Economic Crisis of Sri Lanka

 

Opening Statement

 

Sri Lanka’s government declared an economic emergency to deal with foodstuff shortages and to contain soaring inflation.

 

Everyday life for people in Sri Lanka has become a major challenge. Essentials like food, medicine and fuel are much more expensive – and that is, if they are even available. The COVID-19 pandemic and a recession are being blamed, while a dramatic fall in the value of the Sri Lankan rupee is making things worse. The island nation depends largely on imports for its food, and a weaker currency means they are now costlier. Government has announced an economic emergency in a bid to ease the burden for millions of families and has empowered authorities to seize stocks of staple foods and set their prices amid the forex crisis.

 

Economic Overview of Sri Lanka 

 

The free-market economy of Sri Lanka was worth $84 billion by nominal gross domestic product (GDP) in 2019 and $296.959 billion by purchasing power parity (PPP). The country had experienced an annual growth of 6.4 percent from 2003 to 2012, well above its regional peers. This growth was driven by the growth of non-tradable sectors, which the World Bank warned to be both unsustainable and unequitable. Growth has slowed since then. In 2019 with an income per capita of 13,620 PPP Dollars or 3,852 (2019) nominal US dollars.

 

After Independence

 

Sri Lanka was ahead of many Asian nations and had economic and social indicators comparable to Japan when it gained independence from the British in 1948.

Sri Lanka's social indicators were considered "exceptionally high". Literacy was already 21.7% by the late 19th century. A Malaria eradication policy of 1946 had cut the death rate from 20 per thousand in 1946 to 14 by 1947. Life expectancy at birth of a Sri Lankan in 1948 at 54 years was just under Japan's 57.5 years.

 

With its strategic location in the Indian Ocean Sri Lanka was expected to have a better chance than most other Asian neighbors to register a rapid economic take-off and had "appeared to be one of the most promising new nations."

But the optimism in 1948 had dimmed by 1960.

Sri Lanka had inherited a stable macro-economy at independence. A central bank was set up and Sri Lanka became a member of the IMF entering the Bretton Woods system of currency pegs on August 29, 1950. By 1953 exchange controls were tightened with a new law.

 

The economy was then progressively controlled and relaxed in response to foreign exchange crises as monetary and fiscal policies deteriorated. Controls and restrictions in 1961-64 were followed by partial liberalization in 1965-70.

Controls were tightened in 1970 to 1977 alongside the collapse of the Bretton Woods system.

 

In sum it was a story of tightening partial relaxing, and again tightening the trade regime and associated areas to over a perceived foreign exchange crisis.

 

In the early 1960s strategy for dealing with the foreign exchange crisis was the gradual isolation of the economy from external market forces. It was the beginning of a standard import-substitution industrial regime with all the controls and restrictions associated with such a regime and state intervention in economic activities was common.

 

Post-1977 period

 

In 1977, Colombo abandoned static economic policies and its import substitution industrialisation policy for market-oriented policies and export-oriented trade.

 

Between 1977 and 1994 the country came under UNP rule in which under President J.R Jayawardana Sri Lanka began to shift away from a socialist orientation in 1977. Since then, the government has been deregulating, privatizing, and opening the economy to international competition.

 

In 2001, Sri Lanka faced bankruptcy, with debt reaching 101% of GDP. The impending currency crisis was averted after the country reached a hasty ceasefire agreement with the LTTE and brokered substantial foreign loans.

 

After 2004 the UPFA government has concentrated on mass production of goods for domestic consumption such as rice, grain and other agricultural products however twenty five years of civil war slowed economic growth, diversification and liberalisation, and the political group JVP uprisings, especially the second in the early 1980s, also caused extensive problems.

But after the end of the JVP , increased privatization, economic reform, and a stress on export-oriented growth helped improve the economic performance, increasing GDP growth to 7% in 1993.

 

Post civil war period

 

Pre 2009 there was a continuing cloud over the economy with the civil war and fighting between the Government of Sri Lanka and the LTTE. However the war ended with a resounding victory for the Sri Lankan Government on 19 May 2009 with the total elimination of the LTTE.

As the civil war ended in May 2009 the economy started to grow at a higher rate of 8.0% in the year 2010 and reached 9.1% in 2012 mostly due to the boom in non-tradable sectors.

However, the boom didn't last and the GDP growth for 2013 fell to 3.4% in 2013 and only slightly recovered to 4.5% in 2014.

Sri Lanka's tax revenues per GDP also increased from 10% in 2014 which was the lowest in nearly two decades to 12.3% in 2015.

Despite reforms, Sri Lanka was listed among countries with the highest risk for investors by Bloomberg. 

Growth also further slowed to 3.3% in 2018 and 2.3% in 2019. The rupee fell from 131 to the US dollar to 182 from 2015 to 2019, inflating foreign debt and slowing domestic consumption ending a period of relative stability.

China became a top creditor to Sri Lanka over the last decade, overtaking Japan and the World Bank.

 

 

 

What Started the Economic Crisis?

Amid the COVID-19 pandemic, Sri Lanka’s economy contracted by 3.6 percent in 2020, the worst growth performance on record, as is the case in many countries fighting the pandemic. Swift measures enacted by the government in the second quarter helped contain the first wave of COVID-19 successfully, but these measures hit sectors like tourism, construction, and transport especially hard, while collapsing global demand impacted the textile industry. Job and earning losses disrupted private consumption and uncertainty impeded investment. The economy began to recover in the third quarter as the first wave was brought under control and containment measures were relaxed. The momentum continued in the fourth quarter as the economy was broadly kept open despite the second wave of COVID-19 infections.

The government took proactive measures to mitigate the impact of the pandemic. Despite limited fiscal space, resources were allocated (approximately 0.7 percent of GDP) for health measures, cash transfers, and postponed tax payments. While public expenditures increased, revenues declined, resulting in a widening of the fiscal deficit in 2020.

Due to the economic contraction and the elevated fiscal deficit amid COVID-19, public and publicly guaranteed debt is estimated to have increased to 109.7 percent of GDP. In line with the government strategy to reduce external debt over the medium term, debt financing relied increasingly on domestic sources.

 

 

 

The Central Bank of Sri Lanka (CBSL) significantly contributed to the crisis response. It undertook considerable monetary policy easing and additional measures to increase liquidity in the market and support businesses. It also introduced financial sector regulatory measures, like a debt moratorium for COVID-19 affected businesses and individuals.

However, despite these efforts, bank lending to the private sector remained low. By contrast, credit to the government and state-owned enterprises surged and accounted for 80 percent of the total credit in 2020. The pandemic likely worsen pre-existing financial sector vulnerabilities.

An improved trade balance and strong remittance inflows narrowed the current account deficit. A sharp drop in imports in 2020 more than offset the decline in exports. However, with financial inflows insufficient to meet external liabilities, reserves declined to an 11-year low in February 2021, before a currency swap worth US$ 1.5 billion with the People’s Bank of China was approved in March 2021. Due to a shortage of foreign currency, the exchange rate depreciated by 6.5 percent from January through March 17, 2021.

 

Main reasons behind the Economic Crash 

 

•      The tourism industry, which represents over 10% of the country’s Gross Domestic Product and brings in foreign exchange, has been hit hard by the coronavirus pandemic. As a result, forex reserves have dropped from over $7.5 billion in 2019 to around $2.8 billion in July this year. [ Drop of $4.7 billion ]
•      With the supply of foreign exchange drying up, the amount of money that Sri Lankans have had to shell out to purchase the foreign exchange necessary to import goods has risen. So the value of the Sri Lankan rupee has depreciated by around 8% so far this year.

 

•     It has to be noted that the country depends heavily on imports to meet even its basic food supplies. So the price of food items has risen in with the depreciating rupee.
•    The government’s ban on the use of chemical fertilizer in farming has further aggravated the crisis by dampening agricultural production. Earlier this year, Mr. Rajapaksa made public his plan to make Sri Lanka the first country in the world with an agriculture sector that is 100% organic. But many people believe that the forced push towards organic farming could halve the production of tea and other crops and lead to a food crisis that is even worse than the current one.

 

Steps taken by Government to tackle the Economic Crisis 

 

•     The Sri Lankan government has blamed speculators for causing the rise in food prices by hoarding essential supplies and has declared an economic emergency under the Public Security Ordinance.
•      The army has been tasked with the duty of seizing food supplies from traders and supplying them to consumers at fair prices.
•      It has also been given the powers to ensure that forex reserves are used only for the purchase of essential goods.
•    The government has refused to end its aggressive push for complete organic farming claiming that the short-term pain of going organic will be compensated by its long-term benefits. It has also promised to supply farmers with organic fertilizer as an alternative. 
•    Sri Lanka’s central bank earlier this year prohibited traders from exchanging more than 200 Sri Lankan rupees for an American dollar and stopped traders from entering into forward currency contracts.

 

My Opinion 

 

An Economic crisis is like a volcano, it does not explode in one day but it takes years to build up the pressure inside it and after that a small earth quick can trigger the explosion.

The same scenario applies to Sri Lanka. For years it was building up the pressure like - slow economic growth, increase in debt, unfavorable BOP, etc. the Covid was just a small earth quick which triggered the whole economic crisis.  

The International Monetary Fund has recently stepped in to provide an emergency relief package worth $787 million. Government should use the relief package carefully and ensure that the public is not deprived from any basic necessities.  

Thank You

 

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