesses affected by a fall in tourism due to the circular flow of income, as tourists may purchase other non-tourism related goods and services while they stay, injecting more money into the economy- which will be lost if tourists avoid coming to Sri Lanka. This could also reduce FDI into the country as plans for facilities such as resorts and hotels maybe delayed due to fears over the return on investment as demand for tourism in Sri Lanka is falling.
Poor economic management:
Another factor that ultimately increased the severity of the crisis was a government that did not effectively manage the economy. The president of Sri Lanka was Gotabaya Rajapaksa where the island is a semi-presidential representative democratic republic where power is used by the President on the advice of the Prime Minister and the Cabinet of Ministers. Multiple actions taken by the government in the recent years such as involving floating the exchange rate, tax cuts, keeping a heavy budget deficit and using up foreign currency reserves all were factors that created or worsened the situation Sri Lanka is in.
(Scale in LKR Million)
After the events of the civil war (from 1983 to 2009), the Sri Lankan government chose to prioritise on producing goods for domestic consumption, instead of choosing to boost exports to increase flows of money into the country. The question whether this decision was correct or not at the time is largely debatable, as we need to remember that the country came out of years of warfare in the country, leaving many without homes and without essential supplies so the country’s decision to do this was to allow the nation to recover economically and socially. But as a result of this, as shown on the diagram above, Sri Lanka has built a large budget deficit, recording a government budget deficit of 1016483 LKR Million in 2019 (worth US $6.09 Billion as of the exchange rate of 2019). As we know, keeping a large budget deficit can have many consequences, as this is a signal that more money may be leaving the country than money the country has made from abroad, as Sri Lanka has increased its over dependence on foreign goods. This large budget deficit led to the government depleting their foreign currency reserves as they had to pay for various imported goods from various countries. As of March 2022, Sri Lanka had US $1.9 Billion in foreign currency reserves, a huge fall in comparison to 2018 where foreign currency reserves peaked near to US $10 Billion. This meant that the government would not be able to pay the $4 Billion in foreign debt obligations for 2022, which ultimately led to the fall in Sri Lanka’s economy. In aims to reduce imports into the country, the president suddenly, with no public knowledge to who advised this, banned the importations of chemical fertilisers for farmers, meaning farmers had to use local organic fertilisers to nurture their crops. But this led to wide crop failure in the country due to lack in the effectiveness of these fertilisers, which in turn worsened the problem the president was trying to ease, as Sri Lanka had to supplement food stocks from abroad, further increasing imports.
The government deciding to float the rupee and tightening monetary policies such as interest rates also had short run impacts on the country. In March of 2022 the country decided to change to a floating exchange rate for the country meaning the currency’s value is allowed to fluctuate depending on foreign market forces. This led to the rupee devaluing as a heavy fall was experienced as the rupee lost nearly half of its value from March to May against the US dollar from approximately 0.0049 to 0.0027. The government did this as well as increase interest rates in order to be eligible to gain an International Monetary Fund loan programme to receive money in order to help with replenishing their foreign currency reserves and debt restructuring to help the country overcome the crisis. But this decision has made it harder on the households of Sri Lanka as importations have become more expensive, and economic activity could be reduced due to the cost of borrowing for loans for capital or consumer goods increasing. But the long term benefits of this has to be considered, as this measure can also prevent hyperinflation further occurring in the economy.
Another significant contribution to the economic collapse of Sri Lanka, in 2019 the government placed tax cuts, with VAT having the most noticeable change in tax from 15 to 8 percent. This was in aim to stimulate the economy and free up disposable income and money circulation in the economy to increase economic growth in the long run. But these tax cuts were a wrong decision for the government to make given the already large fiscal deficit, the widespread tax evasion occurring in the country (direct taxes only contributed 2% of the GDP) and this reduced government revenue meaning less money for the government to spend on debts. Overall, this tax cut did not create any long term positives which the government had planned.
The Sri Lankan government also took out many loans to various countries, China being Sri Lanka’s biggest bilateral lender owning approximately 10 percent of the island's foreign debt- with some speculating that Sri Lanka fell into a debt trap set by China. As of 2022, Sri Lanka had accumulated $51 Billion in debt, owing $6.5 Billion to China, as well as Japan and India. A reason for the government amounting this much debt was due to a failure of debt restructuring, which put Sri Lanka deeper into the hole of debt.
In conclusion, we have seen many wrong actions by the Sri Lankan government which were set to potentially save Sri Lanka from the oncoming economic crisis but these choices ultimately led Sri Lanka to the severe crisis that they are now in- from choice in fiscal policies to the choice of producing goods for domestic consumption after the events of the civil war.
The Impacts of the crisis in Sri Lanka
In 2022, the severe consequences of the crisis was felt by mainly the citizens of the island and the country gained international attention as many people worldwide only now became aware of the economic and financial struggles the country has been going through.
The people of Sri Lanka were left to queue many hours for basic food supplies due to the low supply of goods in the country- due to minimal imports into the country as foreign currency reserves have been depleted and the wide crop failure due to the use of organic fertiliser. It is estimated that 30% of the population is food insecure. Many citizens are unable to travel to work, due to petrol being in short supply, having to be prioritised for emergency service vehicles as well as the price of fuel sky rocketing. Annual inflation rates of up to 70% were being witnessed, meaning many people lost value in their savings as goods became increasingly more expensive.
Due to these many problems faced by the average Sri Lankan, many started to protest due to economic mismanagement from the President Gotabaya Rajapaksa. In 2019 when the president was elected into his new role, there was huge controversy as to if this was the right move. Rajapaksa was the defence minister during the civil war and was applauded by some for bringing the war to an end by “crushing” the Tamil tiger separatist rebels. But he was accused of many war crimes as there were accounts of Tamil forces being killed even when waving white flags or after surrendering. There were also disappearances of journalists, reporters and protestors who were seen as opponents to Rajapaksa. In 2016, Rajapaksa was charged with corruption for selling state-owned weaponry and during the election, many questions were raised about his eligibility, as he had a US citizenship that he gave up. Many also speculated that Rajapaksa would be likely to be a way for Mahinda Rajapaksa, a family member in Gotabaya’s powerful family, to regain power as he could not participate in the 2019 elections due to Sri Lankan presidential limits. These fuelled the anger for many citizens in Sri Lanka and further protests led to the government cabinet being effectively dissolved on the 3rd April as 26 ministers stepped down due to anti-government protests escalating despite curfews being set. Protestors then broke into the president’s mansion, where videos were seen of protestors sleeping on his bed and swimming in his pool. His mansion was then the target of arson attacks as it was burnt down. This was successful for the protestors as the president fled to the Maldives by plane and handed in his resignation, resigning on July 14th. Now Ranil Wickremesinghe is the new president of Sri Lanka, also being the country’s Minister of Finance.
What is the country now doing in order to combat the crisis?
Sri Lanka is now in the process of aiming to receive a bailout from neighbouring countries or the International Monetary Fund (IMF) as the country estimates USD $1.5 Billion is needed to end the crisis immediately. Sri Lanka and the IMF agreed upon a $2.9 Billion bailout over 4 years, but this is currently on hold, now expected to only be received in early 2023 as Sri Lanka has to restructure their debts as part of the agreement. Debt restructuring is done when a firm/ country is facing financial problems, which involves the organisation aiming to maintain relationships with creditors and banks by negotiating lower interest rates or asking for extensions for debt payments. Currently, Sri Lanka is in the process of debt restructuring as well as waiting for assurances from Sri Lanka’s bilateral creditors including India, Japan and China says Sri Lanka’s Central Bank Governor P. Nandalal Weerasinghe telling “The Hindu” in an interview as the country has been in the talks with these countries in order to restructure the debt of billions owed to them.
These are steps taken by Sri Lanka to potentially come out of their biggest economic crisis in the nation’s history. But this can only be effectively done with a stable government in place and aid to the country as goods such as food and essentials such as fuel and medicine needs to be imported to the country to help the many shortages of supply in the short run. This and the loan will help the country build a foundation in the short run to be able to recover from this event caused by many man-made problems due to poor economic management and bad luck of the island.
References:
Comentarios