Open Access Research Article
Current Economic Crisis In Shri Lanka (By-Adv. Maitheelee Ashok Mohite)
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Current
Economic Crisis In Shri Lanka
Submitted By-Adv. Maitheelee Ashok Mohite
Savitribai Phule University, Pune.
LLM-LL Yr.. 4th Semister
Abstract
Sri
Lanka is in the throes of
the worst economic
crisis it has seen in decades,
collapsing under the weight of its debt. While
neighbours India and China have
assured President Gotabaya
Rajapaksha of assistance, citizens of the island
nation have deserted the sinking economy and are showing up in dozens at Indian coasts. The Sri Lanka Development Update (SLDU) notes that the country,
hit with an unprecedented economic
downturn due to the pandemic, is now on the road to recovery. Sri Lanka’s economic
growth is expected to recover to
3.4 percent in 2021, mainly
due to foreign investments as well
as normalizing tourism and other economic activities. However, the slow global
recovery, coupled with continued
trade restrictions, economic scarring from the slowdown, and the high debt
burden may continue to affect
growth.
Introduction
“As in countries around
the world, COVID-19 has had an unprecedented impact on Sri Lanka’s economy and people’s livelihoods. But we
are already seeing positive signs as the country enters the recovery phase,” said Faris H. Hadad-Zervos, the World Bank Country Director
for Maldives, Nepal
and Sri Lanka. “Through an enhanced focus on an export-oriented growth
model that taps the full potential of
private investment, Sri Lanka could increase its competitiveness and raise
growth in a sustainable manner.”
The Update includes a
special focus section, which discusses
the impact of COVID-19 on poverty. With jobs
lost and earnings reduced, especially in urban areas and among private sector
employees and informal workers, the
$3.20 poverty rate is projected to have increased from 9.2 percent in 2019 to
11.7 percent in 2020.
The report
notes that the current
social protection system
could support the reintegration of those who lost
their jobs. It suggests that a more targeted social safety nets could help the
authorities to scale up support to
the poor and vulnerable quickly and effectively in times of crises. Investments
in digital technologies and literacy can also help Sri Lankans find new economic opportunitie.
Global Economic
Crises And Implication And Prospectus
The longer-term consequences of the COVID-19 pandemic
for the global economy are coming into focus. The pandemic is now recognised as having
constituted the largest synchronised fall in global GDP in modern
history, although its impact was quickly mitigated
by governments which were guided
by lessons learned
from the global
financial crisis in 2009. This time, governments have far more swiftly
introduced stimulus
programmes to counter recessionary forces. The European Union, for instance,
facilitated joint debt issuance and
created conditions for a powerful fiscal response to the crisis. The United
States acted with very large spending
packages to sustain demand and maintain income and employment. Massive government spending, however, has generated extraordinary levels of public
debt. There are concerns that this
could eventually trigger inflation. Prices have indeed begun to rise and
interest rates may eventually follow—a
trend that would have important negative consequences particularly for highly
leveraged developing countries. Moreover, it is not yet clear how this mass of debt will ultimately be financed. This will remain a compelling
challenge for hard-pressed governments over the medium
and longer-term. There is
clearly an element of systemic competition that has emerged during the current
crisis, and this competition has an
important strategic dimension. Several authoritarian actors have
instrumentalised the pandemic
partly to discredit democratic governance. China, for example, has incorporated the fight against
COVID-19 into a broader national narrative of its “peaceful rise” and
systemic superiority. It has sought diplomatic
and public relations leverage from its contributions to the global fight
against COVID-19. Countries that
managed to contain the disease have also kept their economies more or less
functioning, and this has invariably
conferred a degree of strategic advantage. Meanwhile, the capacity to vaccinate populations quickly and to help other countries vaccinate
has become a kind of diplomatic currency.
Those leaders who have
discounted the virus altogether have invariably learned that the disease does
not follow political diktats.
The world appears slated to return to growth in 2021
albeit on a lower trajectory than was envisioned before the crisis. But there are several potential downside
risks that might lead the global economy to underperform.
These include: ongoing bottlenecks to global vaccination production and
distribution, public anti-vaccination
sentiments, the emergence of drug resistant strains of the COVID-19 virus and renewed infection surges. Debt defaults
precipitated by rising interest rates could precipitate a financial market panic, which could spread rapidly
given the huge debt burdens governments have assumed. Economies impaired by the recession have had to cope with
shrinking tax bases and new borrowing requirements.
On the upside, a ramping up of vaccination schedules could hasten the onset of
so-called herd immunity, rapidly
restore investor and consumer confidence, unleash pent-up demand, and thereby hasten a demand-led recovery. But
developing countries require access to vaccines or this optimistic outlook will be undermined. The
persistence of low interest rates and low inflation could lengthen the period in which governments are positioned
to provide essential monetary and fiscal support to national economies as the green shoots of recovery
take root. But there are now signs that a benign period of low interest
borrowing may end sooner than
was initially hoped.
What Is A Financial
Crisis?
In a
financial crisis, asset prices see a steep decline in value, businesses and consumers are unable
to pay their debts, and financial institutions experience liquidity shortages.
A financial crisis is often associated with a panic or a bank run during which investors sell off assets or withdraw money from savings accounts because
they fear that the value of those assets will drop if they remain in a financial institution.
Other
situations that may be labeled
a financial crisis include the bursting of a speculative
financial bubble, a stock market crash, a sovereign default, or a currency crisis. A financial crisis may be limited to banks or spread throughout
a single economy, the economy of a region, or economies
worldwide.
A financial crisis may have multiple causes. Generally, a crisis
can occur if institutions or assets are overvalued, and can be exacerbated by irrational or herd-like investor
behavior. For example, a
rapid
string of selloffs
can result in lower asset prices, prompting
individuals to dump assets or make huge savings withdrawals when a bank failure
is rumored.
Contributing factors to a
financial crisis include systemic failures, unanticipated or uncontrollable human behavior, incentives to take too much risk, regulatory absence or failures, or contagions
that amount to a virus-like spread of problems
from one institution or country to the
next. If left unchecked, a crisis can cause an economy
to go into a recession or depression. Even when measures
are taken to avert a financial crisis,
they can still happen, accelerate, or deepen.
Financial crises are not
uncommon; they have happened for as long as the world
has had currency. Some well-known financial crises include:
·
Tulip Mania (1637). Though some historians argue that this mania did not have so much impact on the Dutch economy, and therefore shouldn't
be considered a financial crisis, it did coincide with an outbreak of bubonic plague which had a significant impact on the country. With this in mind, it is difficult
to tell if the crisis was precipitated by over-speculation or by the pandemic.
·
Credit Crisis of 1772. After a period
of rapidly expanding credit, this crisis started in March/April in London. Alexander
Fordyce, a partner
in a large bank, lost a
huge sum shorting shares of the East India
Company and fled to France to avoid repayment. Panic led to a run on English banks that left more than 20 large banking houses either bankrupt or stopping payments
to depositors and creditors. The crisis quickly spread to much of Europe. Historians
draw a line from this crisis to the cause of the Boston Tea Party—unpopular tax legislation in the 13 colonies—and
the resulting unrest that gave birth to the American
Revolution.
·
Stock Crash of 1929. This crash, starting on Oct. 24, 1929, saw share
prices collapse after a period of wild speculation and borrowing to buy shares. It
led to the Great Depression, which
was felt worldwide for over a dozen years. Its social impact lasted far longer. One trigger of the crash
was a drastic oversupply of commodity crops, which led to a steep decline in prices.
A wide range of regulations and market-managing tools were introduced as a result of the crash.
·
1973 OPEC Oil
Crisis. OPEC members started an oil embargo in
October 1973 targeting countries that backed Israel in the Yom
Kippur War. By the end of the embargo, a barrel of oil stood at $12, up from $3. Given that modern economies depend on oil, the
higher prices and uncertainty led to the stock market crash of 1973–74, when a
bear market persisted from January 1973 to December 1974 and the Dow Jones Industrial Average lost 45% of its value.
·
Asian Crisis of 1997–1998. This crisis started in July 1997 with the collapse
of the Thai baht. Lacking
foreign currency, the Thai government was forced to abandon its U.S. dollar peg and let the baht float.
The result was a
huge devaluation that spread to much of East Asia, also hitting Japan, as well
as a huge rise in debt-to-GDP ratios. In its wake, the crisis led to better financial regulation and supervision.
·
The 2007-2008
Global Financial Crisis. This financial crisis was the worst economic disaster
since the Stock Market Crash of 1929. It started with a
subprime mortgage lending crisis in 2007 and expanded into a global banking crisis with the failure of investment bank Lehman Brothers
in September 2008. Huge bailouts
and other measures
meant to limit the spread of the damage failed and the global economy fell into recession.
As the most recent and most damaging financial crisis event, the Global Financial
Crisis, deserves special
attention, as its causes, effects,
response, and lessons
are most applicable to the current financial system.
A financial
crisis can take many forms, including a banking/credit
panic or a stock market crash, but differs from a recession, which is often the result of such a crisis.
The amount
The crisis was the result of a sequence
of events, each with its own trigger and culminating in the near-collapse of the banking
system. It has been argued that
the seeds of the crisis were sown as far back as the 1970s with the Community Development Act, which required banks to loosen their credit requirements for lower-income
consumers, creating a market for subprime mortgagest
of subprime mortgage debt, which was guaranteed
by Freddie Mac and Fannie Mae, continued
t o expand into the early 2000s when the Federal Reserve
Board began to cut interest rates drastically to avoid a recession. The combination of loose credit requirements and cheap money spurred a housing boom, which drove speculation, pushing
up housing prices and creating
a real estate bubble
In the meantime,
the investment banks, looking for easy profits in the
wake of the dot-com bust and 2001 recession, created
collateralized debt obligations (CDOs) from the mortgages purchased
on the secondary market. Because
subprime mortgages were bundled with prime mortgages,
there was no way for investors
to understand the risks associated
with the product. When the market for CDOs began to heat up,
the housing bubble that had been building
for several years had finally burst. As housing
prices fell, subprime
borrowers began to default on loans that were worth more than their homes, accelerating the decline in prices.
When investors realized
the CDOs were worthless due to the toxic debt they represented, they attempted to unload the obligations. However,
there was no market for the CDOs. The subsequent
cascade of subprime lender failures created liquidity
contagion that reached
the upper tiers of the banking
system. Two major investment
banks, Lehman Brothers and Bear Stearns, collapsed
under the weight
of their exposure to subprime
debt, and more than 450 banks failed over the next
five years.
Several
of the major banks were on the brink of failure and were rescued by a taxpayer-funded bailout.
The U.S. Government responded to the Financial Crisis by lowering interest rates to nearly zero, buying back mortgage and government debt, and bailing out some struggling financial
institutions. With rates so low, bond yields became
far less attractive to investors
when compared to stocks. The government response
ignited the stock market, which went on a 10-year bull run with the S&P 500 returning 250% over that time. The U.S. housing market recovered
in most major cities, and the unemployment rate fell as businesses began to hire and
make more investments
One big upshot of the crisis was the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act, a massive
piece of financial reform legislation passed by the Obama administration in 2010. Dodd-Frank brought wholesale changes to every aspect of the U.S.
financial regulatory environment, which touched every regulatory body and every financial services
business. Notably, Dodd-Frank had the following
effects:
·
More comprehensive regulation
of financial markets,
including more oversight
of derivatives, which were brought
into exchanges.
·
Regulatory agencies, which had been numerous and sometimes redundant,
were consolidated.
·
Greater investor protections were introduced, including
a new consumer protection agency
(the Consumer Financial
Protection Bureau) and standards for "plain-vanilla" products.
·
The introduction of processes and tools (such as cash infusions) is meant to help with the winding down of failed financial institutions.
·
Measures meant to improve
standards, accounting, and regulation of credit rating agencies.
A financial crisis is when financial instruments and assets decrease significantly in value. As a
result,
businesses have trouble
meeting their financial
obligations, and financial
institutions lack sufficient
cash or convertible assets to fund projects and meet immediate
needs. Investors lose confidence
in the value of their assets and consumers' incomes and assets are compromised, making it difficult for them to pay
their debts.
The financial crisis can be segmented into three stages,
beginning with the launch of the crisis.
Financial systems fail, generally caused by system and regulatory
failures, institutional mismanagement of finances, and more. The next stage involves the breakdown of the financial
system, with financial
institutions, businesses, and consumers unable to meet obligations. Finally,
assets decrease in value,
and the overall level of debt
increases.
Here's A
Look At Key Points To Understand About This Crisis
What is
happening in Sri Lanka?
The island's foreign reserves have hit rock bottom,
with commercial banks unable to secure dollars to finance imports of food, fuel and medicines. Sri Lanka... Sri Lanka was in a deep economic crisis
when the Covid-19 pandemic hit, reducing foreign worker remittances and crippling the lucrative tourism sector -- a key
source of dollars for the economy. The government imposed a broad import ban in March 2020... save foreign currency. The shortages
pushed food prices up 25 per cent last month, with overall inflation at 17.5 per cent -- the fifth
consecutive monthly record high. Sri Lanka is also facing five-hour rolling electricity blackouts as
thermal generators have run out of fuel.
Three international rating
agencies have downgraded the island since late last year, on fears it may not be able
to service its $51 billion sovereign debt. The International Monetary
Fund (IMF) in an analysis, pointed out that the country’s “debt overhang,” along with persistent fiscal and
balance-of-payments shortfalls, “will constrain growth and jeopardise macroeconomic stability in both the near
and medium term”.
“Based on staff analysis,
the fiscal consolidation necessary to bring debt d... down to safe levels would require excessive adjustment over the coming years, pointing
to a clear solvency problem,” the IMF said.
Sri Lanka's
debt profile
Sri Lanka has to repay about $4 billion
worth of debt this year, including a $1 billion international sovereign bond maturing in July. But its
reserves dipped to $2.31 billion as of end February, down around
70 per cent from...
The country, through repeated cycles
of borrowing since 2007, has piled up $11.8 billion worth of debt through sovereign bonds (ISB), which makes
up the largest part - or 36.4 per cent - of its external debt. The Asian Development Bank (ADB) is in
se... second place with a 14.3 per cent share,
having lent $4.6
billion. Japan is at 10.9 per cent and China at 10.8 per cent, with each
having lent about $3.5 billion each.
The China
debt connection-
China is Sri Lanka's fourth-biggest
lender, behind international financial markets, the Asian Development Bank (ADB) and Japan. Over the last decade China has
lent Sri Lanka more than $5 billion
for the construction of highways, ports, an airport and a coal power plant.
But critics say the funds were used
for white elephant projects with low returns, which China has denied.
President Gotabaya Rajapaksa
asked China to help restructure debt repayments when he met Chinese Foreign
Minister Wang Yin in January,
but China is yet to respond
to the request.
Repayments to China are estimated at about $400-$500
million, a finance ministry source told Reuters.
Before the pandemic, China was Sri Lanka's
main source of tourists and the island imports more goods from China than
from any other country.
Sri Lanka is a key part
of China's Belt and Road Initiative (BRI), a long-term plan to fund and build infrastructure linking China to the rest of the world, but which others
including the United States have
labelled a "debt trap" for smaller
nations.
What do
experts say?
Some experts believe Sri Lanka should
restructure its debt and establish a three-year repayment structure. Doing so would save precious
dollars and lessen the burden on Sri Lankan citizens who are facing
shortages of imported goods such as milk powder,
gas and fuel. "Sri Lanka is unreasonably committed to repaying its
debt. It is more prudent to press pause on debt repayment and take care of critical economic
needs," Verité Research Executive
Director and Economist Dr. Nishan de Mel said.
Fitch estimates the Sri Lankan central bank will also need
to arrange for $2.4 billion to help state- owned and private firms in
the country honour the debt obligations
they have in 2022, over and above
the $4.5 billion central government debt. The country debt...
The country
also needs around
$20 billion for essential imports
such as fuel,
food and intermediate goods for exports.
Reserves have been at a critical
level for months but grew to $3.1 billion at the end of December
boosted by a $1.5
billion yuan currency swap from China.
What caused the economic crisis?
Experts
say the crisis has been years in the making,
driven by a little bad luck and a lot of government mismanagement.
Over the past decade, the Sri Lankan
government has borrowed vast sums of money from foreign lenders to fund public services,
said Murtaza Jafferjee, chair of Colombo-based think tank Advocata
Institute.
This borrowing spree has coincided with
a series of hammer blows to the Sri Lankan economy, from both natural disasters -- such as heavy monsoons
-- to man-made catastrophes, including
a government ban on
chemical fertilizers that decimated
farmers' harvests.
These problems were compounded in 2018,
when the President's dismissal of the Prime Minister sparked a constitutional crisis; the following year, when
hundreds of people at churches and luxury hotels were killed in the 2019 Easter bombings;
and from 2020 onwards with the arrival
of the Covid-19
pandemic
For Sri Lankans,
the crisis has turned their daily lives into an endless cycle
of waiting in lines for basic goods,
many of which are being
rationed.
In recent weeks,
shops have been forced to close because they can't run fridges, air conditioners
or fans. Soldiers are stationed at gas stations to calm customers, who
line up for hours in the searing heat to fill
their tanks. Some people have even died waiting.
Protesters in Colombo took to the
streets in late March, demanding government action and accountability. Public frustration and anger erupted
on March 31, when demonstrators hurled bricks and started fires outside the President's private
residence. Police used tear gas and water cannons to break up the protests, and
imposed a 36-hour curfew afterward. President Rajapaksa declared a nationwide public
emergency on April 1, giving
authorities powers to detain
people without a warrant,
and blocked social media platforms.
But protests
went ahead the next day in defiance
of the curfew, prompting police
to arrest hundreds of demonstrators.
Protests have continued in the days since, though
they remained largely
peaceful. On Tuesday
night, crowds of student protesters surrounded Rajapaksa's residence again, calling for his resignation.
The emergency ordinance was revoked on April 5.
President Rajapaksa issued a statement Monday but did not directly
address the resignations, only urging all parties
to "work together for the
sake of all the citizens and future generations."
"The current crisis is a result
of several economic
factors and global developments," the statement read.
"As one of the leading democratic countries in Asia, solutions
should be found to this within a democratic framework."
Later
that day, when announcing the cabinet reshuffle, the President's office
released a statement
saying Rajapaksa
"sought the support of all the people to overcome the economic challenge
faced by the country."
Previously, Rajapaksa has said he is attempting to resolve the issue, saying in an address to the nation
last month that "this crisis was not created by me.
What's next?
Sri Lanka is now seeking financial support from the IMF and turning
to regional powers that may be able
to help.
During
last month's address,
President Rajapaksa said he had weighed the pros
and cons of working with
the IMF and had decided to pursue a bailout from the Washington-based
institution something his government had been reluctant to
do.
Sri Lanka
has also requested help from China
and India, with New Delhi already issuing a credit line of
$1 billion in March - but some analysts warned that this
assistance might just prolong the crisis rather than solve it.
There is still much uncertainty around
what comes next; national consumer price inflation has almost tripled, from 6.2% in September to 17.5%
in February, according to the country's central bank. And Sri Lanka
has to repay about $4 billion
in debt over the rest of this year, including a $1 billion international sovereign bond that matures
in July.
India Aiding The Food And Energy Security
To Sri Lanka’s Economic Crisis:
|
1. Recently, India and Sri Lanka agreed to a
four-pronged approach to discuss initiatives on food and
energy security to
help mitigate Sri
Lanka’s economic crisis.
|
|
2. Earlier in 2021, Sri Lanka declared an economic emergency amid
rising food prices, a depreciating currency, and rapidly depleting forex reserves.
3. The country’s heavy dependence on imports for essential goods like sugar, pharmaceuticals, fuel, pulses and cereals worsened the crisis.
4. The government’s ban
on chemical fertilizers last April as it looked to become the
first country to fully adopt
organic farming backfired.
5. A survey showed that 90% of Sri Lanka’s farmers used chemical fertilisers for cultivation.
6.
The move
led to a drastic drop
in domestic food
production, pushing up
food prices.
7. The decision was
rolled back after
months of mass
protests by farmers but the damage was done.
8. Food inflation soared to 25.7% in February.
The crisis is now starting to impact Indian exporters.
9. Thousands of containers sent from India to Sri
Lanka, including for
its own consumption as well as
trans-shipment cargo, have
been lying uncleared at Colombo port
as authorities can’t afford to transfer containers between terminals.
10. This, in turn,
has led to some build-up of cargo intended for Sri Lanka at Indian ports. India also relies considerably on Colombo port for global trade given it is a
transhipment hub.
11. 60% of India’s trans-shipment cargo is handled by the port. India-linked cargo, in turn,
accounts for 70% of
the port’s total
trans-shipment volume
|
In a December speech in Parliament, MP
de Silva said that the “only one way” to get the country out of the current crisis is
to request help from
the International Monetary
Fund (IMF).
He said that domestic measures
would be ineffective and that only the International Monetary Fund (IMF)
could assist in rebuilding the country’s economy.
Udith Jayasinghe, the Agriculture Secretary, also warned
reporters in late December that the government
may have to seek
international assistance to help feed the poor and hungry.
“We may need to borrow
crops from friendly
nations, such as maize, and consider rationing
food to ensure
pregnant women and those with illnesses are fed. Others
may be required to make concessions. “He stated this only hours before another
government official removed him.
According to the AFP news agency, his dismissal was not explained
by the president’s administration.On the other hand, the central bank issued a
request for foreign cash, including any loose change that individuals may have with them after returning from in It had previously restricted dealers from exchanging
more than 200 Sri Lankan rupees for a US dollar and engaging in forwarding
currency contracts earlier in the calendar year. Since then, the administration has instituted interim measures to alleviate the situation.
How Did Sri
Lanka Reach This Economic
Precipice?
Sri Lanka was
under a civil war from 1983-2009
where the economy barely made any progress.
In
the period from 1970 to 2020, the share of agriculture declined from 28 percent
of GDP to 7.7 percent, the share of industry has remained
stagnant at 17-19 percent, and the share of services has risen from 54 percent to 73 percent. Within services,
share of trade, hotels and transport has comprised 30-35 percent of GDP.
The
economy is highly-dependent on imports for essential items such as food, and
oil. The economy finances these
imports mainly via agricultural exports (tea, rubber, and coconut), industrial
products (textiles), and remittances
from abroad. The revenues from exports, and remittances have not covered the cost of imports, and Sri Lanka has
always been in a current account deficit (CAD). The average CAD in 2010-19 was around 1.2 percent of GDP.
The
CAD has been met mainly by the government borrowing from abroad. As the government borrowing from abroad has been larger than
the CAD, the balance has been pegged to the foreign exchange reserves. What can one make of an economy
where the forex reserves consist
of mainly borrowings from abroad!
Apart from a large CAD, the government also ran large
fiscal deficits. The average fiscal deficit in
2011-20 has been ~6.2 percent of GDP. The government was financing
fiscal deficits through both domestic
and foreign sources. As foreign sources dried up, it resorted to borrowing
domestically by issuing bonds
and taking advances
from The Central
Bank of Sri Lanka. The government also
lowered tax rates to
check high tax evasion.
The twin deficit Sri Lankan economy
was under enormous pressure in the 2010-19
period, but somehow
managed to run the show. The conditions were ripe for an economic
wildfire, and all that was needed was
a spark.
In
2020, COVID-19 was more than a spark, and completely sucked out the air from
the Sri Lankan economy. The pandemic
led to a global recession curtailing global demand. Sri Lanka’s exports dipped and imports (mainly
goods for survival)
went up, and adding to this Sri Lanka’s tourism
sector came to a grinding halt. The GDP declined by 3.5
percent, the CAD touched 7.9 percent of GDP, and the fiscal deficit
climbed to 11.1 percent.
Before
the economy could stabilize, in April 2021 the government decided to stop the
use of chemical fertilizers and go
100 percent organic. While the intentions cannot be questions, it’s the timing
that matters. At ~2 percent of the
import bill, fertilizers is a marginal expense. This shift in an important sector such as agriculture pushed inflation from 5.7 percent
in July 2021 to 15 percent in February 2022.
The
Sri Lanka official reserves as of end January 2022 was provisionally estimated
at $2.4 billion, equivalent to 1.3
months of imports. The country is struggling to import oil, and is facing power
cuts for more than 10 hours per day. The central bank is firefighting the crisis by
raising policy rates, and has also
asked the government to take measures to improve its finances. The
Russia-Ukraine war only added to woes as tourists from Russia and Europe could not travel
to Sri Lanka. Sri Lanka’s
economic crisis reminds one of India in 1991. The seeds of India’s 1991
economic crisis were sown in the
1980s when we saw a rise in both fiscal deficits and current account deficits.
Unlike Sri Lanka today, India
followed a highly-restrictive trade policy where
forex reserves were scarce
due to policy design. By 1989-90, on the eve of the crisis, India’s
forex reserves had declined, and were equivalent
to just 1.9 months of imports. The economy was precariously placed, and the
West Asian oil crisis acted as a shock
for the economy.
Thirty-one
years later, Sri Lanka is in a similar economic situation. However, there is
one key difference: While New Delhi
had leaders such as (late)
PV Narasimha Rao and Manmohan Singh to rely
on, there are none visible so far in Colombo. Public anger is largely
towards the Rajapaksas (and rightly so,
because seven family members are part of the government, including President,
Prime Minister and Finance Minister).
In this regard, Sri Lanka’s economic crisis is a lot like the Arab Spring
during the beginning of the last
decade, where people protested against leaders in the backdrop of an economic crisis
shri
Lanka’s economic crisis, yet again, draws attention to politics in South Asia.
Questions are being raised about Sri
Lanka heavily relying on China, and Beijing’s ‘debt trap’ politics (the effects
of which are now also being discussed in many African
countries). Pakistan, an of India’s
neighbours and China’s
‘all-weather friend’, is undergoing a political and economic turmoil.
Amidst all these developments, India stands out as a ray of hope for keeping its economic buoyancy stable despite
testing times.
Shri Lankas
Economic Crisis Poses
Challenges For India-
Our Neighbourhood First policy had led
to increased economic
cooperation with Sri Lanka but its economy is in deep trouble and India’s relations
with it have taken a turn for the worse this year.
India’s ‘Neighbourhood
First’ policy towards Sri Lanka had resonated with Sri Lanka’s ‘India First’ foreign and security policy in 2020. India
is Sri Lanka’s third largest export destination, after the US and UK. More than 60% of Sri Lanka’s exports
enjoy the benefits of the India-Sri Lanka Free Trade Agreement, which came into effect in March 2000. India is also a
major investor in Sri Lanka. India’s development
partnership with Colombo has always been demand-driven, with projects covering
social infrastructure like education,
health, housing, access to clean water and sanitation, besides industrial development. Concessional financing of about $ 2 billion
has been provided to Sri
Lanka through various Indian government-supported Lines
of Credit across sectors (for railway connectivity, infrastructure, supply of defence equipment, security, and
counter-terrorism and solar projects, among others). Foreign
direct investment (FDI) from India
amounted to around $ 1.7 billion over the years from 2005 to 2019 and went into retail petroleum, hotels and
tourism, real estate and manufacturing, apart
from telecom, banking and
financial services.
However, relations
between the two neighbours seem to have plummeted since the beginning of this year. In February, Sri Lanka backed out
from a tripartite partnership with India and Japan for its East Container
Terminal Project at the Colombo
Port, citing domestic issues. Later, the West Coast Terminal was offered under a public
private partnership arrangement to Adani Ports and Special Economic Zones
Ltd
Last July, the Reserve Bank of India (RBI) had signed a currency-swap agreement
with the Central Bank of Sri
Lanka (CBSL) under the Saarc Currency Swap Framework 2019-22, for withdrawals
of up to $400 million. The CBSL
settled the scheduled facility with RBI in February 2021. Even though the agreement
was valid till 13 November 2022, India declined
any further renewal
of it in the absence
of an International Monetary Fund programme to address Sri Lanka’s current
macroeconomic imbalances
On 31 August 2021, Sri
Lanka declared a state of economic emergency, as it is running out of foreign exchange reserves for essential imports
like food. The CBSL was the first Asian central bank to increase policy rates after the covid pandemic in
response to rising inflation in August 2021 caused by currency depreciation. Tourism, a big dollar earner
for Sri Lanka, has suffered since the Easter Sunday terror attacks of 2019, followed by the pandemic.
Earnings fell from $3.6 billion in 2019 to $0.7 billion in 2020, even
as FDI inflows halved from $1.2
billion to $670 million over the same period.
Sri Lanka’s fragile
liquidity situation has put it at high risk of debt distress. Its public
debt-to-GDP ratio was at 109.7% in
2020, and its gross financing needs remain high at 18% of GDP, higher than most
of its emerging economy peers.
Following an international sovereign bond settlement of $1 billion in July 2021, its gross
official reserves slipped
to $2.8 billion, which is equivalent to just 1.8 months of imports. The external debt-to-GDP ratio stood at 62% in 2020 and is
predominantly owed by its
public sector.
More
than $2.7 billion
of foreign currency
debt will be due in the next two years
Sri Lanka’s economic crisis may further push it to align its
policies with Beijing’s interests. This comes
at a time when India is already on a diplomatic tightrope with Afghanistan
and Myanmar. Other South Asian
nations like Bangladesh, Nepal and the Maldives have also been turning to China
to finance large- scale
infrastructure projects. Nurturing the Neighbourhood First policy with Sri
Lanka will therefore be important for
India, albeit with due caution, to preserve its strategic interests in the
Indian Ocean region. The Colombo
port is crucial for India as it handles 60% of India’s trans-shipment cargo.
Regional platforms like the Bay of
Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation and the Indian Ocean Rim Association could be
leveraged to foster cooperation in common areas of interest like technology-driven agriculture and marine sector
development, IT and communication infrastructure, renewable
energy, and transport and connectivity. Both countries could also cooperate on
enhancing private sector investments to create economic resilience.
Colombo Battling
With High Debt And Low Foreign Exchange
Reserves
However, the problem did not start in 2020. Since the
end of ethnic war in 2009, the island nation is struggling to keep its economy
afloat. It started
taking up loans
and issuing bonds to keep its foreign
exchange reserves intact. In 2018, it took debt worth $1 billion from
China. Sri Lanka leased its Hambantota
port to China which helped it to boost foreign currency reserves and bridge its
fiscal deficit.
In
April 2020, after the pandemic hit, it took another $500 million loan from
Beijing in order to strengthen its
forex reserves. It also upsized that loan. India has also helped the country to
finance its essential needs. India offered
$ 1 billion in credit lines to supply essential
commodities for procurement of food, medicine and other essential items. In February, it
signed a $500 million credit line with India
to import fuel
The country relies
heavily on tourism revenues. In fact tourism
accounts for 10% of its GDP. But attacks in the country in 2019 dented its tourism sector.
Tourism dropped by 50%
after the Easter bombings.
And to add to the fire, with the pandemic hitting
the world, tourism further came to a standstill. “Since early 2020,
the Sri Lankan economy has suffered significant losses in foreign exchange
earnings; revenue from tourism alone
dropped by $3 billion over the first eight months of 2021, compared with the same period in 2018,” according to Asian Development
Bank report.
Sri
Lanka, through repeated cycles of borrowing since 2007, has piled up $11.8
billion worth of debt through ISBs, which makes up 36.4% of its external
debt, according to a Reuters
report. While, Foreign
direct investment (FDI) into Sri Lanka decreased to $548 million in
2020, compared to $793 million in 2019 and $1.6
billion in 2018, according to the
International Trade Administration.
Global Rating Agencies Cut Sri Lanka’s Sovereign Rating To Junk
Amid
its balance of payment crisis, global rating agencies such as Moody’s, S&P
and Fitch have all downgraded Sri
Lanka’s sovereign ratings. In January, S&P Global Ratings cut Sri Lanka’s
sovereign credit rating deeper into
“junk” territory, to ‘CCC’ with a negative outlook, citing rising repayment pressures
and “uneven access”
to financing. Last year both Fitch and Moody’s downgraded Sri Lanka’s sovereign ratings to junk category
on increased probability of a default
event in coming months.
Fitch
said it downgraded Sri Lanka in the light of Sri Lanka’s worsening external
liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows. While Moody’s said
last year, the country had failed to come up with a comprehensive debt repayment
plan.
Why Is Colombo
Not Seeking IMF’s Help To Restructure Its Debt?
Sri Lanka has so far relied on loans from countries
such as China, India, and Japan, and institutions such as the Asia Development Bank and World Bank. Though rating
agencies as well as experts suggest that the
way out for Sri Lanka is to seek debt restructuring from the International
Monetary Fund (IMF), which the country
has refused to do so far. This is because if the country agrees to get its debt restructured, it would have to comply with
IMF directives on increasing income tax and having an independent central bank. However, last week, Sri Lanka said it will work with the IMF to take action to increase its foreign
exchange reserves. The central bank
clarified that help would not be in the form of debt restructuring. “I have
decided to work with them after
examining the advantages and disadvantages,” the country’s President
Gotabaya Rajapaksa said in
an address to its 220 lakh
people, according to Reuters.
Conclusion
“We
must take action to increase our foreign exchange reserves. To this end, we
have initiated discussions with international financial institutions as well as with our friendly
countries regarding repayment of our loan installments,” he added.
“The outlook (of Sri Lanka) is subject
to large uncertainties with risks tilted
to the downside. Unless the fiscal
and balance-of-payments financing needs are met, the country could experience
significant contractions in imports
and private credit growth, or monetary instability in case of further central
bank financing of fiscal deficits,” the IMF said
earlier this month
Article Information
Current Economic Crisis In Shri Lanka (By-Adv. Maitheelee Ashok Mohite)
Authors: Adv. Maitheelee Ashok Mohite
- Journal IJLRA
- ISSN 2582-6433
- Published 2022/07/29
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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