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How can Sri Lanka overcome the economic crisis?

Sri Lanka Colombo | Queuing for fuel

Avert famine and guarantee political stability: Sri Lanka’s new president must prove himself as a crisis manager. Because the country is economically on the brink.

Sri Lanka’s new President Ranil Wickremesinghe faces the mammoth task of leading his country out of a deep economic crisis. Because the economy of the island in the Indian Ocean has collapsed.

A lack of medicine and food, fuel rationing – the lack of supply of the population with essential goods has triggered months of protests.

The Colombo government is groaning under $51 billion in foreign debt and is struggling to make the interest payments on those loans — let alone repay the principal.

Many analysts blame years of mismanagement and corruption for the crisis, including major idle infrastructure projects financed with Chinese loans.

Well-known so-called white elephants include the 350-meter-high “Nelum Kuluna” observation tower near Colombo and the new $190 million airport that was to be built nearby.

Slump in crop yields

In addition, the debt crisis was exacerbated by a series of political mistakes by the government. These included the planned tax cut just months before the outbreak of COVID-19 and an abrupt switch to organic farming that caused crop yields to plummet.

Sri Lanka Anti-Terrorism Laws l St. Anthony Kirch -Bombings in Colombo of 2019
First, the attacks on churches, then COVID-19 – Sri Lanka’s tourism sector has gone through difficult years

The important tourism sector also suffered a slump: in 2018, the industry brought the country 4.3 billion US dollars in foreign exchange. But the terrorist attacks on Easter 2019 made travelers hesitate for the first time; the decline continued to worsen during the pandemic. During the corona pandemic, revenue fell by almost 80 percent.

According to estimates, the economy will shrink by up to eight percent this year.

Will the Monetary Fund step in?

The first priority for the new government will therefore be an external debt restructuring. Negotiations on a rescue package from the International Monetary Fund (IMF) are already underway. Loans from China, India, and Japan also need to be restructured.

However, financial aid is likely to be subject to conditions, including the privatization of state-owned companies and stricter austerity measures. “The population can no longer be expected to take further austerity measures,” Ahilan Kadirgamar, a political economist at the University of Jaffna, told DW. “A lot of people don’t have any reserves,” he adds. Almost two-thirds of the population work in the informal sector.

Sri Lanka - Protest against Prime Minister Ranil Wickremesinghe
Protest against Prime Minister Ranil Wickremesinghe on July 17: the reserves of many Sri Lankans have been depleted

Kadirgamar is skeptical about the traditional “bailout programs” of international financial organizations. According to the economist, Colombo will probably not be able to afford the even higher foreign debt, since the borrowing costs are very high for a country with a bad rating.

Fear of famine

Kardirgamar urged the government to prioritize the use of Sri Lanka’s foreign exchange earnings – which he says totals between $1.3 billion and $1.5 billion a month – to import essential necessities such as food, fuel and medicines. The government must also take out new loans to finance more aid measures to avert an impending famine, he added.

Sri Lanka protests lead to ouster of President Rajapaksa
On July 13, protesters stormed the residence of President Rajapaksa, who has since resigned

The previous government of President Gotabaya Rajapaksa – who fled to Singapore and resigned from office in exile last week – has already reversed some of the policy missteps that exacerbated the crisis.

Tax cuts off the table

For example, sweeping tax cuts announced in 2019 to boost growth have since been rolled back. This was a requirement to meet the conditions for access to further credit from the IMF bailout package.

The original decision called for a drop in government revenue of up to 800 billion rupees ($2.2 billion) a year, according to business and financial broadcaster Bloomberg.

According to the specifications of the IMF, value added tax and corporate taxes are now to be increased. However, there is a risk that these measures could completely stall the economy. Then even higher tax rates would no longer bring any additional income.

Sri Lanka |  Protest against interim President Ranil Wickremesinghe
After July 13, the protests continued

“I would say that the benefits [of the tax increases] are negligible,” Soumya Bhowmick, an associate fellow at the Observer Research Foundation’s Center for New Economic Diplomacy in Chennai, India, told DW. “The additional tax revenues will not be used to strengthen the economy, but to combat food shortages and other measures.”

Crop failures due to lack of fertilizer

A second reversal came with the ban on synthetic fertilizers and pesticides announced by the government in November 2021. Because of the reduced use of fertilizers, domestic rice production fell by a third. Tea production – the country’s most important export and source of foreign exchange – fell by 16 percent.

“The ban quickly wiped out the productivity gains made over many years,” explains Bhowmick. The reconstruction will take a lot of time.

Sri Lanka tea harvest
Tea is an important source of foreign exchange for Sri Lanka – but yields have recently fallen

Economist Kadirgamar told DW that many of Sri Lanka’s two million farmers “lost confidence” after the failure and needed an “active incentive” to return to farming.

Even if agriculture is of little importance in terms of gross domestic product, it is of great importance for food security and people’s livelihood,” explains Kadirgamar.

Lifeline foreign transfers

So far, remittances abroad have been a stable and growing source of income for the estimated three million Sri Lankans working abroad. But they, too, have been impacted by the pandemic and by the exchange controls introduced last year.

Typically, Sri Lankans working abroad send home between $500 million and $600 million a month. However, when the Colombo government fixed the rupee exchange rate at an uncompetitive rate, the use of the informal “hawala” transfer system increased and official remittances fell by as much as 52 percent.

India | Protest in solidarity with Sri Lanka in New Delhi
Anger at Sri Lanka’s now ceded government was also high in neighboring India

“Hawala” allows migrant workers to transfer cash in the currency they earn to an intermediary who ensures the migrant worker’s family receives the equivalent amount in rupees.

“Unless the government finds a way to incentivize remittances through formal channels, the number will not return to previous levels,” predicts Kadirgamar.

Expert Bhowmick is more optimistic. The number of Sri Lankans looking for work abroad has increased. “I’m quite confident that remittances will return to their normal levels within a year after the pandemic is over,” he told DW.

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