Sri Lanka economic crisis explained: what and why Sri Lanka’s economy faced economic crisis

Sri Lanka economic crisis explained: what and why Sri Lanka's economy faced economic crisis
Sri Lanka economic crisis (Image: Canva)

Sri Lanka is going through a major economic crisis like 10-hour long power cuts or food shortages, besides people facing a shortage of petrol and diesel. The economy of Sri Lanka is dependent on imported goods even for basic products.

According to the report, people have been facing power cuts of 10 hours and in the last 3 months alone, the price of petrol has increased by 94% and the price of diesel has increased by 81%.

Food prices have almost quadrupled since October 2021. Because of all this, many people started protesting against the government and President Gotabaya Rajapaksa.

And the Protest has increased so much that an emergency has been declared in the country and a full curfew has been declared in the western part which includes Capital Colombo.

In February, Sri Lanka’s foreign exchange reserves stood at only $2.3 billion while it fell below 70% as compared to January 2020. If a country has low foreign exchange reserves, it is difficult for it to import goods.

In addition, forex reserves were also depleting and oil prices increased due to the Russia-Ukraine war. Due to this, inflation in Sri Lanka increased by more than 16% and in February 2022, food inflation increased to more than 27%.

Sri Lanka is an island nation based in the Indian subcontinent and is one of the close neighbors of India. Sri Lanka was one of the world’s top destinations for tourism in 2018 and more specifically, 2018 was a foreign tourist record-breaking year for Sri Lanka.

There are major ports on all sides of this country which are as follows: Galle Port in the South West, Hambantota Port in the South East, Trincomalee Port in the East, and Colombo Port in the West.

About 12% to 13% of Sri Lanka’s economy is dependent on tourism, and 2.3 million foreign tourists visit Sri Lanka. Apart from this, Sri Lanka is also a major garment exporter.

Sri Lanka is a founding member of the SAARC (South Asian Association for Regional Cooperation) Group of Nations and ranks second in terms of GDP per capita in the Indian subcontinent.

According to reports, Sri Lanka owes a debt of $ 4 million. Sri Lanka saw 25% inflation in March 2022 alone; in 2019, debt was 94% of GDP and by 2021 it had risen to 119% of GDP.

In financial year 21, textiles contributed 56% of the total exports, followed by tea, which has a market share of 6.98% in exports.

Sri Lanka is an agricultural powerhouse. Sri Lankan country’s products Ceylon tea is very famous. Sri Lanka is a major exporter of tea, rubber, coconut, coffee, sugar, etc. Sri Lanka is the second largest tea exporter country in the world.

In order to increase the forex reserves of Sri Lanka, RBI (Reserve Bank of India) announced a swap of $ 400 million in January 2022, and on March 17, the Finance Minister of Sri Lanka signed a $1 billion credit line with India so that essential goods such as food and medicine can be imported.

Apart from this, India has also signed an agreement in February, according to which India will provide a credit line of $ 500 million to buy fuel for Sri Lanka.

The government ordered its electricity board to obtain diesel from the Lankan Indian Oil Corporation, the Sri Lankan arm of the Indian Oil Corporation. Lankan Indian Oil Corporation has given 6,000 metric tonnes of diesel to Sri Lanka, according to reports.

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Sri Lanka economic crisis: why Sri Lanka’s economy faced economic crisis

The Sri Lanka economic crisis has been caused by several events such as depleting foreign exchange reserves, rising prices, increasing external debt, weak currency, etc., and a nationwide policy to shift to organic or organic farming, tax cuts, and the COVID-19 pandemic.

Covering the government spending was a big challenge for Sri Lanka, but they wanted to solve this challenge without increasing the tax and interest rate, so the central bank started printing money in huge amounts.

The International Monetary Fund (IMF) had also advised them that they should reduce government spending, along with increasing interest rates and taxes and not printing money in large quantities.

But the Central Bank of Sri Lanka, ignoring this warning, kept printing money, due to which this economic crisis came. Sri Lanka also faced food shortages due to a shortage in agricultural products.

In the year 1970, 93% of exports came from agricultural products such as tea, rubber, and coconut which was a significant contribution to the economy.

Therefore, when the prices of commodities such as tea and rubber went down, the country of Sri Lanka had to face a recession, whereas when the prices of commodities such as tea and rubber went up, there was an improvement in the economy.

Gradually Sri Lanka started reducing its dependence on agricultural products and by the 80s the economy was also growing at a study rate but when civil war broke out in the country against LTTE (The Liberation Tigers of Tamil Eelam) the country suffered a lot.

This war lasted for almost 2 decades, causing great damage to the economy and foreign investor sentiment in Sri Lanka country.

Many multinational companies have closed their operations in the country and started to refrain from doing business in this country. The country also suffered a lot due to the 2004 Asian Tsunami. Then in May 2009, the civil war ended and Sri Lanka began its journey as a full-fledged nation.

The country had suffered a lot due to civil war and tsunami, so a lot of improvement was needed in the country to cover that damage. The government that came was not able to maintain fiscal prudence, due to which the debt level continued to rise.

At the same time, China started investing in Sri Lanka and financed many infrastructure projects, and later when Sri Lanka could not repay this loan, the economic control went into the hands of China.

A prime example of this is the Hambantota International Port, Sri Lanka. It was built in November 2010 at a cost of $1.3 billion with a loan from China. But this port suffered heavy losses and Sri Lanka could not repay the debt.

So the new government decided that 80% of the port’s stake would be privatized (sold to private companies). A Chinese company named China Merchants Port finally signed the deal in July 2017 after negotiations and a 70% stake was sold to China Merchant Port.

In addition, the port was leased to this company on a 99-year lease and in return, Sri Lanka received foreign exchange of $1.2 billion.

Apart from this, China also started making its contribution in military contracts for the supply of defense products to the Sri Lankan Army.

Sri Lanka’s GDP has declined drastically over the past decades and in the year 2019, its foreign debt was equal to 94% of its GDP.

The biggest reason for this is that the successful governments implemented some policies that supported the populist economy rather than the developmental economics. Apart from this, the level of corruption in the country has increased a lot.

Recently, the government cut the tax rate very much, due to which there was a negative effect on the government revenue and due to fiscal policies, the budget deficit also increased to 15% in the year 2022 while in the year 2020 this number was only 5%.

Apart from this, the Pandemic also had a very negative impact on the economy and in the year 2021, the country’s foreign debt became equal to 119% of its GDP.

Tourism contributed 12.6% to Sri Lankan GDP, but due to the pandemic, there was a huge decline in its forex reserves.

Promised in the 2019 election to switch the country’s agriculture to organic and in the campaign explained how, in 10 years, they would shift agriculture to 100% organic, and then in June 2021 came to a sudden decision.

Sri Lanka has banned all in-organic fertilizers and pesticides to make its country the first 100% organic farming nation. This was a very wrong move as it had a negative impact on the agricultural sector and the agriculture sector has a huge contribution to the economy of Sri Lanka.

The result of this decision was also seen very soon and the farming output saw a decline of up to 50% by September 2021. Because of this, a lot of food shortages were seen and inflation also increased.

Rice did not have to be imported but within 6 months after the ban, the government had to spend $450 million to import rice.

Due to all these reasons, the forex reserves of Sri Lanka fell by 2 billion dollars. Its debt payment for the year 2022 has also been 4 billion dollars.

There was a large production of tea in Sri Lanka and tea was exported to other countries. Tea export was a major source of foreign exchange for the government.

Sri Lanka’s total debt in 2017 was $64 billion. 95% of government revenue went into loan repayment. In 2020, the debt stood at $51 billion, and Sri Lanka imposed import restrictions on foreign currency to pay off this debt. Thus Sri Lanka became a twin deficit economy.

A twin deficit economy means where both the fiscal deficit and the current account deficit exist together. Sri Lanka has both present fiscal deficit and current account deficit conditions.

The condition of fiscal deficit occurs when the expenditure of the government is more than its revenue and in the case of current account deficit, the value of imports of a country exceeds its exports.

Due to these reasons, the value of the Sri Lankan rupee is falling rapidly. At the beginning of March, $1 was approximately SLR 200. Now $1 is approximately SLR 325.

Because the value of their currency is falling and whatever they import is becoming more and more expensive and this, in turn, causes more inflation.

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FAQs about Sri Lanka economic crisis

Why did Sri Lanka’s economy face an economic crisis?

The Sri Lanka economic crisis has been caused by several events such as depleting foreign exchange reserves, rising prices, increasing external debt, weak currency, etc., and a nationwide policy to shift to organic or organic farming, tax cuts, and the COVID-19 pandemic.

What problems did the Sri Lankan economy face in the economic crisis?

Food prices have almost quadrupled. According to the report, people have been facing power cuts of 10 hours and in the last 3 months alone, the price of petrol has increased by 94% and the price of diesel has increased by 81%.
Due to this, inflation in Sri Lanka increased by more than 16% and in February 2022, food inflation increased to more than 27%.