Sri Lankan Economic Crisis: An Analysis

                                              Source: The Times of India 

 

Sri Lanka: An Overview

Sri Lanka is a developing country in South Asia. It is a densely populated with majority of its people living in rural areas and dependent on agriculture. Being one of the world’s most scenic countries, Sri Lanka is highly dependent on tourism for its revenue. Though the country achieved a 6.4% growth from 2003 to 2012, the growth had been driven by non-trade sectors. It was given the status of upper middle-income country. However, in 2021, it was reclassified as a lower middle-income nation. In 2022, the economy shrank by 7.8%, and the proportion of people living on less than $3.65 a day more than doubled to roughly 25% of the total. The IMF gave the nation a $3 billion USD loan on March 20, 2023, as part of a 48-month debt relief program.

Macroeconomic issue in Sri Lanka:

In 2022, Sri Lanka faced an economic crisis. Sri Lanka ran short of essential goods as well as fuel for essential services such as buses, trains and medical vehicles. It also ran short of foreign exchange reserves to import the essential goods and services. This fuel shortage resulted in high prices of petrol and diesel. Moreover, the sale of fuel was strictly restricted to essential vehicles. This led the country to face inflation. The rate of inflation rose to 50% a year. The onset of the Sri Lankan economic crisis however, dated back to 2019, and is still prevailing.

What is Inflation?

Inflation is the pace at which a nation's prices for goods and services increase. Over time, it reduces a currency's purchasing power.

Headline inflation:

Headline inflation records changes in the price of all commodities in the basket. It is more relevant to assess short term fluctuations since it includes volatile commodities as well.

Core inflation:

Meanwhile core inflation excludes food and fuel items since cost of food and fuel tends to be volatile in nature. It filters out all the temporary and unpredictable influences from inflation calculation for the long run.

The Sri Lankan Economic Crisis: An Analysis

Sri Lanka faced the most severe political and economic crisis since 1948, when it gained independence. Lower- and middle-class Sri Lankans preemptively defaulted on foreign debt exceeding US$50 billion in April 2022 due to an emergency balance of payments crisis. There was a devastating economic downturn, skyrocketing inflation, a lack of food and fuel, and unstable financial conditions.

According to National Consumer Price Index (NCPI), the headline inflation in Sri Lanka in December 2021 was 14% while core inflation was 10.8%. By September 2022, the headline inflation rose to 73.7%. Prices of essential commodities drastically rose due to shortages. In 2023, the Sri Lankan economy witnessed a single digit inflation rate. The year started with a 53.2% inflation rate while ended with 2.8% inflation rate. If we exclude volatile items, the inflation by the end of 2023 was 0.8%.

Fig 1: Data on Inflation in Sri Lanka – 2021, 2022, 2023

Source: Central Bank of Sri Lanka

Causes:

Sri Lanka was highly dependent on tourism for its revenue. The 2019 Easter bombings negatively affected the tourism sector and then COVID-19 hit, which made the recovery of tourism in Sri Lanka difficult. The Russo-Ukrainian war further aggravated the problem as most of the tourist arrivals would be from these nations. The government therefore increased its expenditure starting from December 2019 till mid-2022. This expenditure was used up to create 100,000 new jobs. Simultaneously, it had cut taxes since earnings of most people in the economy was now limited due to the pandemic. Additionally, tax cuts were implemented on the grounds of a "persistent output gap”. Now, the increased expenditure, but reduced revenue created a budget deficit, which only grew with time.  It borrowed from the Central Bank to cover a large portion of these expenditures, including the rollover of its domestic debt. The Central Bank just continued to purchase government securities by placing low-ball bids. Record low interest rates were reached, and the economy briefly flourished.

Sri Lanka has created 588 billion rupees in the first quarter of 2022, raising the total money printed since January 2020 to address an output gap to 2.3 trillion rupees, as data from the central bank indicates. The printing of currency led money supply to increase more than the production of goods and services, which resulted in each currency of money losing its value. This implies that people now would require more money in order to purchase the same items. This causes inflation.

Fiscal policies taken up by the Rajapaksa government in Sri Lanka included banning inorganic fertilizers and agro-chemicals based fertilizers and only pertaining to organic farming, which not only affected rice production but tea production as well, resulting in economic losses of around $425 million. The country's foreign debt increased from around 42% of GDP in 2019 to 119% of GDP in 2021. Lack of suffiecient foreign exchange reserves led the country to face debt trap.

Consequences:

In 2022, schools postponed their examinations and several hospitals were suspended, due to shortages of paper, medicines and other vital medical tools throughout the country. The lack of foreign reserves prevented importing these items. A medical crisis had occurred and the death rate increased. The foreign exchange reserves further worsened when leading textile companies, such as Zara, Mango, and H&M, have shifted their focus from Sri Lanka to India in order to place their orders as a result of the current economic crisis in that country, affecting the country’s exports.

Due to a shortage of foreign reserves, the Sri Lankan consulates in Germany and Cyprus as well as the High Commission of Sri Lanka in Nigeria were temporarily shut down in January 2022. Due to a shortage of dollar reserves, Sri Lanka's consulate in Australia as well as its embassies in Iraq and Norway were dissolved in March 2022.

Moreover, the already affected tourism sector faced difficulty to revive when the UK and Canada advised its visitors to be mindful of Sri Lanka's present economic crisis in March 2022.

Sri Lanka’s economic stabilization:

In the graph in fig 2, it is observed that the inflation rates in 2023 according to National Consumer Price Index (NCPI) showed a downward trend compared to inflation in 2022, which showed high and increased rates of inflation. This could be taken as a sign of onset of economic stabilization in the country. The noteworthy change of 2023 may be attributed to the decisive measures implemented by President Ranil Wickremasinghe's new administration, which took office in July 2022 following the resignation of then-President Gotabaya Rajapaksa due to widespread protests. In order to reduce inflation, the Wickremasinghe administration raised interest rates, eliminated fuel subsidies, increased taxes, and passed legislation enhancing the Central Bank of Sri Lanka's autonomy and transparency. Additionally, the administration engaged in talks with creditors about external debt restructuring, stepped up talks with the International Monetary Fund (IMF) about an economic aid, and requested assistance from India.

However, the country still faces risk to its stabilization process from several factors such as policies of the government. The efforts taken to stabilize the economy still has a long way to go to revive the economy as a whole.

Fig 2: Inflation in Sri Lanka – 2022 & 2023

Source: Central Bank of Sri Lanka

 

Conclusion:

From my viewpoint, there exists a lack of proper understanding and assessment of the root level problem that has caused the Sri Lankan economy to face a downfall from both policy makers side as well as public side. Monetary policy and fiscal policies must be properly aligned, with consequences reviewed over and over again. Suggestions and opinions of international organizations such as IMF must also be considered and reviewed, rather than neglecting. 

References

·       Perera, B. A. (2023, March 29). Sri Lanka: Why is the country in an economic crisis? BBC News. https://www.bbc.com/news/world-61028138

·       Fernando, J. (2023, December 14). Inflation: what it is, how it can be controlled, and extreme examples. Investopedia. https://www.investopedia.com/terms/i/inflation.asp

·       Sri Lanka | History, Map, Flag, Population, Capital, & Facts. (2024, January 14). Encyclopedia Britannica. https://www.britannica.com/place/Sri-Lanka/Industry

·       Wikipedia contributors. (2024, January 7). Sri Lankan economic crisis (2019–present). Wikipedia. https://en.wikipedia.org/wiki/Sri_Lankan_economic_crisis_(2019%E2%80%93present)#Impact

·       Contributors, E. (2021, January 4). What are headline and core inflation? The Economic Times. https://economictimes.indiatimes.com/wealth/save/what-are-headline-and-core-inflation/articleshow/80071229.cms?from=mdr

·       Sri Lanka’s economic crisis: causes, consequences and cure. (2023, May 24). Groundviews. https://groundviews.org/2023/05/24/sri-lankas-economic-crisis-causes-consequences-and-cure/

·       Jazeera, A. (2022, October 21). Inflation in Sri Lanka hits record 73.7 percent. Al Jazeera. https://www.aljazeera.com/economy/2022/10/21/inflation-in-sri-lanka-hits-record-73-7-percent

·       Measures of consumer price inflation | Central Bank of Sri Lanka. (n.d.). https://www.cbsl.gov.lk/measures-of-consumer-price-inflation

·       Wignaraja, G., & Wignaraja, G. (2023, December 28). Political risks loom over Sri Lanka’s economic stabilisation | East Asia Forum. East Asia Forum. https://www.eastasiaforum.org/2023/12/17/political-risks-loom-over-sri-lankas-economic-stabilisation/

·       Sri Lanka money printing in 2022 reaches Rs588bn in first quarter. (2022, May 15). EconomyNext. https://economynext.com/sri-lanka-money-printing-in-2022-reaches-rs588bn-in-first-quarter-94262/