Economic Crisis of Sri Lanka

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What’s happening in Sri Lanka?

Sri Lanka's economy has been moving towards an economic crisis since the pandemic hit hard. The Sri Lankan government declared an economic emergency on 1st September 2021 amid plummeting forex reserves, depreciating currency, and soaring inflation. Gotabaya Rajapaksa, the President of the country, has appointed a commissioner of essential services to keep in check the hoarding practices by traders and ensure proper supply of essential commodities at set prices by the government.

What Caused the Crisis?

Multiple factors led to the economic crisis in Sri Lanka:

·       Tourism Industry Faced Setback
The tourism industry of Sri Lanka contributes 10% towards the country's Gross Domestic Product and is a significant source of foreign exchange. However, it was hard hit by pandemic due to which countries forex reserves dropped significantly. It fell from above $7.5bn in 2019 to approx—$ 2.8bn in July of 2021. To meet the import demand of goods, the Sri Lankan's have had to shell out more money to buy necessary foreign exchange reserves in the face of drying up reserves. Consequently, the Sri Lankan rupee depreciated by 8% in 2021. Moreover, even for primary food supplies country depends majorly on imports, and falling rupees have caused the food prices to rise along.

·       Government Organic Farming Policy
Mr Rajapaksa has announced his plans in early 2021 to make Agriculture 100% organic by banning chemical fertilizers. Instead of creating a positive impact, the policy has further accelerated the crisis by affecting agricultural production. Many farmers and agriculture scientists opposed this law. They believed it could create worse food shortage problems as tea and other crop production could soon reach half of the current production capacity.

·       Public Security Ordinance & Other Restrictions
According to the government, speculators were responsible for hoarding and causing an increase in prices of essential food items. Under the Public Security Ordinance, the government has declared an economic emergency and called in armies to seize food supplies from traders and supply them at fair prices. Further, they were tasked to ensure that only essential food items were imported using forex reserves. Initially, the government refused to end its aggressive farming policy, justifying its long-term benefits over short-term pain. As an alternative, they promised farmers to provide organic fertilizers. Further, the Central Bank of Sri Lanka prohibited traders from entering into forwarding currency contracts and capped exchanging Sri Lankan rupee for US dollar at 200. All these led to the fuelling of the existing crises in the economy.

·       Foreign Currency Debt
Currently, more than a $5bn loan is due to China, and it's paying an additional $1bn loan raised from Beijing in instalments. Sri Lanka owes money to many other countries and private sectors apart from China, mainly Japan and India. The total outstanding debt would be $6.9bn this year. As of November, $1.58bn worth of forex reserves were only available, down from $7.5bn in 2019. Consequently, many rating agencies have downgraded the Sovereign debt bond rating to a significantly low level. Both economic and financial crises can reduce food security by reducing production and halting imports due to scarcity of foreign exchange.

What’s the Current State of the Economy?

From 2021 up to 3rd September 2021, the Sri Lankan rupee (LKR) depreciated by 10.1 % against the US dollar, 11.4 %, and 10.3% against the pound sterling and Indian rupee, respectively.
The graph below indicates a depreciating Sri Lankan currency with respect to US Dollar. It shows monthly exchange rate data, where the rate was 202 in Jan 2022, up from the rate of 190.5 in Jan 2021. An increasing trend has been observed, which points towards the falling or depreciating currency of Sri Lanka amid the ongoing crisis.

Source: World Bank

In August 2021, headline inflation rose from 6 per cent to 5.7 per cent in July 2021 because of the increased monthly food and non-food items prices.
The graph below shows yearly Inflation rate data. It can be observed that the annual inflation rate is constantly rising during the period from 2018-to 2021. The points mentioned above could be the reason for rising consumer prices. In 2018 the inflation rate was 2.14% which rose to 6.15% in 2020 and equals approximately 6% in 2021.

             Source: World Bank

In August 2021, food and non-food inflation (YoY) was recorded at 11.5 and 3.5 per cent, respectively. The table below shows the Colombo Consumer price index (CCPI) for 2021. Data for Core and Headline inflation is given below; headline inflation measures total inflation in the country and includes food and energy prices, whereas Core Inflation indicates a change in goods and services costs excluding food and energy prices. For this reason, headline inflation tends to be more volatile than core inflation. The Headline inflation rate in November 2021 was 9.9% YoY, while core inflation touched 7% YoY. Again a rising trend can be observed in inflation rate data.

The graph below shows the total reserves in $US billion, including gold . At the end of July 2021, the gross official reserves were estimated at $2805.9mn. There's a substantial drop in total reserves from 2018-to 2020. It was at 7.65 $ bn in 2019 and reached 5.66 $bn in 2020.

 Source: World Bank

 What are the Future Prospects?

The President has rolled back its agricultural policy; however, the situation has deteriorated. Farmers lack the incentive to import fertilizer to produce goods due to the currency's falling value. The foreign debts from other countries are pressuring the government to take external assistance from the IMF and neighbouring partners.

Recently, Sri Lanka has approached China to restructure its debt. Moreover, the government plans to provide $1.2 billion in economic relief to 1.5 million government employees, soldiers, and pensioners through a special monthly allowance of Rs 5000 from January 2022. To help feed the needy, the government might have to raise funds from foreign aid.

Regarding debt obligation, International Sovereign bondholders would be asked to reinvest and likely renegotiate terms with them. The authority plans to offer subsidies to farmers who have suffered 25-30 per cent crop loss and provide 15kg wheat each month to plantation sector workers.

It's high time for the Sri Lankan administration to introduce effective measures to control the ongoing situation. Corrective actions regarding inflation and weakening currency would stabilize the economy and eventually cater to its growth. Foreign Financial assistance and an internal set of policy measures could help the economy recover from its current crisis.

Disclaimer: The above write-up is only for informational purposes. Do not treat it as investment advice.

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  • Lalit Tuty @Lalit Tuty
    incomplete reserve since 1948 will upgrade .
    Like 0

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