By Dr. Santosh Kumar Mohapatra*
Sri Lanka, the island nation in the Indian Ocean has plunged into one of the worst economic crises it’s ever seen since its independence in 1948. The country’s 2.2 crore people are facing crippling 12-hour power cuts, and an extreme scarcity of food, fuel, and other essential items including medicines. Protests have broken out countrywide. The country is insolvent and on 12 April 2022, defaulted on its foreign debts for the first time and hoped for an IMF bailout to save it from the worsening crisis. The prices are skyrocketing. Inflation is at an all-time high of 17.5%, with food inflation touching a record 25% in February which has added to the burden of the common man in the island nation.
A severe shortage of foreign currency has left President Gotabaya Rajapaksa’s government unable to pay for essential imports, including fuel, leading to debilitating power cuts. The country relies on the import of many essential items including petrol, food items, and medicines. Most countries will keep foreign currencies on hand in order to trade for these items, but a shortage of foreign exchange forced Sri Lanka to impose import restrictions on 367 items such as milk products, fruits, meat, fish, grapes, fresh or dried, apples, pears, chocolate, and oranges.
The size of the Sri Lankan economy is a modest $84 billion. Even though the economy has grown from $42 billion in 2009 to nearly $88 billion in 2018, $92.12 billion in 2019 the growth rate has slowed down since 2011. The Sri Lankan economy has begun to shrink after 2019 and reached $88.832 billion. The growth of the economy declined from 2.255% in 2019 to a negative 3.569% in 2020. This period coincides with the pandemic and poor policy decisions. But it rose to 3.7% in 2021.
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 the precarity of the balance-of-payments of the country. With more than $50 billion (€46 billion) in external debt and a shortage of foreign exchange reserves, the country struggled to pay for essential imports. Sri Lanka’s foreign debt obligations for this year alone exceeded $7 billion. Sri Lanka’s current debt-to-GDP ratio has skyrocketed in recent years, increasing from 86.5% in 2019 to 101% in 2020 and further to 119% in 2021.
The present crisis is triggered by a severe Balance of Payment (BOP) crisis including the scarcity of foreign exchange. The island nation’s reserves have slumped more than two-thirds in the past two years. The foreign reserves plummeted from a healthy level of $8.8 billion in June 2019 to $4.8 billion in January 2021. It declined to $1.6 billion in November 2021. In December 2021 after a currency swap with China worth $1.5 billion, it increased to $3.1 billion in December 2021. But again, declined to $2.36 billion in January 2022 and $1.93 billion in March 2022, enough only for a month’s imports.
However, a few years ago, Sri Lanka seemed to be on the right track. Tourism which contributed almost 13% of the country’s GDP was booming, with mega-infrastructure projects making headlines worldwide. The multiple bombings, which killed over 260 people, in 2019 devastated Sri Lanka’s tourism industry. The blasts led to a steep decline in tourist arrivals – with Sri Lanka losing approximately $4 billion of annual foreign currency inflows earned from tourism.
The second setback was the Workers’ remittances from abroad, a major source of foreign exchange in Sri Lanka, dropped to a 10-year low at $5.49 billion in 2021, from $7.103 billion in 2019 as many lost jobs during a pandemic. Tourist inflows and tourism revenues fell further; exports of tea and rubber declined due to lower demand. The currency has also taken a hit. After the International Monetary Fund (IMF) urged Sri Lanka to devalue its currency and raise taxes, the Central Bank of Sri Lanka depreciated its currency by 15% in early March. The Sri Lankan rupee has plunged by 32% since the beginning of the year, making it the world’s worst-performing currency against the dollar. The devaluation also made imports costlier draining more foreign exchange. The Current Account Deficit touched 7.9 % of GDP when in excess of 2.5% is bad.
Sri Lanka’s agriculture was dominated by export-oriented crops such as tea, coffee, rubber, and spices. A large share of its gross domestic product came from the foreign exchange earned from exporting these crops. That money was used to import essential food items.
A large-scale shift to organic farming set food prices afire. The Lankan government on 29 April 2021 decided to ban the import of chemical fertilizers and any other agrochemicals to make the Indian Ocean nation the first in the world to practice “organic-only” agriculture. The move was aimed at reducing pressure on forex reserves. But this move proved as “ill-advised” and “unscientific” and resulted in a steep drop in yield by 25%.
Tea cultivation, which is one of the mainstays of the economy was also badly hit. The output of pepper, cinnamon, and vegetables went down by 30%. A fall in productivity led to lower export incomes. This forced the government to rely even more on foreign countries for rice and other staples and more imports became necessary. But foreign exchange reserves remained under strain. Due to lower export incomes, there was less money available to import food and food shortages arose.
There were other problems, too. Extravagant tax cuts dried up revenue. In late November 2019, after winning Sri Lanka’s presidential election and months ahead of a parliamentary ballot that would again test his popularity, Gotabaya Rajapaksa announced sweeping tax cuts. The Cabinet cut the value-added tax (akin to some nations’ goods and services taxes) to 8% from 15% and also abolished seven other taxes, including a 2% nation-building tax paid by businesses.
The pay-as-you-earn tax and economic service charges were abolished. Corporate tax rates were reduced from 28% to 24%. About 2% of the gross domestic product was lost in revenues because of these tax cuts. The sweeping tax cuts led to a credit rating downgrade in 2020, leading to Sri Lanka losing access to international financial markets. Nonetheless, annual fiscal deficits exceeded 10% of GDP in 2020 and 2021, due to the pre-pandemic tax cuts, weak revenue performance in the wake of the pandemic, and expenditure measures to combat the pandemic.
The countries which have embraced IMF dictated policies have never extricated themselves from the quagmire of crisis permanently. Getting IMF packages and pursuing IMF dictated policies is akin to getting drug addiction from which no country has recovered, rather requiring higher doses of packages in the future and losing economic sovereignty. In 1991, it was India on the precipice due to the balance of payments crisis, all building up to a crescendo amid the first Gulf War. It is now the island nation’s turn. But the solution is not IMF dictated austerity.
From 1965 onwards, it obtained 16 loans from the International Monetary Fund (IMF). Each of these loans came with conditions including that once Sri Lanka received the loan, they had to reduce their budget deficit, maintain a tight monetary policy, cut government subsidies for food for the people of Sri Lanka, and depreciate the currency (so exports would become more viable).
But usually, in periods of economic downturns, governments should spend more to inject stimulus into the economy. This becomes impossible with the IMF conditions. Despite this situation, the IMF loans kept coming, and a beleaguered economy soaked up more and more debt. The last IMF loan to Sri Lanka was in 2016. The country received US$1.5 billion for three years from 2016 to 2019. The conditions were familiar, and the economy’s health nosedived over this period. Growth, investments, savings, and revenues fell, while the debt burden rose.
Many believe Sri Lanka’s economic relations with China are a key driver behind the crisis. The United States has called this phenomenon “debt-trap diplomacy”. The “debt-trap diplomacy means a creditor country or institution extends debt to a borrowing nation to increase the lender’s political leverage – if the borrower extends itself and cannot pay the money back, they are at the creditor’s mercy.
However, loans from China accounted for only about 10% of Sri Lanka’s total foreign debt in 2020. The largest portion – about 30% – can be attributed to international sovereign bonds. Japan actually accounts for a higher proportion of its foreign debt, at 11%. India holds nearly 3%.
Defaults over China’s infrastructure-related loans to Sri Lanka, especially the financing of the Hambantota port, are being cited as factors contributing to the crisis. But these facts don’t add up. The construction of the Hambantota port was financed by the Chinese Exim Bank. The port was running losses, so Sri Lanka leased out the port for 99 years to the Chinese Merchant’s Group, which paid Sri Lanka US$1.12 billion. So, the Hambantota port fiasco did not lead to a balance of payments crisis (where more money or exports are going out than coming in), it actually bolstered Sri Lanka’s foreign exchange reserves by US$1.12 billion.
Actually, Sri Lankan cries cannot be attributed to higher debt-GDP ratio, but rather a scarcity of foreign exchange. If higher debt-GDP ratio is responsible for such a crisis, then countries with higher debt-GDP must be embroiled in such a crisis. When the debt-to-GDP ratio in Sri Lanka is 119%, it is 124 % in the US at the end of December 2021, 155.80% in Italy, 266% in Japan, 97.7%, in Europe, 103.7% in the UK, 115.70% in France, 90% in India. The US debt as a percentage of GDP is expected to have touched 137.2% now. It is not that Sri Lankan debt-GDP ratio has increased only, IMF’s January 2021 Fiscal Monitor Update revealed that global public debt has risen to 98% of GDP (higher by 14% from, October 2019), primarily due to additional spending, forgone revenue, and liquidity support. The US debt has increased by more than 800% from 1989 to 2021.
Actually, it is the international financial system -that allows dollar hegemony, a system of reserve currencies- that is responsible for the crisis. The global trade and payments are done in a few currencies with the US dollar accounting alone (40.51%), followed by Euro (36.6%), pound sterling (5.85%). India, Pakistan, Sri Lanka, and Nepal don’t enjoy such privileges at all. Even China being the second-biggest economy in terms of GDP and the biggest in terms of GDP (PPP), global trade, and payments made in its currency yuan account for 2.75% only. Even in the case of the Russian rouble, it is only 0.95 %.
Countries like the US are able to print their own currency and borrow heavily and dominate the entire world despite having huge debt. Had trade been allowed in its own currency or currency swapping with tradable currencies freely allowed, it is not only Sri Lanka but other countries will not be facing any balance of payment or foreign exchange crisis. Had Sri Lanka been able to import in its own currency or enjoyed currency swapping with the dollar, then it would have imported necessary items and crisis would have been averted.
The author is an Odisha-based eminent columnist/economist and social thinker. He can be reached through e-mail at [email protected]
DISCLAIMER: The views expressed in the article are solely those of the author and do not in any way represent the views of Sambad English.