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Sri Lanka is teetering on the edge of a financial collapse: Understanding the island nation’s worst economic crisis in its history

India had extended a $1.5 billion credit line for the purchase of 40,000 tonnes of diesel. Meanwhile, Sri Lanka had sought an additional $1 billion credit line for importing essential items.

Sri Lanka is faced with the worst economic crisis in its history, with inflation reaching a record high of 17.5% in February 2022. The residents of the island nation are struggling with an acute shortage of food, and cooking gas. Power cuts are frequent and people are seen standing in long queues in the National Capital for buying diesel fuel.

The government, headed by President Gotabaya Rajapaksa, has been seeking credit lines from countries such as India, China and even Bangladesh for purchasing milk powder and diesel. The situation is so grim that the central bank is forced to buy oil from Iran by bartering tea leaves.

Opindia had earlier reported how schools in the western province of Sri Lanka were forced to postpone the exams of their students because the country had run out of printing paper. Due to a shortage of US dollars, it had become impossible to finance the imports.

Aggrieved by the financial crisis in the island nation, a group of 6 had set sail for India from Sri Lanka. They were later rescued by the Indian Coast Guard. In a bid to fix the situation, the Rajapaksa government is closing down embassies, scheduling power cuts, selling prime real estate and converting US dollars to Sri Lankan rupees.

Disastrous economic policies of the Rajapaksa regime

These temporary measures, however, are unlikely to solve the economic distress caused to Lankans. “We’ve really hit rock bottom,” remarked Paikiasothy Saravanamuttu of the Center for Policy Alternatives. Chairman of think tank Advocata Institute, Murtaza Jafferjee, said, “Sri Lanka’s economy is experiencing multiple organ failure, and sepsis has set in.”

According to policy analyst K Don Vimanga, the root cause of the current economic crisis lay in the trade liberalisation of 1977. He explained that Sri Lanka had been suffering from a combination of factors, including large deficits in the budget, tax cuts and macroeconomic instability.

“The country could not refinance maturing debts or finance the current account deficit that was growing rapidly due to fiscal expansion. They then tried to fix the exchange rate and control imports, which have led to the shortages,” he emphasised.

People stand in long queues to buy kerosene, images via Twitter/@seanjgleeson

Although President Gotabaya Rajapaksa and his brother Prime Minister Mahinda Rajapaksa have pinned the blame on the past governments, experts believe that the ongoing crisis is the result of policy errors made by the Rajapaksa regime between 2005 and 2015.

In that 10 year period, Sri Lanka amassed large debt in the hopes of turning the island nation into Singapore. The government spent lavishly on ambitious infrastructure projects. However, most of them failed to garner private investments and had to be stalled such as Hambantota Port and the Ceylon Electricity Company.

This created a political crisis for the following government of President Maithripala Sirisena. After being faced with pricey loan repayment, the Sirisena administration restructured the loans into cheap long-term debts. This helped Colombo rake up foreign reserves up to $7.5 billion.

The island nation also posted a budget surplus during his tenure. However, things quickly changed after Rajapaksa returned to the power corridors. Today, yields on the country’s sovereign debt have risen to 16% from 7%.

Import ban and tax cuts proved fatal

Gotabaya Rajapaksa banned the import of spices, chemical fertilisers and luxury vehicles in the hopes of encouraging domestic production, protecting foreign exchange reserves and boosting exports. It must be mentioned that Sri Lanka has traditionally been an import-dependent country and the abrupt policy reversal led to economic problems.

Prior to the ban, the island nation was annually importing vehicles and chemical fertilisers worth $1.5 billion and 400 million respectively. The administrative action failed to meet its objectives. The sprawling apparel industry of Sri Lanka had crippled due to the import ban on essential supplies and raw materials.

While speaking about the matter, Economics Professor Kopalapillai Amirthalingam said, “When imports are stopped, how can we ensure quality in exports? Sri Lanka depends on imports for raw materials.” Far from protecting foreign exchange reserves, the Rajapaksa government had to sell its gold reserves by mid-January this year.

Economist R Ramakumar had tweeted, “Sri Lanka had one of the lowest indirect tax rates in the world prior to the pandemic. This led to a major fall in indirect tax revenues. GST/VAT revenues fell from 443,877 LKR million in 2019 to 233,786 LKR million in 2020 i.e., by close to 50%.”

“We have been spending beyond our means for years,” remarked Professor Ahilan Kadirgamar of the University of Jaffna. The situation was further aggravated by an unprecedented tax cut, which reduced the number of registered Sri Lankan taxpayers by almost 35%.

In the aftermath of the decision, revenues plummeted to an all-time low of 9% of the Gross Domestic Product (GDP). According to Parliamentarian Patali Champika Ranawaka, the tax cut by the Gotabaya administration derailed Colombo’s financial situation and led to debt repayment at ‘a huge social cost’.

Covid-19 and the blow to Sri Lanka’s tourism century

The Coronavirus pandemic, which originated in the Wuhan province of China, had restricted people to their homes. This proved fatal for the tourism industry across the globe, especially in Sri Lanka where tourism is a key source of foreign exchange.

Economist R Ramakumar had explained that the 2019 Easter bomb blast, which claimed about 253 lives, led to a decline of 18% in tourist footfall in the island nation.

The decline in tourist footfall in Sri Lanka, graph via Twitter (@ramakumarr)

“The pandemic caused tourism revenues to fall from $7.5 billion in 2019 to $2.8 billion last year. Just as the sector was limping back to normalcy, the Russia-Ukraine war has come as a major setback. A significant portion of foreign tourists who visit Sri Lanka are from Russia, Ukraine and Belarus,” reported The Week.

Sri Lankan officials are hopeful that the tourism industry will revive again and help ease the economic crisis. While speaking about the matter, Centra Bank governor Ajith Nivard Cabraal remarked, “We know that this difficulty that we’re facing is mainly because of the tourism receipts not being there. If the tourism receipts had been there, notwithstanding the Covid debacle, nobody would have been talking about I.M.F.”

Organic farming and the final death knell

During his 2019 election campaign, Sri Lankan President Gotabaya Rajapaksa had vowed to transform the country’s agriculture sector into 100% organic. On April 26. 2021, he imposed a complete ban on the import of chemical fertilisers. The objective was to save import costs and the environment at the same time.

The ban coincided with the Wuhan Coronavirus pandemic. Many experts had warned the government that such a move could lead to food scarcity. Interestingly, the move was supported by both liberal groups and Christian churches.

“Sri Lanka’s organic farming policy was a disaster. In most countries, agriculture held up during the pandemic. But it was the opposite in Sri Lanka. According to IMF, there was a “worse-than-anticipated impact of the chemical fertilizer ban on agricultural production,” economist Ramakumar had pointed out.

Moreover, tea and paddy cultivation took a severe blow and the output of vegetables, pepper and cinnamon shrunk by over 30%. By the time the Rajapaksa government intervened, it was already late. The island nation had lost about 50% of its production capacity.

As per a report in Al Jazeera, 1/3rd of all agricultural land became dormant in the immediate aftermath of the fertiliser ban. Today, Sri Lanka is forced to import white and parboiled rice from Myanmar, India and China. The country is dependent more than ever on foreign countries for staples that it once excelled in production.

Professor Saman Dharmakeerthi of the University of Peradeniya had said, “The ban led to a reduction in yield, which went down by 25 per cent. Organic agriculture, being low-yielding, is land-intensive. The crops may be resilient, but they cannot feed a growing population when cultivable land is shrinking”

India reaches out to Sri Lanka in testing times

Amidst the economic crisis in Sri Lanka, India has extended a helping hand to the island nation. On Tuesday (March 29), it had come to light that surgeries were suspended at the Peradeniya hospital due to a shortage of medicines.

India’s Minister for External Affairs, S Jaishankar, had called upon the Indian embassy in Sri Lanka to make necessary provisions for the hospital.

India had extended a $1.5 billion credit line for the purchase of 40,000 tonnes of diesel. Meanwhile, Sri Lanka had sought an additional $1 billion credit line for importing essential items.

The EAM arrived in Srilanka on March 27 to hold bilateral talks with Prime Minister Mahinda Rajapaksa, President Gotabaya Rajapaksa and other ministers in the cabinet. On Tuesday (March 29), Dr Jaishankar participated in the 18th BIMSTEC (Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation) Ministerial Meeting in Colombo.

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Dibakar Dutta
Dibakar Dutta
Fascinated by Indian politics

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