Tata Institute of Social Science, Professor of Economics R Ramakmar
The island nation of Sri Lanka is in the midst of the worst economic crisis we have ever seen. For the first time since independence, 22 million people have faced a 12-hour power cut, with an extreme shortage of food, fuel and other necessities (such as medicines).
Inflation is the highest ever at 17.5%, and the price of groceries such as 1 kilogram of rice has skyrocketed to 500 Sri Lankan rupees, although it is usually around 80 rupees. In the shortage, one 400g packet of milk powder is reported to cost more than 250 rupees, compared to the usual cost of about 60 rupees.
On April 1, President Gotabaya Rajpaksa declared a state of emergency. In less than a week, he withdrew after a large-scale protest by angry citizens over the government’s response to the crisis.
The country relies on imports of many necessities, including gasoline, food and medicine. Most countries have foreign currency on hand to trade these commodities, but the shortage of forex in Sri Lanka is blamed on high prices.
Many believe that economic relations between Sri Lanka and China are the main impetus behind the crisis. The United States calls this phenomenon debt-trap diplomacy. This is when the creditor or institution extends its debt to the borrowing country, expanding itself and increasing the political leverage of the lender if the borrower is unable to repay. They are left to the mercy of the creditors.
However, loans from China will account for only about 10% of Sri Lanka’s total external debt in 2020. Most of the approximately 30% can be attributed to international sovereign debt. Japan actually accounts for as high as 11% of external debt.
China’s infrastructure lending to Sri Lanka, especially the default of lending to Hambantota Harbor, has been cited as a factor in the crisis.
However, these facts do not add up. The construction of Hambantota Harbor was funded by Exim Bank of China. The port was losing money, so Sri Lanka lent the port to a group of Chinese merchants who paid Sri Lanka US $ 1.12 billion for 99 years.
Therefore, the Hambantota Harbor blunder did not cause a balance of payments crisis (more money and exports than immigration) and actually boosted Sri Lanka’s foreign exchange reserves by US $ 1.12 billion.
After independence from Britain in 1948, Sri Lankan agriculture was dominated by export-oriented crops such as tea, coffee, rubber and spices. Most of the gross domestic product comes from foreign exchange derived from the export of these crops. The money was used to import essentials.
Over the years, the country has also begun exporting clothing and earning forex from tourism and remittances (probably money sent by families from abroad to Sri Lanka). The decline in exports will be an economic shock and will put a strain on foreign exchange reserves.
For this reason, Sri Lanka frequently encountered a balance of payments crisis. Since 1965, we have received 16 loans from the International Monetary Fund (IMF). Each of these loans requires reducing the budget deficit, maintaining strict monetary policy, reducing government subsidies for food for the Sri Lankan people, and depreciating the currency after Sri Lanka receives the loan. There was a condition that there was (hence, export is more feasible).
However, in times of recession, good fiscal policy usually states that governments should spend more to inspire the economy. This is not possible under IMF conditions. Despite this situation, the IMF’s lending continued and the poor economy absorbed more and more debt.
The last IMF loan to Sri Lanka was in 2016. Sri Lanka received US $ 1.5 billion over the three years from 2016 to 2019. The situation is well known, and economic health plummeted during this period. Growth, investment, savings and income have declined, but debt burden has increased.
The bad situation was exacerbated by the two economic shocks in 2019. First, in April 2019, a series of bombs exploded at a church and luxury hotel in Colombo. The explosion drastically reduced the number of tourists arriving, with up to 80 reports. % Dropped and ran out of Forex reserve. Second, the new government under President Gotabaya Rajapaksa has unreasonably reduced taxes.
The VAT rate (similar to goods and service taxes in some countries) has been reduced from 15% to 8%. Indirect taxes such as national tax, income tax and economic service fee have been abolished. The corporate tax rate has been reduced from 28% to 24%. Due to these tax cuts, about 2% of GDP was lost in earnings.
In March 2020, the COVID-19 pandemic occurred. In April 2021, the Rajapaksa government made another fatal mistake. Imports of all fertilizers have been completely banned to prevent the outflow of foreign exchange reserves. Sri Lanka has been declared a 100% organic farming country. The policy, which was withdrawn in November 2021, led to a dramatic decline in agricultural production and required more imports.
However, foreign exchange reserves were still tense. The decline in tea and rubber productivity due to the ban on fertilizers has also led to lower export revenues. As export revenues declined, less money was available to import food, creating a food shortage.
You buy less food and other commodities, but demand does not decrease, so prices for these commodities increase. Inflation rose to 17.5% in February 2022.
Perhaps Sri Lanka will get its 17th IMF loan to survive the current crisis with new circumstances.
Deflationary fiscal policy will be implemented, which will further limit the outlook for economic recovery and exacerbate the suffering of the Sri Lankan people. (PTI)
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