Sri Lanka used to earn revenues to the tune of $455 million
a month during the healthy pre-pandemic days, which plummeted
to a meagre $3 million a month in the second half of 2021.
Albin Joseph
The ongoing economic crisis in Sri Lanka has been sending shock waves not only within the island nation, but across the South Asia region. Soaring prices and lack of essential food supplies have created panic amongst the vast majority of the 22 million population. Moreover, the lackluster attitude of the government in dealing with the crisis resulted in people taking to the streets. Sri Lanka’s problem stems from the fact that the country is quickly running out of its foreign exchange reserves; and while this prognosis may seem right at first, it’s a symptom of a problem that is much deep-rooted. Let’s take a reality check on the core issues and the way forward in resolving this impending crisis.
Basically Sri Lanka falls under the category of a “Frontier Economy”, an economy that’s neither developed nor big enough to be branded as an emerging economy. It can be positioned somewhere in between these two spheres. Countries like these are usually reliant on a few focused sectors to generate national income. The nation’s economy has also been classified as a twin deficit economy by Asian Development bank in 2019. Twin deficits signal that the country’s national expenditure exceeds its national income and that its production of tradable goods or services is inadequate.
Sri Lanka’s national income is highly dependent on tourism, tea and a few other agricultural products. In fact, tourism accounts for more than 10% to its GDP and when the pandemic hit, it was inevitable that the country would have to deal with unprecedented issues in this sector. Sri Lanka’s tourism industry took a severe beating, and the economy nosedived, with a shrinkage of 3.6% in 2020. Tourists were no longer thronging the fascinating beaches of the island and the nation’s foreign income dropped significantly. According to data from Trading Economics, Sri Lanka used to earn revenues to the tune of $455 million a month during the healthy pre-pandemic days, which plummeted to a meagre $3 million a month in the second half of 2021. While large economies such as US, Japan, China, and India were easily able to muster resources to fight the pandemic, frontier economies like Sri Lanka had to face an uphill task on this front.
As the country was reeling under the pressure of an economic crisis, its government took an untimely and unwarranted decision to go “hundred per cent organic” and in a bid to fully realise this vision, it banned the import and sale of all chemical fertilizers. This was a severe blow to the tea plantations and since tea exports accounted for a major chunk of the foreign trade, foreign exchange reserves took a hit once again. Tea accounts for the major share of Sri Lanka’s exports, generating more than $1.25 billion a year and making up almost 10% of the country’s export income. This “ill thought out” crusade not only cost tea plantations and farmers dearly but also impacted related services and financial sectors that fed off from tea exports. Eventually, tea industry capitulated, as did many other plantations. By the time the government relaxed some restrictions, the damage was already done beyond repair, and the country had already lost out on much needed foreign income.
At present, Sri Lanka is in a state of economic emergency. The nation’s foreign exchange reserves are getting depleted as it plummeted to $2.0 billion by the end of 2021 from $7.5 billion in November 2019. The outbreak of the Russia-Ukraine war was the last nail in the coffin on the foreign exchange reserves of Sri Lanka, as fuel prices soared globally making imports too expensive. With the current state of affairs, the chances of making a major recovery at the foreign exchange reserves front seems to be very remote.
What makes foreign exchange reserves so precious?
Foreign exchange, basically dollars , is how a country makes payment for importing goods from international markets. So, if Sri Lanka wants to buy fuel or foodstuff, it will have to pay for it with foreign exchange reserves they have earned. Unfortunately, they have been spending a lot of foreign currency while not earning as much. So, if they need to import basic amenities from the international markets anytime soon, they’ll be in a bit of a pickle.
That’s not the end of the nation’s woes. The country was heavily reliant on foreign loans to pursue developmental and infrastructure activities. Sri Lank must repay $26 billion of its loan by 2026 and by the end of 2022 alone, they will have to settle $7 billion as repayment of loans, that they have borrowed from countries like, China, Japan and India. With hardly $1.5 billion in its reserves, and deteriorating foreign exchange income, the repayment of loans would turn out to be a herculean task.
What’s the way forward?
Although there aren’t any quick fixes to resolve these issues, the first priority is to ensure that the nation’s loan repayments need to be restructured with the major lending countries. The forex reserves will get a sigh of relief, once a deferred and prolonged repayment schedule is charted out. Subsequently, the government will have to come out with concrete and positive measures to boost its exports with impetus on tea and other agricultural products. Imported coal accounts for almost 44% of Sri Lanka’s electricity generation, which causes a major drain on the foreign exchange reserves. Long-term policies to reduce the dependency on coal for power generation are the need of the hour. Approaching International Monetary Fund for immediate financial assistance is very much on the cards to get an immediate bailout. Though this is viewed as one of the ideal measure to deal with this crisis, it can only be done by adhering to IMF’s stringent regulations and measures to restructure the economy in its entirety.
Lessons Learned
It’s quite imperative to have a look at the lessons learned from this crisis from a political point of view and from an academic perspective as well. Misappropriation of government funds and corruption at the peripheral level can ruin the economic stability of any nation and this is a key learning that one can infer from the current turmoil in Sri Lanka. Secondly, borrowing of loans has to be done with adequate due diligence and clear rationale. Obtaining foreign loans for the overall development of a nation is ideally right and this is something that most of the frontier economies and developing nations do on an ongoing basis. But these loans can turn out to be a heavy burden on the exchequer if they are not utilised in productive areas.
Sri Lanka is a classic example of an economy that took huge loans, particularly from China for infrastructure development, which hardly generated any significant revenue to the government directly or indirectly. A frontier economy such as Sri Lanka should have used these loans in highly productive areas that could enhance the technology to fuel agricultural and industrial growth. Last, but not the least, decision making on major policy change should be done rationally and logically instead of doing it in an ad hoc manner. The current regime did a historical blunder by taking a decision overnight to abolish the import of fertilizers in order to resort to hundred per cent organic farming. The end result of this immature decision-making was quite apparent, with drop in agricultural produce and resulting in acute food shortage.
The author is a Member of Loka Kerala Sabha.
