The economic crisis endangering Sri Lanka’s future

The economic crisis endangering Sri Lanka’s future

The damage of the COVID-19 pandemic has combined with a mounting financial crisis to pose a serious threat to Sri Lanka’s development, Jeevethan Selvachandran writes.

The COVID-19 epidemic has nearly halted global mobility and dominated worldwide media since March 2020. While attempts to restore to normalcy are making headway in affluent countries, still-developing countries are still a long way from conversations about full pandemic recovery and future growth. Sri Lanka, a democratically unstable and war-torn country, is one among them. In addition to the epidemic, Sri Lanka has been dealing with a debt issue. Sri Lanka has managed to repay a billion-dollar bond in foreign currency debt by July 25, but two further debt payments – $1.5 billion and $1.25 billion in bonds – are due in 2022 and 2023. Because the first payment was made using foreign exchange reserves, the government imposed capital restrictions, restricting outgoings of foreign currency. This has prompted calls for International Monetary Fund’s (IMF) assistance to solve the economic crisis.

Sri Lanka has rejected the plan, preferring to pursue its own strategy of bolstering reserves and financing imports through foreign exchange swaps with China, South Korea, Bangladesh, and India. Despite receiving some payback and financial help as a result of this strategy, the economy remains shaky. As a result, President Gotabaya Rajapaksa declared an economic emergency to combat rising inflation, which had led to a rise in food costs. Sri Lanka has put import limits on motor cars, agricultural items, and consumer durables since 2020 in order to reduce foreign currency outflows.

Prior to this, Sri Lanka's foreign reserves had plummeted to $2.8 billion at the end of July, down from $7.5 billion when the Rajapaksa-led administration took office in November 2019. Since January 2019, the Sri Lankan Rupee has lost more than 20% of its value versus the US Dollar, requiring the Central Bank of Sri Lanka to raise interest rates in order to support the local currency.

The rupee's depreciation is projected to increase the cost of repayments. Despite taking steps to address the situation, imports of tea, rubber, seafood, and textiles are surpassing exports due to increased costs and insufficient revenue. Above importantly, Sri Lanka's prized European Union preferential trade status, worth $360 million per year, has been maintained.

If the European Union upholds the decision to cancel the agreement, the United Kingdom may follow suit. This would be a major economic setback for Sri Lanka, since combined exports to these markets account for 30% of the country's overall exports. To make matters worse, the currency crisis has compounded the pandemic's economic impact, severely limiting Sri Lanka's economy, which was heavily reliant on tourism, investments, exports, and remittances - all of which were vulnerable to the epidemic.

Whether Sri Lankans are enthusiastic about economic recovery and growth is a different matter, but the World Bank believes the island nation will recover — but with caution. It advocates an export-oriented and private investment-led economic model as the best approach for the country to prosper sustainably in its 2021 development report. If Sri Lanka continues on this path, encouraging trade and private investment, including foreign direct investment, it may be able to establish the conditions for a prosperous economy. It must do so through facilitating public-private partnerships in critical sectors like as infrastructure, health, and tourism.

Other moves Sri Lanka might take include lifting fertilizer prohibitions, as the country isn't ready for organic agriculture. This might help to down food prices and calm the increasing inflation. Second, the government should seek assistance from the IMF to maintain its foreign exchange reserves, as well as collaborate with international economic experts to develop a strategy to address the problem the economic crisis amidst the pandemic – similar to the neighboring Indian state of Tamil Nadu.

Still, Sri Lanka’s dire financial state clearly shows that restructuring is required in order to make progress. Against the backdrop of the ongoing crisis, financial expert Dr Nishan De Mel noted that, most of all, Sri Lanka needs “a publicly-backed plan that will establish [investment] credibility.”

Country Context

Sri Lanka is saddled with unsustainable debt and severe balance-of-payments problems. Due to fiscal and external imbalances, the economic future is severely unpredictable. To address the high levels of debt and debt payment, lower the budget deficit, restore external stability, and lessen the negative repercussions on the poor and vulnerable, immediate policy actions are required.

Recent developments

Real GDP is expected to grow by 3.5 percent in 2021, owing to a robust year-on-year rebound of 12.3 percent from a low base in the second quarter. Manufacturing, financial services, construction, transportation, and real estate all made significant contributions. Despite low tourism revenues, exports increased dramatically, with the textile industry leading the way. Imports of intermediate and capital products increased as a result of higher imports. In 2021, the $3.20 poverty rate is expected to have decreased somewhat to 10.9 percent, still higher than pre-pandemic levels.

In February 2022, year-on-year inflation increased to 17.5 percent, owing mostly to high food inflation of 24.7 percent, rising global commodity prices, gasoline price changes, and partial monetization of the budget deficit. Furthermore, between May and November, an agrochemical import embargo hampered agricultural output. The increase in prices impacted households' capacity to afford living expenditures, resulting in a decline in welfare and increased food insecurity. To alleviate the tensions, the central bank has hiked policy rates and the statutory reserve ratio by 200 basis points since August 2021.

Despite import limits on non-essential products, the trade imbalance increased to USD 8.1 billion in 2021 from USD 6 billion in 2020, as higher import expenditure offset an increase in export profits. The current account deficit is expected to grow to USD 3.2 billion (or 3.8 percent of GDP) in 2021 due to decreases in remittances (22.7 percent) and tourism receipts (61.7 percent).

The administration has sought external finance from bilateral partners, including a US$ 1.4 billion financial aid package from India in January 2022 to cover vital imports and increase foreign exchange liquidity. On March 17, 2022, India agreed to provide another $1 billion in aid. Official reserves, on the other hand, were valued at US$ 2.3 billion in February 2022 (equal to 1.3 months  of imports) remain low relative to foreign currency debt service, estimated at USD 5.6 billion from April to December 2022 (including domestic instruments issued in foreign currency). The banking system's net foreign assets fell to US$ -4.9 billion in December 2021, indicating worsening foreign exchange liquidity problems. The CBSL floated the currency on March 07 to stop reserve losses after holding the exchange rate widely stable around 201 LKR/US$ for seven months. The currency had fallen by 46 percent by the end of March.

In 2021, the budget deficit is expected to remain at 11.1 percent of GDP, while public and publicly insured debt is expected to reach 117 percent of GDP. Domestic resources, particularly the central bank, were mostly used to fund the budget deficit. Fitch, S&P, and Moody's all cut the sovereign rating, putting it in the high-risk category.

Economic Crisis in Sri Lanka; An Assessment

Sri Lanka is experiencing a severe economic crisis as a result of dwindling foreign reserves. Foreign reserves have been declining since August 2020, but they reached a perilous level in November 2021. It was just enough to cover one month's worth of imports. There was a little rise a month later, but it was still insufficient for two months' import. 1 According to reports, overall foreign reserves fell further 24% to US$ 2.3 billion in January 2022.The Sri Lankan government's capacity to account for imports of vital products and debt payments has been hampered by dwindling foreign reserves. The Sri Lankan government has admitted that it is becoming increasingly difficult to settle import invoices as a result of conflict the dollar crunches, particularly for import of fuel for daily requirements. The government and the Central Bank of Sri Lanka (CBSL) are certain, however, that owing to the present economic crisis, Sri Lanka will not default on debt service. With a steady supply of currency, the Governor of the CBSL expects that the stresses on the economy would lessen shortly. The reality on the ground, as well as analysis of the government's policy initiatives and global geo-political economic developments, such as the aftermath from the Russia–Ukraine war, all show that the Sri Lankan economy is in a state of flux.

Foreign Reserves Crisis in Sri Lanka

Since independence, the Sri Lankan economy has always had a trade imbalance since its import expense has always been higher than its export earnings. For years, a large portion of the foreign cash gained has been used to pay for the import cost. The government's debt-servicing commitment has put further strain on foreign reserves in recent years. Foreign exchange inflows to the country, on the other hand, have decreased, first as a result of the Easter Sunday attack on the tourism sector in 2019, and then as a result of the global pandemic, which has severely impacted all of Sri Lanka's major foreign currency earning sectors, including tourism, remittances, and exports.

Since April 8, 2020, the CBSL has continued to provide liquidity from the foreign reserves since the government has been unable to raise enough cash due to unprecedented poor market circumstances. The Central Bank used its foreign reserves to settle US$ 1,007 million in government debt between April 8 and June 22, 2020. 8 The debt obligation for the period July 2021–July 2022 is estimated to be between $5 and $7 billion. 9 The current foreign crisis has worsened in recent years due to a decrease in foreign reserve inflows at a time when outflows are high. The country is experiencing significant fuel shortages as a result of the foreign reserves issue, which has resulted in regular power outages as well as shortages of food, medications, cement, and other necessary materials. Long lines in front of supermarkets pharmacies and fuel depots in many parts of Sri Lanka indicate the shortage of essential items. Due to a paucity of foreign currency in the nation, importers are having difficulty obtaining Letters of Credit (LOC) from banks. As a result, many of the containers are stranded at the Colombo port for several days due to a lack of payment. Many power plants had to be shut down due to a lack of fuel, resulting in a power crisis throughout the country. Some power facilities are turning to hydro energy to generate electricity utilizing water that was previously utilized for agriculture. Water shortages are expected as a result of low rainfall and increasing usage of reservoirs for power plants, according to experts, which would negatively impact agricultural productivity and perhaps lead to a food crisis. According to the All-Island Private Pharmacy Owners' Association, a significant shortage of prescription drugs has hit the island drug shortage is looming as the existing back-up stocks of medicines are due to be used up within three months. Reportedly, Sri Lanka has a five-percentage shortage of required medicines.

Measures Taken

The Sri Lankan government believes that previous governments' approach of importing more than income collected has contributed to the current foreign exchange reserves issue. Loans from international institutions are also thought to have contributed to the country's current state of turmoil. Furthermore, the COVID-19 epidemic has exacerbated the problem; as a result, one of the government's top strategic priorities is to cut import expenditure. Several additional "homegrown" strategies to limit capital outflow and increase inflow have also been used in order to improve foreign reserves. To cope with the issue of paying import and debt, the government has sought bilateral partners for a loan, credit, and currency exchange facility. While dealing with the issue, special focus is being paid to boosting investor confidence by not defaulting on debt service.

v Import Restrictions

To curb foreign currency outflows, the Sri Lankan government has prohibited the import of luxury automobiles, chemical fertilizers, and food staples such as turmeric. Since March 2020, there has been an import restriction on motor vehicles. In May 2021, the Sri Lankan government imposed import restrictions on chemical fertilizers and agrochemicals (insecticides and herbicides). Even while the government claims that the prohibition is necessary to encourage organic farming in the nation, the chemical fertilizer import ban policy was also implemented to limit the outflow of foreign funds. Sri Lanka used to spend over US$ 400 million on fertilizer imports each year, and more than US$ 7 million on turmeric imports before the prohibition.

v Restrictions on forward contracts of foreign exchange

In view of the need to avoid excess volatility in the foreign exchange market, the CBSL has directed the licensed commercial banks to refrain from entering into forward contracts of foreign exchange for a period of three months.

v Enhancing Remittance Inflow

The government has introduced several policy initiatives to increase remittance inflows to the country, including a proposal to diversify the foreign employment market, which is currently dominated by Middle Eastern countries; the establishment of a contributory pension scheme for migrant employees; and the payment of Sri Lankan Rs 2 per dollar above the normal exchange rate for foreign exchange remittances converted at licensed banks. To encourage increased inward remittances, the government has also implemented a Special Deposit Account system.

v Assistance from Bilateral Partners

Sri Lanka's government is seeking loans and currency exchange facilities from bilateral partners to help it deal with the present economic crisis. Bangladesh has renewed a currency swap facility worth $200 million. China has extended a swap facility worth US$1.5 billion. The China Development Bank has also given Sri Lanka US$ 700 million. India has already committed US$ 2.4 billion in financial assistance, which includes: (a) US$ 400 million under the SAARC currency swap arrangement; (b) a two-month delay in the A.C.U. settlement of US$ 515.2 million; (c) US$ 500 million for fuel imports from India; and (d) US$ 1 billion for food, essential items, and medicine imports. Furthermore, Indian Oil Corporation has provided 40,000 Metric Tonnes. India has also agreed to positively contribute to enhance Sri Lanka’s energy security by signing an MoU to jointly develop the Trincomalee oil tank farms; and by providing all kinds of assistance to tap Indian tourists for strengthening Sri Lanka’s tourism sector as well as enhancing Indian investments in Sri Lanka. Pakistan and Qatar have also agreed to provide assistance.

v Boosting investors’ confidence

The government has set aside funds for Special Deposit Accounts in order to increase investor confidence. Despite foreign cash shortages, the government is adamant about avoiding defaulting on its debt payment obligations. Despite opposition parties' repeated requests, the administration has opted not to ask the lender to renegotiate the debt payment.

v No to International Monetary Fund (IMF) Bailout

According to the administration, Sri Lanka is not interested in approaching the IMF for a bailout since the IMF help comes with strings attached, which would put extra burdens on people who are already struggling due to the epidemic and the current economic crisis. The existing administration also believes that IMF programs adopted in Sri Lanka have exacerbated the country's economic issues at times. Despite the administration's confidence in its ability to cope with the problem without an IMF bailout, remarks from governing party officials hint that the government may seek technical assistance from the IMF.

Efficacy of Government Measures

Economists and opposition parties in Sri Lanka do not approve of the government's handling of the problem. The administration, opponents argue, is focused on short-term measures and specific sectors rather than taking a holistic approach to overall economic connections. It is suggested that while the import restrictions may have lowered expenditure and hence trade balance in the short term, a continued ban on imports will have an impact on exports as well, because Sri Lanka's export economy is heavily reliant on the purchase of intermediate capital goods. Many importers have suffered as a result of the import prohibition.

The Sri Lankan government is optimistic that the foreign exchange position would improve in the coming days as anticipated inflows from bilateral partners and non-debt generating foreign currency inflows materializes. The tourist sector's foreign exchange revenues and remittances are projected to improve shortly. Despite the government's and CBSL's confidence, it is doubtful that the people of Sri Lanka would see economic respite in the near future. Sri Lanka has a massive debt burden. It has a debt service obligation of almost US$ 29 billion from July 2021 to June 2026. There is considerable skepticism about the tourist and export sectors improving. Because both Ukraine and Russia are significant markets for Sri Lankan tourism, the expansion of the war between Russia and Ukraine would have ramifications for Sri Lanka. Russians accounted for 15.8% of all visitors who visited Sri Lanka this year through February 11th, while Ukrainians accounted for 8.7%. The tourism industry would suffer as a result of the lack of tourists from these nations as a result of the conflict. Furthermore, the Russia–Ukraine conflict has already pushed up global oil prices, complicating Sri Lanka's ability to acquire gasoline for its daily needs. The rising conflict between Ukraine and Russia, which are both significant markets for Sri Lankan tea, may have an impact on exports.

The Major Natural Resources Of Sri Lanka

Natural Resources Of Sri Lanka

Arable Land

Arable land is one of Sri Lanka's most precious resources. Arable land accounted for over 21% of the country's total land area in 2014, according to Trading Economics data. Sri Lanka's government established the Department of Agriculture to appropriately use the country's fertile land. Arable land was very important in Sri Lanka's history, and the country's agricultural economy grew dramatically in the 19th and 20th centuries. Ceylon tea, cinnamon, and rubber were among the most significant products farmed in Sri Lanka at the time. Agriculture is similarly significant in the current period, since it employs around 32% of the country's entire population. Agriculture generated 12 percent of GDP in 2010, according to data from the Ministry of Finance of the country's gross domestic product. Some of the main crops grown in Sri Lanka include rice and tea.

Rice

According to the Sri Lankan government, rice is the most extensively planted crop in the country. Rice crops accounted for around 34% of arable land utilization in Sri Lanka, according to some estimates. Close to 2 million Sri Lankan families are thought to be actively involved in rice farming, according to the government. The majority of rice harvested in Sri Lanka is consumed locally because rice is the country's primary diet.

Tea

Tea is mostly grown for export in Sri Lanka, and it contributes significantly to the country's GDP. According to the Sri Lanka Export Development Board, tea contributed over $1.5 billion to the country's gross domestic product in 2013, accounting for around 2% of the total. Sri Lanka used to export more tea than any other country in the world, but Kenya quickly surpassed them. Tea is farmed by both large-scale and small-scale producers across the country. According to the Sri Lankan government, the tea sector employs almost one million people.

Gemstones

Gemstones are another important natural resource in Sri Lanka. Sri Lanka has a long history of producing high-quality jewels that have been famous across the world for centuries. Ptolemy is said to have been one of the first to appreciate the excellence of Sri Lanka's jewels. He commended the country's sapphires and beryl for their high grade. Marco Polo is also said to have complimented Sri Lankan diamonds. Gemstone mining has become an important business in Sri Lanka in the contemporary age. The majority of Sri Lanka's jewels come from secondary deposits. The construction and subsequent breakup of supercontinents on the planet is thought to have influenced the genesis of gemstone deposits in Sri Lanka.

Wildlife

Because Sri Lanka is regarded one of the world's biodiversity hotspots, wildlife is one of the country's most valuable natural resources. Because of the large number of endemic plants and animals, the country has the title of having the highest biological endemism rate in the world. Nearly 3,300 square miles of land in Sri Lanka have been designated as Wildlife Protected Areas by the government.