Sri Lanka’s Economic Emergency -

The Unnoticed Crisis

What has led to the crisis, and what does it mean for India?

Dr. RAJAN KATOCH

Sri Lanka has recently imposed an economic emergency. It is in the throes of a major economic crisis. The crisis hasn’t got much attention in the media. Most of us are not even aware that anything out of the ordinary is happening there.

So, what is the crisis?

Sri Lanka’s Gross Domestic Product (GDP) has shrunk by 3.6%. Foreign exchange reserves have fallen from US $ 7.5 billion in 2019 to $ 2.8 billion now. Against this, external debt repayments of around $ 4 billion are due this year. International rating agencies have downgraded the outlook on Sri Lanka to reflect a long-term prospect of default in external debt.

There isn’t enough foreign exchange available to meet Sri Lanka’s import needs. Imports have had to be cut, even of essential items. There are rampant shortages of food and essentials. To deal with the situation, President Gotabaya Rajapaksa declared an economic emergency on 31st August.

What led to this crisis? Three factors are significant.

The first is the disruption caused by covid pandemic. Currently, the third wave is raging through the country, and a nationwide lockdown is in force till 1st October. The major setback has been to the tourism sector, which had accounted for about 20% of export earnings in the pre-pandemic period.

Many tourism dependent countries are similarly impacted, some more than others. Till tourism revives, this factor will remain and severely impact the Sri Lankan economy.

The second (strangely) is a new farming initiative. On 29th April this year, the Government decided that Sri Lankan farming would go 100% organic. One would have thought that going organic farming would be welcome. But this decision was made applicable with immediate effect. All fertilizer and pesticide imports were totally banned. No transitional period was provided for.

Hard hit by this drastic new policy are the major crops of tea, rubber and paddy. Tea and rubber farming was earlier heavily reliant on chemical fertilizers and pesticides. Tea exports alone bring in about 10% of total export earnings. In the current year, some plantation owners are estimating that there may be a 50% drop in production due to the sudden switchover to organic farming. Similarly, yields of the staple food crop paddy are also expected to decline.

Reduced domestic production coupled with no foreign exchange to import food and essential commodities has led to shortages. Rice, sugar, potatoes, onions, palm oil, kerosene, cooking gas are reportedly in short supply. Long lines are seen outside stores. An army general had to be appointed to crack down on hoarding and enforce price control of essential commodities.

Some agriculture experts and environmentalists say that Sri Lanka’s organic farming policy will have long-term benefits. They may be right. The government’s intentions may well have been noble, but the sudden and heavy-handed implementation has hit the economy hard. As a result, the immediate reality is that in the middle of a pandemic the people are also struggling to meet their daily needs, and there is no easy solution in sight.

The third factor is the Government’s policy on external financing. In particular, there has been increasing reliance over the years on Chinese financing for development projects to the exclusion of other options. China has obliged, with loans on relatively stiff terms. Sri Lanka already owes $ 5 billion to China, which is more than 10% of its total external debt.

There are multilateral financing alternatives e.g. International Monetary Fund (IMF) lends funds to countries on easy terms to overcome short run balance of payments difficulties. The World Bank and other development banks provide development project financing on better terms than the market. The Sri Lankan Government has decided not to seek IMF assistance, preferring instead higher cost Chinese financing.

This is despite the fact that Sri Lanka has already been burnt by its preference for usurious Chinese support. A prominent example is the case of Hambanbota Port, which was originally financed with a Chinese loan. Just seven years after it was inaugurated, Sri Lanka found itself unable to pay back or service the Chinese loan. It had to settle the debt by handing over the port to a Chinese controlled company on a 99-year lease!

Nevertheless, Sri Lanka have again sought and are hopeful of obtaining financial support of another $1.5 billion from China to meet this year’s crisis!

Not much noticed by the outside world, Sri Lanka is slipping deep into an economic morass.

What does this mean for India?

As it seems, although the pandemic has hit the island hard, the bigger economic mess it is in is largely of its own making. It has made conscious policy choices that have accelerated the slide.

Yet leaving Sri Lanka to deal with its crisis on its own is not really an option for us. Sri Lanka is a close neighbor that we need to remain engaged with.

The Sri Lankan Government appears to have encouraged Chinese involvement in the economy. Partly due to this, Sri Lanka is caught between a foreign exchange crunch and an external debt trap. However, this has resulted in the strategic dimension of the relationship becoming more important. India has to stay in the game with investments and financial support. That does indeed seem to be the effort, as indicated by the news of a recent $ 700 million investment commitment by the Adani group for building a new terminal of Colombo port. The extended visit to Sri Lanka last week by India’s foreign secretary Harsh Shringla also appears to have been aimed at reinforcing the economic outreach.

As we have seen, the situation is dire. Sri Lanka will find it difficult to extract itself from the economic quicksand it is currently in. India will have to be part of the solution, regardless, because by virtue of its geography, Sri Lanka is always going to be important for India. A stop-go approach as adopted at times in the past isn’t meaningful in the current context. The strategic dimension is here to stay. And it is in this backdrop that efforts need to be and are being made.

We can only hope that these efforts succeed.

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