Sri Lanka is in the midst of a severe economic crisis, with dwindling reserves and the government unable to afford the cost of essential imports. In 2021, the Sri Lankan government declared an economic emergency due to rising food prices, falling currency and rapidly depleting foreign exchange reserves.
What’s going on in Sri Lanka?
In a chilling event over the weekend, two men collapsed and died while waiting in different queues to buy petrol, police said, local media reported. The government ordered forces to prevent violence from erupting at petrol stations on Tuesday March 22, when spontaneous protests erupted among vehicle owners queuing for petrol.
Amid this economic nightmare, Sri Lanka’s central government has turned to India and China for help as it tries to pull the country out of crisis and calm public opinion. The disintegration of the country’s economy is mainly due to a lack of foreign exchange, which has led to a sharp drop in imports of necessary goods.
The reason for the Sri Lankan economic crisis
Sri Lanka is heavily dependent on imported products. Among other necessities, it imports fuel, food, paper, sugar, lentils, medicine and transport equipment. Due to a lack of foreign liquidity, the country is unable to purchase (import) certain goods. Imports are so crucial that the government has had to postpone exams for millions of students due to a lack of printing paper. Here are the five points that have hit Sri Lanka’s economy hard:
- The pandemic has weighed on the country’s tourism economy, which accounts for 10% of GDP. Due to the currency issue, several countries including Canada have recently imposed travel restrictions on their citizens when visiting the island country. Such reviews from other countries have a negative impact on businesses. The UK, India and Russia are the main sources of tourism entering the island nation.
- The government’s decision to ban the use of chemical fertilizers in order to switch agriculture to 100% organic has had a negative economic impact. Experts predict that this legislation would have a tragic effect on agricultural development as organic farming halves production. Additionally, the rising cost of staples like rice and sugar, allegedly due to hoarding by the “food mafia”, has exacerbated the challenges.
- A heavy external debt burden of around $5 billion with China alone is a major contributor to this crisis. Sri Lanka is repaying a billion dollar loan acquired from Beijing in 2021. It also owes a large sum of money to India and Japan. The country’s foreign exchange reserves stood at around $1.58 billion in November, up from $7.5 billion when Gotabaya Rajapaksa took office in 2019.
- Currency supply was affected when foreign exchange reserves fell from over $7.5 billion in 2019 to around $2.8 billion in July 2021, increasing the amount of money Sri Lankans owed pay to buy the currency needed to import goods. As a result, the value of the Sri Lankan rupee fell.
- Sri Lanka’s reliance on imports of essential goods like sugar, pulses, grains and pharmaceuticals has compounded the country’s problems as the country lacks foreign currency to pay for import expenses.
According to Ashoka Ranwala, president of the Petroleum General Employees’ Union, the situation in Sri Lanka is so bad that the government had to shut down its only fuel refinery because it ran out of crude oil. Inflation, which topped 15.1% last month, is wreaking havoc on the economy. Food inflation soared to 25.7%, according to government figures. For example, the price of a 400 gram package of milk rose $0.90 over the weekend.
In addition, Laugfs Gas, Sri Lanka’s second-largest gas supplier, on Sunday raised costs by 1,359 rupees ($4.94) for a 12.5-kilogram cylinder, according to a company statement. The current economic crisis in Sri Lanka is caused by a shortage of foreign exchange or a balance of payments (BOP) crisis. Simply put, the BOP is the difference between all the money that has entered the country and all the money that has left the country during a given period of time.
Prime Minister Mahinda Rajapaksa revealed last week that the country would have a $10 billion trade deficit in his address to the nation. This means that Sri Lanka imported more than it exported last year. As a result, outflows of money exceed inflows, resulting in a shortage of foreign currency over time.
Sri Lanka Tourism & Forex
After the series of terrorist attacks in Colombo in 2019, tourism was already in decline. The COVID-19 outbreak has exacerbated the situation. As a result, sectors of the economy that generate foreign currency have been decimated, leading to a decrease in the inflow of foreign currency, which is used to conduct import transactions.
Due to COVID-19, even key export destinations like China and European Union countries have faced trade difficulties, which has reduced Sri Lanka’s foreign exchange earnings. Another consideration is FDI (foreign direct investment) (FDI). FDI in Sri Lanka fell to $548 million in 2020, according to government figures, from $793 million in 2019 and $1.6 billion in 2018.
When foreign direct investment (FDI) in a country decreases, so does the foreign money in the country’s reserves. Sri Lanka is also refusing to accept a loan from the International Monetary Fund (IMF). Ajith Nivard Cabraal, the central bank governor, told reporters in January that “the IMF is not a magic wand.” He said, “Right now the other options are better than going to the IMF. He was referring to China when he said “other options”.
China has been Sri Lanka’s largest bilateral lender and source of FDI for the past two decades, but the latter’s debt to the former has reached over $2 billion and is due in 2022. In Conclusion , Sri Lanka is experiencing a shortage of foreign currency, which is severely limiting its ability to import crucial goods. The recent failure of the tourism industry, the inability to attract adequate FDI and the refusal to take out an IMF loan are all contributing factors to the current crisis.