The economic crisis in Sri Lanka

Dr Sudhir Kumar Das

(dasudhirk@gmail.com)

Sri Lanka has been a moderately prosperous country in the Southeast Asian region. As an island nation, it has attracted tourists from all over the world. Sri Lanka always conjures up images of serene sea beaches, natural scenic beauty, wildlife, and ancient Buddhist monuments. But of late these soothing images of Sri Lanka have been replaced by desperate people standing in long queues in front of grocery shops to collect daily essentials. Like many countries during the pandemic, Sri Lanka too suffered a contraction of 3.6% in its GDP growth in the year 2020. Sri Lanka's foreign exchange reserves dipped to an alarmingly low level of $2.8 billion last July, enough to meet just two more months of import bills. As an import-dependent country, the government does not have enough money to buy basic food items and other essentials. The government attributes the cause of the food shortage to hoarding and black marketing by unscrupulous traders ignoring the basic fact that hoarding and black marketing becomes reality when demand far exceeds supply. To show that the government is acting, President Gotabaya Rajapaksa appointed Major General N. D. S. P. Niwunhella as the Commissioner General of Essential Services to coordinate the supply of paddy, rice, sugar, and other consumer goods with authority to check and seize food items found hoarded in godowns. Sri Lanka has banned all imports of non-essential items to save the fast depleting foreign exchange reserves. The president has declared a state of economic emergency to tide over the present economic crisis. The Sri Lankan rupee is fast losing its value against the dollar daily. In August 2019 Sri Lankan rupee was sold at 216.55 against the dollar but now it is selling at over 230. Rating agencies like Standard and Poor and Fitch have downgraded Sri Lanka's economy to CCC- in November 2020. The worst sufferers in the country's economic meltdown are the common masses. Prices of daily essentials and food items have gone through the roof most of them being beyond the affordability of the common man and also became scarce in supply.

An analysis of this economic crisis can be traced to some natural as well as man-made causes. The major reason for this economic crisis can be attributed to the outbreak of the Covid-19 pandemic but it also got compounded by some irrational decisions by the Gotabaya Rajapaksa government. The first cause can be traced down to Sri Lanka's excessive dependence on external debts. By the end of 2020, Sri Lanka's debt-GDP ratio was 101% and it can rise to 108% by 2022. To service its huge external debt Sri Lanka requires $4 to $5 billion annually from 2021 to 2025. It is a herculean task in the present economic context because it has not only a huge budget deficit but also a balance of payment deficit. Sri Lanka has been presenting a deficit budget for the last decade. The budget deficit before 2020 averaged 6% of the GDP. However, in 2020 it steeply rose to 11.2%. The cause of this deficit can be attributed to the rising cost of governance. In a populist move, the Rajapaksa government announced the creation of one lakh government posts annually (sounds similar to the declaration of the Chief Minister of Assam). As the result, 58% of the government's revenue goes into the payment of salaries of the civil servants and if pension amount is added it comes to 80% of the government's total revenue collection. This leaves no room for the government to attend to its many other financial obligations. Debt servicing is another drain on the exchequer. The government paid an amount of 900 million SL rupees as interest on loans taken for infrastructure building. The state-owned enterprises make huge losses and gobble up billions of rupees for their inefficiency. Sri Lanka has an oversized army. Although over a decade has passed since the end of the civil war, the government has not attempted to rationalize the size of its army to lighten the burden on the exchequer.

Rajapaksa government, quite irrationally, announced one after another populist measure detrimental to the economic health of the nation. One such irrational decision is the decision to reduce taxes. After Rajapaksa got elected in November 2019 he reduced the corporate tax and value-added service taxes which drastically reduced the revenue collection of the government by about 560 billion SL rupees. Reduced revenue generation coincided with the extra expenditure to fight the Covid pandemic and the government resorted to more borrowing. A deficit budget reduced revenue collection, and more borrowing created a perilous cocktail economic meltdown. To tide over this man-made economic crisis, the government pumped in more currency creating uncontrollable inflation. The rate of inflation in August 2021 was 6% and inflation in essential food items was 11.5%. Excessive printing of money has resulted not only in high commodity prices but also affected the rate of exchange against the dollar.

The second cause of this crisis is an unavoidable one, the outbreak of the Covid pandemic all over the world at the beginning of 2020. The first Covid-19 case in the country was detected on January 27th 2020 and by August 2021; Sri Lanka became the country to count as the fourth-largest daily deaths in the world by population. The lockdown declared not only slowed down an already ailing economy but also affected the inflow of tourists into the country, a major source of foreign exchange earnings. Sri Lanka was earning $3 to $5 billion from the tourism industry annually till the outbreak of Covid-19 in 2020. Lockdowns and such other restrictive measures discouraged tourists to visit Sri Lanka, till July 2021, Sri Lanka has only seen some 19,300 tourists entering the country. It is less than 1% of its 2.3 million usual tourists. The Sri Lankan government followed an opaque vaccination policy to combat the Covid-19 crisis. Sri Lanka faces a catch 22 situation so far as reviving tourism is concerned. The problem is; if tourism is to be encouraged, Covid protocols need to be slackened. There is always the possibility of another wave striking with more ferocity denting the already ailing economy further.

The third reason that substantially worsened the food crisis in Sri Lanka is the most irrational decision of the Rajapaksa government. It banned all imports of chemical fertilizers and pesticides in pursuit of a new organic agriculture policy overnight. The decision to ban the import of chemical fertilizers seemed like a health-conscious decision of the government. But in reality, it was a decision taken under compulsion to save rare foreign exchange worth $250 million that it spends annually on fertilizer imports. Soon it was realized that it impacted the agricultural yield. Sri Lanka's tea industry contributes substantially to the exchequer but without fertilizers and pesticides, its yield is to be reduced by 50% according to experts. It will result in affecting valuable foreign exchange earnings causing an approximate loss of $625 million and affect the income prospects of three million Sri Lankans who depend on the tea industry. Along with tea, the fertilizer ban would also affect Sri Lanka's spice, fruit, and vegetable production. Sri Lanka imports approximately $400 million worth of fruits and vegetables per year to meet its total domestic demand, low yield of domestic production will further worsen the situation. What remedial course of action the Gotabaya government takes to put the economy on track again remains to be seen.