What Led To Sri Lanka's Worst Economic Crisis In Recent History, What Is The Way Forward?

Sri Lanka is facing an acute economic and energy crisis triggered due to a shortage of foreign exchange. A sudden rise in prices of key commodities and fuel shortage forced tens of thousands of people to queue for hours outside petrol pumps.

A Sri Lankan bus worker carries empty containers searching for fuel in Colombo, Sri Lanka

Two elderly men reportedly fainted on Sunday in Sri Lanka while waiting in a queue to secure fuel amid sky-rocketing prices leading to record inflation. Sri Lanka on Tuesday deployed military personnel at state-run petrol pumps to monitor and manage fuel distribution amid a shortage that led to long queues of consumers outside petrol pumps.

The island nation is facing an acute economic and energy crisis triggered due to a shortage of foreign exchange. A sudden rise in prices of key commodities and fuel shortage forced tens of thousands of people to queue for hours outside petrol pumps. People are also facing long hours of power cuts daily.

Energy minister Gamini Lokug said to reporters, “We decided to deploy military personnel at petrol sheds to tackle unwanted situations where people are taking fuel in cans to do business. They will ensure that fuel is being distributed fairly amongst the people."

Sri Lanka's economy was facing "mounting challenges" with public debt reaching "unsustainable levels". In early March, the International Monetary Fund (IMF) called for urgent reforms in the island nation's economy as it is facing the worst economic crisis. Sri Lanka is currently reeling under a severe foreign exchange crisis with falling reserves and the government is unable to foot the bill for essential imports.

Why is Sri Lanka facing an increasing economic crisis?

Sri Lanka has been hit hard by the Covid-19 pandemic. On the eve of the pandemic, the country was highly vulnerable to external shocks owing to inadequate external buffers and high risks to public debt sustainability, exacerbated by the Easter Sunday terrorist attacks in 2019 and major policy changes including large tax cuts at late 2019," the IMF said in a release after global lender's executive board's consultative meeting held on February 25, early this year.

The acute shortage of US dollars in the country has pushed up the price of basic food items including milk, that are essential for regular meals and food businesses. The country is facing a double whammy of increasing prices and high external debt.

In September 2020, Sri Lankan President Gotabaya Rajapaksa announced an economic emergency. It allowed the government to take control of the supply of basic food items and set prices to control rising inflation, which spiked to 14.2% in January 2021.

According to economists, Sri Lanka’s debt spiral was already on an unsustainable path even before the pandemic dried up the tourism funds.

In an interview with CNBC,  Dushni Weerakoon, executive director at the Institute of Policy Studies of Sri Lanka said that successive Sri Lankan governments have been issuing sovereign bonds since 2007 without any plan of how to repay the loans. Further, reserves were built by borrowing foreign funds rather than a high earning through export services. This only exacerbated the foreign debts of the country.

The report further states that the Sri Lankan government spent the foreign currency on repaying the debt and the central bank has been running down foreign exchange reserves to prop up the Sri Lankan rupee. As a result, there is not much foreign currency left to repay the debt, causing inflation to rise to double digits.

Along with that, with the pandemic, the tourism sector completely dried up in an already weakening economy. This caused a slash in government revenue. The tax cuts in 2019 made the situation worse pushing the economy to further worsen.

Sri Lanka’s public debt is projected to have risen from 94 per cent in 2019 to 119 per cent of GDP in 2021.

What are economists and experts saying?

According to a report, the country’s official reserves fell by $779 million to $2.36 billion in January. In December 2021, it was at $3.1 billion.

Despite the ongoing economic recovery, directors noted that the country faces mounting challenges, including public debt that has risen to unsustainable levels, low international reserves, and persistently large financing needs in the coming years, the release said.

The IMF has also called for urgent reforms to the island's economy. Analysts say that the government’s next big challenge is to repay the $1 billion bonds due in July.

Directors emphasised the need for an ambitious fiscal consolidation that is based on high-quality revenue measures. Noting Sri Lanka's low tax-to-GDP ratio, they saw scope for raising income tax and VAT rates and minimising exemptions, complemented with revenue administration reform.

The bleak picture of the local economy has come in at a time when the government here is coming under increased pressure to seek an IMF bailout as the island's foreign reserves have hit a critical low. Analysts said the country needs to either restructure the debt or go to the International Monetary Fund for a relief package.

However, the government has steadfastly refused to resort to the IMF even in the backdrop of the ongoing energy and power crisis and shortages of almost all essentials and medicine. Instead, it has approached India and China for financial aid.

India announced a $1 billion line of credit to Sri Lanka as part of its financial assistance to help the island nation deal with its economic crisis. After an agreement to extend the line of credit was inked, Ministry of External Affairs (MEA) spokesperson Arindam Bagchi said India has always stood with the people of Sri Lanka and will continue to extend all possible support to the country.


Protests to oust President

Mass protests have been roiling the country as it faces one of the worst economic crises. Anti-government protests have demanded the resignation of  President Gotabaya Rajapaksa over economic woes.

Demonstrators accused the government of mismanaging the economy, making the public face the brunt of fuel shortage along with the shortages of cooking gas, milk powder and medicine.

(with agency inputs)