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Sri Lanka’s Economic Crisis

  • Category
    Economy
  • Published
    5th Apr, 2022

Context

Refugees arriving in Tamil Nadu from Sri Lanka due to economic crises developing in the island country.

About

What type of economic crises is Sri Lankan facing?

  • Sri Lanka is facing the Balance of Payment (BoP)

What does Balance of Payment crises mean?

  • BOP is the difference between all the money that has entered the country during a particular period of time and all the money that has left the country during that same period.
  • It has to be understood that money which enters and moves out of a country is in foreign currency (mostly US Dollars).
  • Hence, more money moving out of the country than coming in implies depletion of country’s foreign currency reserves.
  • These reserves are important for a country because payment for imported goods can only be done through foreign currency.

What are the reasons for Balance of Payments crises surfacing in Sri Lanka?

  • Sri Lanka’s economy and its foreign currency revenue to large extend depends on tourism, which has received a severe beating in the recent times.
  • The 2019 serial blast in Sri Lanka had caused decline in the arrival of foreign tourist in the country.
  • Global pandemic of Corona has further decimated the tourism industry.
  • The pandemic also did not allow Sri Lankan labourer to travel outside the country were they are employed (mostly gulf countries), thus impacting the foreign currency earned by Sri Lanka through the way of remittances.

Remittance: It is a non-commercial transfer of money by a foreign worker, a member of a diaspora community, or a citizen with familial ties abroad, for household income in their home country or homeland. 

Remittances are transferred to the recipient country in the form of foreign currency and are then converted into local currency before reaching the intended beneficiaries.

They therefore become the source of foreign currency reserve for the recipient country.

  • The Sri Lanka Central Bank in its zeal to make its currency stronger vis-à-vis US, sold off a major portion of its foreign currency assets.
  • The above step not only deleted foreign currency reserves of Sri Lanka but it also made the country’s exports uncompetitive in international market.

For the purpose of making indigenous currency stronger, countries sell their foreign currency. 

In the world market, goods from one country must compete with those from all other countries. Car makers in America must compete with car makers in Europe and Japan. If the value of the euro decreases against the dollar, the price of the cars sold by European manufacturers in America, in dollars, will be effectively less expensive than they were before. On the other hand, a more valuable currency make exports relatively more expensive for purchase in foreign markets.

  • In 2019, after coming to power, President Gotabaya Rajapaksa, slashed both direct and indirect taxes.
  • This led to the exchequer suffering from serious loss.
  • It complicated the situation as the Sri Lankan government did not possess enough money to purchase the foreign currency and the projection of booming fiscal deficit due to low taxes scared away the foreign investors.
  • There has been a drastic reduction in the foreign investment received by Sri Lanka, which has directly impacted the foreign reserves of the South Asian country.
  • Situation compounded even more due to the spread of Corona and implementation of nationwide lockdown, the final result these being economic activities coming to standstill.

How grave is the situation in Sri Lanka?

  • Sri Lanka is facing its biggest economic crises since its independence in 1948.
  • It is important to note that Sri Lanka is heavily dependent on imports for even the goods of daily usage e.g. petroleum products, dairy product, food items, stationary etc.
  • The supply of imported items has thus being seriously impacted as the government does not possess enough foreign currency to buy these goods from international market.
  • There is extreme shortage of the goods of daily use in the country and people are not able to get the products that they need even after having money to pay for them.
  • For the first time since the 1970s, Sri Lankan government has resorted to the rationing of food items to all its citizens.
  • Death of 2 people, who fainted while being in queue for purchasing fuel, has been reported.
  • Sri Lanka government has also cancelled exams throughout the country because it does not have enough paper to print the question papers (very little printing paper is product in Sri Lanka and most of it is imported).
  • Army has been called in by the government to help the police in tackling the riot like situation that has arose across the country due to lack of availability of essential goods.
  • Government is also seeking the help of army to eliminate the instances of black marketing of essential items of daily use.

What has the Government of Sri Lanka done to overcome the crises?

  • Sri Lankan government has approached China and the latter has promised loan of $ 1 billion and a credit line of $ 1.5 billion.
  • The Foreign Minister of Sri Lanka G. L. Peiris was on a visit to India recently were he has succeeded in receiving line of credit worth $ 1 billion from the Indian Government.

Line of Credit: It is a credit facility extended by a bank or other financial institution or a government to another government, business or individual  that enables the it to draw on the facility and use the funds when needed. 

  • The Central Bank of Sri Lanka was not intending to receive aid from the International Monetary Fund (IMF) as its assistance would have come with conditionalities.
  • But the gravity of the situation has caused the Central Bank and the Sri Lanka government to approach the IMF for immediate assistance.

What is the way forward?

  • In the short term, Sri Lankan government has to seek aid of foreign currency from whatever sources it can to tide over the crises and provide immediate relief to its people.
  • In the long term, the government of Sri Lanka is required to diversify its sources of foreign exchange earnings.
  • The South Asian country also needs to produce, to a greater extend, items of daily consumption and public importance which can be produced/manufactured in Sri Lanka itself.
  • Depreciation of Sri Lankan currency vis-à-vis US Dollar is necessary to make the exports from the country more competitive in international markets.
  • Promotion of tourism must be focused on as Sri Lanka has been seeing fall in Covid cases.
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