Sri Lanka’s economic emergency: the crisis unnoticed

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Posted on October 13, 2021 | Author Dr RAJAN KATOCH

Sri Lanka recently imposed an economic emergency. It is in the throes of a major economic crisis. The crisis has not received much media attention. Most of us are not even aware that something abnormal is going on there.

So what is the crisis?

Sri Lanka’s gross domestic product (GDP) fell 3.6%. Foreign exchange reserves have grown from US $ 7.5 billion in 2019 to US $ 2.8 billion today. In return, foreign debt repayments of around $ 4 billion are due this year. International rating agencies have downgraded Sri Lanka’s outlook to reflect a long-term outlook for external debt default.

There is not enough foreign exchange available to meet Sri Lanka’s import needs. Imports had to be reduced, even of basic necessities. There are endemic shortages of food and basic necessities. To deal with the situation, President Gotabaya Rajapaksa declared an economic emergency on August 31 and imposed price controls. It doesn’t seem to have worked. Just days ago, the president admitted that the government was “not delivering” and removed price controls, causing prices to rise sharply.

What led to this crisis? Three factors are important.

The first is the disruption caused by the covid pandemic. Currently, the third wave is raging across the country and a national lockdown is in effect until October 1. The main setback was suffered by the tourism sector, which accounted for around 20% of export earnings during the pre-pandemic period.

Many tourism dependent countries are similarly affected, some more than others. Until tourism resumes, this factor will remain and will have a severe impact on the Sri Lankan economy.

The second (strangely) is a new agricultural initiative. On April 29 of this year, the government decided that Sri Lankan agriculture would become 100% organic. One would have thought that switching to organic farming would be welcome. But this decision was made applicable with immediate effect. All imports of fertilizers and pesticides have been completely banned. No transitional period has been foreseen.

The main tea, rubber and paddy crops are hard hit by this drastic new policy. Cultivation of tea and rubber previously relied heavily on chemical fertilizers and pesticides. Tea exports alone account for around 10% of total export earnings. For the current year, some plantation owners estimate that there could be a 50% drop in production due to the sudden switch to organic farming. Likewise, paddy yields from the staple food crop are also expected to decline.

The reduction in domestic production coupled with the lack of foreign exchange to import food and basic necessities has resulted in shortages. Rice, sugar, potatoes, onions, palm oil, kerosene, cooking gas are said to be in short supply.

Some agricultural experts and environmentalists claim that Sri Lanka’s organic farming policy will have long-term benefits. They might be right. The government’s intentions may have been lofty, but the sudden and brutal implementation hit the economy hard. As a result, the immediate reality is that in the midst of a pandemic, people are also struggling to meet their daily needs, and there are no easy solutions in sight.

The third factor is the Government’s policy on external financing. In particular, over the years there has been an increasing dependence on Chinese funding for development projects to the exclusion of other options. China has made a commitment, with loans on relatively strict conditions. Sri Lanka already owes China $ 5 billion, or more than 10% of its total foreign debt.

There are alternatives to multilateral financing, for example the International Monetary Fund (IMF) lends funds to countries on favorable terms to overcome short-term balance of payments difficulties. The World Bank and other development banks provide financing for development projects on better terms than the market. The Sri Lankan government decided not to seek help from the IMF, preferring instead more expensive Chinese financing.

This despite the fact that Sri Lanka has already been burned by its preference for usurious Chinese support. A striking example is the case of the Port of Hambanbota, which was originally financed with a Chinese loan. Only seven years after its inauguration, Sri Lanka has found itself unable to repay or repay the Chinese loan. He had to settle the debt by ceding the port to a Chinese-controlled company with a 99-year lease!

Nonetheless, Sri Lanka has again requested and hopes to secure additional financial support of $ 1.5 billion from China to deal with this year’s crisis!

Little noticed by the outside world, Sri Lanka is sinking into an economic quagmire.

What does this mean for India?

As it seems, although the pandemic has hit the island hard, the biggest economic mess it finds itself in is largely on its own initiative. He made conscious political choices that accelerated the slide. Should we then let Sri Lanka settle the crisis on its own?

Leaving Sri Lanka to face its crisis alone is not really an option for us. Sri Lanka is a close neighbor with which we must remain engaged.

The Sri Lankan government appears to have encouraged Chinese participation in the economy. Partly because of this, Sri Lanka is caught between a currency tightening and the external debt trap. However, this resulted in the strategic dimension of the relationship becoming more important. India needs to keep up with investment and financial support. This indeed appears to be the effort, as indicated by the announcement of a recent investment pledge of $ 700 million by the Adani Group for the construction of a new terminal at the port of Colombo. Indian Foreign Minister Harsh Shringla’s extended visit to Sri Lanka last week also appears to have been aimed at boosting economic reach.

As we have seen, the situation is dramatic. Sri Lanka will find it difficult to extricate itself from the economic quicksand in which it currently finds itself. India will still have to be part of the solution, because Sri Lanka’s geography will always be important to India. A stop-go approach such as it has been adopted in the past does not make sense in the current context. The strategic dimension is here to stay. And it is in this context that efforts must be and are being made.

We can only hope that these efforts are successful.

(The author is a former public servant and a regular contributor to RK)


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