How Bad Economics Doomed Sri Lanka
Tharan Sutharson
22% of the country in food insecurity. Inflation at over 70%. $51 Billion in foreign debt. All tragic impacts of the economic crisis that Sri Lanka is currently in, historically the worst economic crisis since the country gained independence in 1948. This is a severe crisis that has been ongoing since 2019, due to many reasons from a weak government body, loans and heavy importations. These are all factors that will be considered in this article in order to answer one fundamental question:
What caused the Sri Lankan economic crisis?
Tourism
Tourism is a valuable income earner for Sri Lanka, being the third largest foreign exchange earner as it accounts for 12% of the country’s GDP of $ 84 Billion (as of 2019). Sri Lanka is a popular holiday destination for various reasons such as tropical climate all year round, a range of diverse and rare animals on the island as well as the culture and the history of Buddhism in the country. But in the recent years, demand for this service has fallen noticeably due to two events that have occurred in the recent years. On the 21st April 2019, 3 luxury hotels and 3 churches in Colombo were victims of coordinated terrorist suicide bombings. This event was dubbed the Easter bombing and claimed the lives of 269 people, which included 45 foreign nationals, and left 500 injured. As a result of these bombings, many were left in fear of using facilities such as churches and hotels, and this deterred other tourists from coming to the island due to fears that terrorists would again coordinate an attack.
In the following year of 2020, the country faced a greater worldwide problem of Covid-19 as a lockdown was announced in near to the middle of 2020, with a following lockdown in August of 2021. As of September 2021, 462,767 Covid-19 cases were recorded in the country and 10,140 people died. Due to flights into Sri Lanka being restricted, and many scared to leave their homes in fear of contracting the virus, this halted the tourism sector, leaving many unemployed and weakening the work force as many became ill as a result of the virus. These two events reduced the number of consumers that entered Sri Lanka due to fears regarding the threat of terrorism and the wider worldwide impact of COVID lockdowns, likely reducing the GDP of the country.
We also need to consider the other businesses affected by a fall in tourism due to the circular flow of income, as tourists may purchase other goods and services while they stay, injecting more money into the economy- which will be lost if tourists avoid coming to Sri Lanka. This could also reduce FDI into the country as plans for facilities such as resorts and hotels may be delayed due to fears over the return on investment as demand for tourism in Sri Lanka is falling.
Poor economic management:
Another factor that ultimately increased the severity of the crisis was a government that did not effectively manage the economy. The island of Sri Lanka is a semi-presidential representative democratic republic, where power is used by the President on the advice of the Prime Minister and the Cabinet of Ministers. Multiple actions taken by the government in the recent years such as floating the exchange rate, tax cuts, keeping a heavy budget deficit and using up foreign currency reserves all were factors that created or worsened the situation Sri Lanka is in.
The government deciding to float the rupee and tightening monetary policies such as interest rates also had short run impacts on the country. In March of 2022 the country decided to change to a floating exchange rate for the country, meaning the currency’s value is allowed to fluctuate depending on foreign market forces. This led to the rupee devaluing as a heavy fall was experienced, with it losing nearly half of its value from March to May against the US dollar from approximately 0.0049 to 0.0027. The government did this as well as increase interest rates in order to be eligible to gain an International Monetary Fund loan programme to receive money in order to help with replenishing their foreign currency reserves and debt restructuring to help the country overcome the crisis. But this decision has made it harder on the households of Sri Lanka as importations have become more expensive, and economic activity could be reduced due to the cost of borrowing for loans for capital or consumer goods increasing. But the long term benefits of this have to be considered, as this measure can also prevent hyperinflation further occurring in the economy.
Another significant contribution to the economic collapse of Sri Lanka were tax cuts. In 2019, the government placed tax cuts, with VAT having the most noticeable change in tax from 15 to 8 percent. This was in aim to stimulate the economy and free up disposable income and money circulation in the economy to increase economic growth in the long run. But these tax cuts were a wrong decision for the government to make given the already large fiscal deficit and the widespread tax evasion occurring in the country (direct taxes only contributed 2% of the GDP). This reduced government revenue meaning less money for the government to spend on debts. Overall, this tax cut did not create any long term positives which the government had planned. The Sri Lankan government also took out many loans to various countries. China was Sri Lanka’s biggest bilateral lender, owning approximately 10 per cent of the island’s foreign debt- with some speculating that Sri Lanka fell into a debt trap set by China. As of 2022, Sri Lanka had accumulated $51 billion dollars in debt, with it owing $6.5 Billion to China, as well as Japan and India. A reason for the government amounting this much debt was due to a failure of debt restructuring, which put Sri Lanka deeper into the hole of debt.
In conclusion, we have seen many wrong actions by the Sri Lankan government which were set to potentially save Sri Lanka from the oncoming economic crisis but these choices ultimately led the country into the severe crisis that they are now in- from choice in fiscal policies to the choice of producing goods for domestic consumption after the events of the civil war.
The Impacts of the crisis in Sri Lanka
In 2022, the severe consequences of the crisis was felt by mainly the citizens of the island and the country gained international attention as many people worldwide only now became aware of the economic and financial struggles the country has been going through. The people of Sri Lanka were left to queue many hours for basic amenities due to the low supply of goods in the country- due to minimal imports into the country as foreign currency reserves have been depleted and the wide crop failure due to the use of organic fertiliser. It is estimated that 30% of the population is food insecure. Many citizens are unable to travel to work, due to petrol being in short supply, having to be prioritised for emergency service vehicles as well as the price of fuel sky rocketing. Annual inflation rates of up to 70% were being witnessed, meaning many people lost value in their savings as goods became increasingly more expensive.
Due to these many problems faced by the average Sri Lankan, many started to protest due to economic mismanagement of President Gotabaya Rajapaksa’s administration. In 2019 when the president was elected into his new role, there was huge controversy regarding his past. Rajapaksa was the defence minister during the civil war and was applauded by some for bringing the war to an end by “crushing” the Tamil Tiger separatist rebels. But he was accused of many war crimes as there were accounts of Tamil forces being killed even when waving white flags or after surrendering. There were also disappearances of journalists, reporters and protestors that were seen as opponents to Rajapaksa. In 2016, Rajapaksa was charged with corruption for selling state-owned weaponry and during the election, many questions were raised about his eligibility. Many also speculated that Rajapaksa would be likely to be a way for Mahinda Rajapaksa, a family member in Gotabaya’s powerful family, to regain power as he could not participate in the 2019 elections due to Sri Lankan presidential limits. These fuelled the anger for many citizens in Sri Lanka and further protests led to the government cabinet being effectively dissolved on the 3rd April as 26 ministers stepped down due to anti-government protests escalating despite curfews being set.
Protestors then broke into the president’s mansion, where videos were seen of them sleeping on his bed and swimming in his pool. His mansion was then the target of arson attacks as it was burnt down. This was successful for the protestors as the president fled to the Maldives by plane and handed in his resignation, resigning on July 14th, leading to Ranil Wickremesinghe becoming the new president
What is the country now doing in order to combat the crisis?
Sri Lanka is now in the process of aiming to receive a bailout from neighbouring countries and the International Monetary Fund (IMF) as the country estimates USD $1.5 Billion is needed to end the crisis immediately. Sri Lanka and the IMF agreed upon a $2.9 Billion bailout over 4 years, but this is currently on hold, now expected to only be received in early 2023 since Sri Lanka has to restructure their debts as part of the agreement. Debt restructuring is done when a firm or country is facing financial problems, which involves the organisation aiming to maintain a relationship with creditors and banks by negotiating lower interest rates or asking for extensions on debt payments. Currently, Sri Lanka is in the process of debt restructuring as well as waiting for assurances from Sri Lanka’s bilateral creditors including India, Japan and China. Sri Lanka’s Central Bank Governor P. Nandalal Weerasinghe told “The Hindu” in an interview that the country has been in the talks with these countries in order to restructure the debt owed to them.
These are steps taken by Sri Lanka to potentially come out of their biggest economic crisis in the nation’s history. But this can only be effectively done with a stable government in place and aid to the country as goods such as food and essentials need to be imported to the country to help the many shortages of supply currently widespread throughout the country. This and the loan will help the Sri Lanka build a foundation in the short run to be able to recover from this event caused by many examples of bad luck and, particularly, bad economic management.