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Sri Lankan Crisis: Problems and Way Ahead

Chetnarayan
Srilankan Crisis

Sri Lanka President Gotabaya Rajapaksa agreed on April 29 to remove his brother, Mahinda Rajapaksa, as the Prime Minister. The President had called a meeting with the defecting members of the ruling allianceto discuss the formation of an all-party government, which dissenting members refused to attend in the presence of the PM. President Rajapaksa agreed that a national council will be appointed to select a new prime minister and Cabinet comprising all parties in Parliament. Maithripala Sirisena the former president before Rajapaksa, a governing party lawmaker, brought this information to the public who had defected from the ruling party along with about 40 other legislators earlier this month.

Meanwhile, protests continued in Sri Lanka and a large number of people participated in a general strike even on April 28 calling for the resignation of President Rajapaksa as the country continues to reel under its worst economic crisis. Protests, which began against the government earlier this month, intensified as workers across sectors joined the strike, leading to shutdowns and disruptions in public transport. The protest spread to the whole nation as various unions from health, ports, electricity, education and postal sectors joined the strike.

Main Demand of the protestors

The protesters sought the resignation of the President and Prime Minister, under the slogan, ‘Bow to the people – government go home’. Businesses, public transport, including train services, banking services and schools were disrupted as workers participated in the strike. Plantation workers of the tea and rubber industry, too, joined the protest, along with doctors and nurses who participated during their lunch hours. The Minister of Transport Dilum Amunugama asked the police to arrest those who harm public transport or block roads.

The crisis facing Sri Lanka

The 2022 Sri Lankan Crisis refers to foreign exchange crisis, shortage of essential commodities, including food, fuel and medicine. This has led to massive public protests amid high inflation and even power outages demanding resignation of the President and the Prime Minister. This has also led to defection of alliance partners of the ruling party. In fact many observers opine that the present crisis was brewing for a long time due to power struggle between President Gotabaya Rajapaksa and the Parliament of Sri Lanka since 2019. The present crisis is the combination of both political power struggle and poor economic performance.

The recent political crisis began on 3 April 2022, after all 26 members of the Second Gotabaya Rajapaksa cabinet with the exception of Prime Minister Rajapaksa resigned en masse overnight. However, critics noted that the resignation was not valid as they did not follow the constitutional protocol and thus deemed it a “sham,” and several were reinstated in different ministries the next day.

 There were even growing calls on forming a caretaker government to run the country or else to go for snap elections but the latter option was deemed unviable due to paper shortages and concerns over election expenditure which would often cost in billions.

The Symptoms and causes of Economic Crisis

Forex Crisis- The main cause of the country’s crumbling economy is its shortage of foreign currency, which has led to a massive reduction in imports of essential items. Sri Lanka relies heavily on its imports. It imports petroleum, food, paper, sugar, lentils, medicines, and transportation equipment, among other essential items. Sri Lanka does not have sufficient foreign exchange to import these commodities from other countries.

Sri Lanka’s foreign exchange reserves have depleted by 70 per cent to USD 2.3 billion as of February in the past two years, thus impacting the country’s ability to pay for its imports. It has debt payments of about USD 4 billion through the rest of the year. The country’s inflation rate is at an elevated level. It was not so in the past. Sri Lanka being an important destination for the international tourists, managed to earn sufficient foreign exchange. But as its indebtedness increased due to decreasing revenues and increasing debt servicing overtime due to borrowing for investment in uneconomic infrastructure projects, especially China assisted projects its foreign exchange depleted. The situation was further worsened due to outbreak of covid-19 pandemic and subsequent lockdowns and restrictions on movement that affected tourists footfalls and foreign exchange earnings of the country. Foreign Exchange Reserves in Sri Lanka averaged $ 5. 5 billion from 2004 until 2022, reaching an all time high at around $10 billion in April of 2018. In the past, Sri Lanka had the lowest foreign exchange reserves of $ 1.2 billion in 2009.

Spiraling Inflation- According to the Bank of Sri Lanka, the country’s Central Bank, inflation as measured by a year-on-year change in the Colombo Consumer Price Index also increased by 29.8 per cent in April. This increase was driven by the monthly increases in both food and non-food categories. The cost of living increased and people were facing difficulties in procuring even food as food inflation jumped by 46.6 per cent in April, while non-food inflation grew by 22 per cent in April. Prices of items in the non-food category recorded increases mainly due to price increases observed in sectors such as transport, water, electricity and gas, while prices of items in the food category increased due to hike in prices of milk powder, rice, bread, dal, sugar and dried fish during the month.

Due to shortage of essential goods and raw materials inflation is also soaring very high in Sri Lanka. Producer prices in Sri Lanka climbed 18.9 percent year-on-year in February of 2022, following a 17.3 percent rise in the previous month. It was the highest producer inflation since June of 2017, as prices went up faster across the board, led by agriculture (22.6 percent vs 22.4 percent in January); manufacturing (18.5 percent vs 17.5 percent); and lastly, utilities (6.7 percent vs 1.0 percent).

Depreciation of Sri Lankan Rupee–  The Sri Lankan Rupee depreciated by LKR 57 against USD in a span of seven days in the first week of March this year, bringing the exchange rate to the lowest ever, LKR 260 per US dollar. Since January 2022, the Sri Lankan rupee has depreciated 26% against the USD.

Downgrading of Credit Ratings– In April Fitch Ratings downgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘C’ from ‘CC’. The issue ratings on foreign-currency bonds issued on international markets were also downgraded to ‘C’ from ‘CC’. The same month the Moody’s Investors Service downgraded Sri Lanka’s sovereign rating to Ca from Caa2 with a stable outlook, following a decision by the island to suspend debt payments. Moody’s said the suspension would lead to “a series of defaults with the first coupon payments for the government’s international bonds coming due today, 18 April 2022.”

Ballooning foreign Debt- With more than $50 billion (€46 billion) in external debt and a shortage of foreign exchange reserves, the country is currently struggling to pay for essential imports. Sri Lanka’s foreign debt obligations for this year exceed $7 billion. But the country’s forex reserves decreased to as low as $1.6 billion in end -March 2022.

Subsequently, the country announced a default on all its foreign debt ($51 billion approx). Now Sri Lanka is hoping for an IMF bailout. Sri Lanka owes about 1% of its total foreign debt to China in comparison to only 2% to India. However, the biggest chunk of Sri Lanka’s foreign debt (47%) is due to market borrowings ($16 billion). Since graduating into a lower middle-income country in the early 2000s, successive Sri Lankan governments have been increasingly borrowing from private international capital markets through the issuance of sovereign bonds, seriously contributing to worsening of the balance-of-payments of the country.  Out of its total foreign debt it owes about 13% to the ADB, 10% to Japan and 9% to the World Bank.

IMF Bailout becomes a necessity

During the 2022 IMF and World Bank Spring Meetings in Washington, D.C., IMF Managing Director Kristalina Georgieva and other senior members of IMF management met (April 23) with a Sri Lankan delegation, led by Finance Minister Ali Sabry and Central Bank of Sri Lanka Governor Nandalal Weerasinghe, and discussed (April 18–22) policy actions to address economic challenges.  The Sri Lankan delegation and the IMF team had fruitful technical discussions on the authorities’ request for an IMF-supported program. The discussions covered recent economic and financial developments in Sri Lanka, the need for implementing a credible and coherent strategy to restore macroeconomic stability, and the importance of stronger social safety nets to mitigate the adverse impact of the current economic crisis on the poor and vulnerable. The IMF team welcomed the authorities’ plan to engage in a collaborative dialogue with their creditors.

Assistance from India

According to Gopal Baglay, India’s High Commissioner to Sri Lanka, since January this year, support from India to Sri Lanka exceeds USD 2.5 billion. A fuel line of credit of USD 500 million was signed in February. Four consignments totaling over 150,000 tons of jet aviation fuel, diesel and petrol have since arrived beginning in March. Five more consignments are to follow till May. Another line of credit of USD 1 billion for food, medicine and essential items was signed in March. India has also supported Sri Lanka’s efforts to seek about $ 4 billion bailout package from the IMF. At the same time as an all weather friend, India after providing a credit line of $ 1 billion, recently offered another credit line of $500. India has also extended the tenure of a $ 400 million swap offered to Sri Lanka in January 2022.It has already agreed to defer payment of $1.5 billion in import payments that Sri Lanka needs to pay the Asian clearing Union.

Sri Lanka’s request for Chinese assistance of $ 2.5 billion has not been entertained by the latter so far. China announced to provide a miniscule $ 31 million of humanitarian assistance in April end but said that there are difficulties in restructuring of debt worth $2.5 billion sought by Sri Lanka from China.

Looking Forward

Sri Lanka is facing scarcity of food and fuel, along with record inflation and blackouts. This has inflicted widespread misery on Sri Lankan people. This is Sri Lanka’s worst economic crisis since independence from Britain in 1948. While its foreign exchange reserves have dried and Sri Lankan rupee has depreciated to its lowest level in recent times against the dollar, its  foreign debt has continued to mount. The Sri Lankan government’s income has also taken a big hit after the tourism-dependent economy was hit by the 2019 Easter bombings and the Covid-19 pandemic. According to experts, the crisis was further exacerbated by the government’s mismanagement and years of accumulated borrowing and ill-advised tax cuts. As Sri Lankan authorities are unable to raise more commercial loans because of credit downgrades, the immediate and plausible solution is that the country manages to get an IMF bailout.

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