Sri Lanka’s Economic Crisis: Lessons and Opportunities

 

Pic courtesy internet

Sri Lanka is suffering its worst economic crisis since its independence from Britain in 1948. Her foreign exchange reserves have depleted to about $2 billion and the debt obligations to be paid back this year have risen to about $7 billion.

Chaotic Situation

 

• The island nation is battling multi-year high inflation, a shortage of food and essentials, and a political conundrum.

 

• People in Sri Lanka have been queuing up outside fuel pumps and grocery stores to buy essentials, which are in scarcity in the country.

 

• Blackouts round the clock and deadly fights over essentials have become a norm lately.

 

• Protests started over rising prices and shortages, have flared up and have grown in size and spread across the country.

 

• Clashes are taking place between the ruling party’s supporters and the anti-government protest camp in the commercial capital Colombo, causing death and destruction.

 

• The President had to impose an emergency in the country, for the second time in less than two months. The PM had to resign.

 

Possible Reasons for Economic Crisis

 

• Superfluous Projects. Sri Lanka has spent big on questionable infrastructure projects backed by Chinese loans that added to its already unsustainable debt.

 

• Populist measures: Tax Cuts. In 2019, the biggest tax cuts were unveiled in the history of Sri Lanka. This further worsened chronic budget deficits.

 

• Debt and Default. In April, Sri Lanka announced it would default on its $51 billion foreign debt to save money for essential imports. The move failed to shore up Sri Lanka’s deteriorating finances.

• Spiraling Debt. Rating agencies soon downgraded the country out of concern that the public debt was spiraling out of control. And it became harder for the government to secure new loans.

 

• ​ Pandemic. A few months after the tax cuts, lockdowns due to Covid happened. International tourist arrivals dropped to zero. Remittances from Sri Lankans working abroad dried up. Easter bombings further added to the decline in tourism.

 

• ​Fertiliser Ban. With foreign reserves dwindling fast, authorities banned several imports in 2021, including fertiliser and agricultural chemicals. About a third of the country’s agricultural fields were left unplanted by farmers. It hit the production of tea, a vital export earner.

 

• Food and Fuel Shortage. With shrinking reserves, traders began struggling to source foreign currency to buy imported goods. Rice, lentils, sugar, and milk powder began disappearing from shelves, forcing supermarkets to ration them. Then gas stations started running out of petrol and kerosene.

 

Pic courtesy: wion

Opportunity

New PM has taken over. The Indian government has so far helped Sri Lanka with billions of dollars of aid to fulfill its essential needs. China has also helped the country by restructuring some of its debt. The Sri Lankan government is also seeking help from the IMF.

 

In this period of economic uncertainty, however, there is an opportunity for India to repair and restore the traditional relationship it had with its island neighbor.

 

Indian Concern. India-Sri Lanka ties took a downward turn in the last two odd decades, with Sri Lanka moving into the Chinese camp. It firmed up a series of agreements with China (including a $1.35-billion deal to construct the coal-fired Lakvijaya Power Plant in Puttalam, and the controversial Hambantota Port). Sri Lanka eventually lost the Hambantota Port when it began to struggle with the repayment of loans. It resulted in the Port and more than 15,000 acres of land being handed to Beijing in a 99-year lease. India was right to worry when the leases gave China an advantage for using it as a possible strategic military port for its Indian Ocean fleet.

 

Realisation. Sri Lanka’s ambitions for a lucrative future, conveniently financed by Chinese loans, have been upset by the downturn in the Sri Lankan economy. Sri Lanka has realised the limits of economic and strategic cooperation with China the hard way. Furthermore, the Sri Lankan leadership has realized that India has always stepped in when Sri Lanka needed it, and the relationship with China could not be at the expense of India. To alleviate India’s concerns, Sri Lanka is trying now to balance its relations with India.  

 

Magnanimous Approach.  As Sri Lanka struggles, India should embrace the spirit of ‘Neighbourhood First’ and restore the image of a traditional partner with Sri Lanka. India should extend support through supplies of food, medicine, and other essential goods. India has provided Colombo with a $1 billion line of credit for food, medicine, and other essential items and $500 million worth of fuel. It should not look for economic concessions or burden Colombo with additional debt, but jointly assist the island to recover from the economic devastation.

 

Focus.  Indian assistance should be focused on humanitarian assistance, capacity-building, human resources development, infrastructure development, agricultural development, and financial management.

 

Lessons

 

• Formulation and implementation of sound Economic Policies is the most important task of governance.

 

• Populist economic policies are harmful when used for political gains.

 

• Equitable growth is essential for stability in the country (Rising tide should lift all types of boats equally). Gini Index should be watched closely.

 

• IMF still has relevance and is beneficial if approached early for assistance. The austerity policies that the IMF demands (including public expenditure cuts, higher taxes, a floating exchange rate, removal of subsidies, etc), maybe politically unpopular but are beneficial in the long run.

 

• Dissent and disagreement are essential elements of democratic discourse, and when that is suppressed one can be sure of a decline.

 

• An atmosphere of nepotism is harmful to the economy and sound democratic governance.

 

• While a strong macroeconomic and financial regulatory structure is necessary, a crisis management mechanism and capability are equally essential. Professional advice should be sought on different matters.

 

• An effective and reliable public communication system is essential to avoid the spread of misinformation.

 

Bottom Line

A strong economy is essential for development and survival.

 

Question

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