Economic Emergency in Sri Lanka

Sri Lanka, an island nation located in the Indian Ocean, off the southeastern coast of India – has recently come to the news owing to the economic emergency declared by the Sri Lankan President Gotabaya Rajapaksa. The country is suffering from a big financial crisis, which aggravated even more when the COVID-19 pandemic hit the island nation. The Sri Lankan Rupee has been depreciating against the USD that led to inflation of certain essential commodities. In addition to the economic crisis, price crisis, and weakening of foreign exchange, there has been a supply crisis in the country as well.

The Emergency was imposed in Sri Lanka under the Public Security Ordinance. Major General N.D.S.P Newunhella has been appointed as the ‘Commissioner General of Essential Services’ by President G. Rajapaksa for the prevention of hoarding of essential commodities by the traders. Such a step was taken to ensure that people have access to essential food supplies and other consumer goods – such as rice, kerosene, sugar, edible oil, etc. and these items are to be provided at prices guaranteed by the government or customs value based on goods imported for the prevention of market irregularities.

What are the Factors that Led to Such an Emergency?

Problems Related to Food Items and Price Rise – Surge in prices of food items, causing a real fear of hoarding essential commodities – being one such reason why an economic emergency was imposed by President Rajapaksa.

The question here arises, why are traders hoarding such commodities? Sri Lanka has been an importer of these commodities and relied heavily upon them. The traders who import commodities, open a Letter of Credit. The exchange rates may differ at the time when payments are made. If suppose, when the Letter of Credit was opened (for 180 days) the exchange rate was 180 Sri Lankan Rupee/ US$. On the payment day, Sri Lankan Rupee per US$ becomes 200 – where the traders find themselves in a very difficult position to afford such a payment (as the imports were made in US$). Clearly, the importer bears the loss due to fluctuations in foreign currency contracted under such a letter of credit.

Traders have started hoarding commodities, and, as a result, a mindset amongst the people has been created that a huge scarcity of commodities is likely to occur, for which people have also started hoarding commodities. Even at a time when COVID-19 cases and deaths are rising in Sri Lanka, and a 16-day curfew was imposed, long queues were witnessed in front of shops. There has also been a ban on any future imports of commodities due to the dwindling foreign exchange rate in Sri Lanka and steep Sri Lankan Rupee depreciation. As a result, there are shortages of commodities. In addition to this, rise in Covid-19 cases, somewhere, led to production shortages and logistical bottlenecks. All the factors mentioned above, have led to inflation or constant price rise of the commodities.

Farming has been affected due to a ban on imports of chemical fertilizers, when the government had decided to make Sri Lanka the world’s first country to practice 100% organic farming. Although this decision to ban chemical fertilizers will help the country save approx. $400 million of annual imports, but agricultural producers are viewing this initiative to be harmful for the yields. It is assumed by some that, Sri Lanka’s no-chemical-fertilizers rule is likely to threaten the tea industry and, also, this has triggered fears of crop disaster in a broader scale which could further deteriorate the already weak economy of Sri Lanka. Sri Lanka is a net importer of food items and any steps taken that could affect its domestic production in anyway would aggravate the foreign exchange crisis – a situation which the country is already struggling with. As the whole world is still in a pandemic situation, almost all nations are giving utmost importance to ensure domestic food security. Proper consultation with the scientists and agriculturists was mandatory prior taking the decision of going for 100% organic farming – along with a systematic and a well-developed plan for a proper and a gradual transition to a predominantly organic farming over a span of time without causing troubles to livelihood and agriculture.

Covid – 19 Pandemic – Unprecedented disruptions in economic activities due to the COVID-19 pandemic around the world took a toll on the lives and livelihood of the people and the economy as a whole. The economic growth had come to a standstill, and there were threats of rising poverty, hunger and severe inequality. Sri Lankan economy suffered to a great extent. Heavy dependence on Tourism and tea exports was affected due to this pandemic. The economy shrank by 3.6% in 2020, and foreign exchange rates were rising – meaning the country had less dollars to pay for their imports. Also, there has been a fall in government revenues amid the pandemic.

Travel restrictions imposed by many countries due to the pandemic had a major impact on the tourism sector. The revenue generation of the service sector of the Sri Lankan economy was mainly from the tourism industry. In 2018, it amounted to $4.2billion and a drop of 18% in the year 2019 was witnessed, amounting to $3.6 billion – due to the Easter Sunday attack in April 2019 which killed 250 people. Due to the deadly COVID-19 pandemic, Island wide curfew was imposed by the Sri Lankan government in March 2020, leading to a decline in its tourism industry, ultimately, making the economy weaker. There was a decline of approximately 70% in international tourist arrivals and earnings from the industry was estimated to be $135 million in 2020 – a drop from $461 million in March 2019.

Remittances from Sri Lankans settled abroad, being another major earner for the country, also declined by 13.9%.

Sri Lanka’s prized tea industry is likely to be under threat due to the organic farming decision made by the government. As mentioned earlier, the country is to become the world’s first 100%, organic food producer – involving a complete halt on the usage of chemical fertilizers, and to achieve such a goal, the Sri Lankan President had put a complete ban on its usage and also on its imports. However, the owners of tea plantation fear that such a drastic move could lead to low yields and also, harm the economy. Some believe that such an unanticipated ban has thrown the tea industry into complete disarray – whereby the tea industry depends heavily on nitrogen, phosphorus, and potassium (NPK). The nitrogen component, mainly, is an important one, without which some experts believe that tea production is anticipated to decline by as much as 50%. About 10% of the island nation’s income comes from its tea industry – being the biggest single export of Sri Lanka. In a UN summit, the president had mentioned that the initiative of banning the chemical fertilizer would bring ‘greater food security and nutrition – to which the tea exporters are not convinced. They are of the opinion that there exists a very little market for organic tea and the decline in crop production will not be compensated by the government in any way. They are likely to suffer a loss from such an initiative. Some of them also fear that trade collapse would lead to job loss of approximately 3 million people.

All these reasons have led to a fall in the foreign exchange reserves in Sri Lanka.

How are Exports Related to Foreign Exchange Reserves?

In the case of Sri Lanka, when the tourism sector is weak or, not much exports are taking place in the economy (these being prime source of foreign exchange) – meaning, the foreign exchange reserves are also not increasing. From $7.5 billion in November 2019, the nation’s foreign exchange reserves have dropped to $2.8 billion at the end of July 2021. Reports have revealed that the country is not left with much of its reserves to even pay off three months of imports, as it has started extracting out money to pay the foreign debts. Foreign debts of about $3.7 billion is to be cleared by Sri Lanka, and such repayments are likely to become more costly, as its currency had weakened against the dollar.

Rise in Covid-19 hospitalizations and deaths which is caused by the Delta Variant in Sri Lanka has led to an extension of lockdowns – meaning, pandemic restrictions are hurting the economic activity of the country to a large extent, whereby, government revenue targets seem quite far from achievement. The deteriorating position of reserves has led to a cut in Sri Lanka’s rating outlook to negative by the S&P Global Ratings. In this backdrop, concerns have been raised that debt service amounting $1.5 billion (due next year) seems almost impossible – speculating, that the country might seek the help of the International Monetary Fund. The country has been downgraded by Fitch Ratings to CCC category, disclosing that for servicing its debt, Sri Lanka has to find for $29 billion over the next five years.

Finance Minister Basil Rajapaksa, mentioned recently, that concessionary funds were received by the country from World Bank and Asian Development Bank to combat the difficult situation of the pandemic. Even though they received a special drawing rights allocation by IMF, he further added, since, IMF comes with strict conditions, Sri Lanka had imposed capital controls and has been using its own resources to pay off external payment obligations. After repayment of $1billion of international sovereign bonds in July ’21, the foreign exchange reserves of the country have come down to its lowest level since 2009. As the reserves run low, monetary tightening measures have been undertaken by the Central Bank of Sri Lanka – monetary board of Central Bank had increased standing deposits and lending facility, taking them to 5% and 6%, respectively. The bank rate, linked to lending facility rate had automatically increased to 9%. The statutory reserve ratio has been increased to 4%. To address imbalances of the external sector and also, prevent further inflationary pressures over medium term during the growth period, such steps have been taken.

Over the past one year, the Sri Lankan Rupee has depreciated about 9% against US Dollar – making the imports more expensive.

Due to difficulties in availability of foreign exchange, and also, to save the hard currency, majority of the items have been put on an import ban. Vehicle imports, considered to be a good source of government income, have been banned, and this has resulted in low earnings for customs. The decision of indefinite ban on items have led small businesses shut down their units and some are finding it very difficult to survive – costing most of them their livelihoods. The second-hand market is observed to have skyrocketed, where, a used scooter was sold for more than a brand-new scooter.

Sri Lanka imported pharmaceuticals, machinery, iron and steel products, vehicles from Europe, and, ban of imports resulted in 27% decline in the value of European Union exports to Sri Lanka, from 2019 to 2020. They had raised an issue to the WTO Committee on Trade in Goods, as EU had serious concerns regarding Sri Lanka’s import ban decision. To discourage imports of unnecessary items, a recent initiative by the government has been imposing 100% cash margin on Letter of Credit over 600 items. This decision was taken by the Monetary Board of the Central Bank of Sri Lanka. To meet such a cash margin, the licensed commercial banks have been barred to provide for any such credit facility to the importers.

Reduction of revenue from direct and indirect taxes by 75%-80% on a daily basis was witnessed during the lockdown. There was an increase in government spending as the state sector employees did not suffer cuts in allowances or salaries. In addition to this, 80% of the payment for the COVID-19 vaccines has been done by the government.

In 2020, Sri Lanka’s public debt-to-GDP ratio stood at 109.7%, where, the gross financing remained higher than most of the emerging nations, which is 18% of GDP. Such a high Debt-to-GDP ratio would mean that the country would face troubles to pay off public debts. In the next two years, foreign currency debt of more than $2.7 billion will be due.

How Does the Economic Emergency of Sri Lanka Poses Challenges to India?

There has been a cordial and stable relationship between India and Sri Lanka since their independence. After the US and UK, India is Sri Lanka’s third-largest export destination. The benefits of India-Sri Lanka Free Trade Agreement are enjoyed by Sri Lanka’s more than 60% of exports. Moreover, India is also a major investor in this island nation. Over the years from 2005 to 2019, the Foreign Direct Investment (FDI) from India to Sri Lanka was $1.7 billion. A currency swap agreement was signed by the Reserve Bank of India (RBI) with the Central Bank of Sri Lanka (CBSL) in July 2020, for withdrawals of up to $400 million, under the SAARC Currency Swap Framework 2019-22.

Issues In India-Sri Lanka Relations

• For a very long time, there have been conflicts related to Fishermen. Concerns have been raised by the island nation that illegal fishing by Indian fishermen within territorial waters across Palk Strait is done. India had also detained Sri Lankan fishermen for illegal fishing. Between January ’15 and January’18, 82 Indian fishermen were missing, 185 Indian boats were seized and about 188 Indian fishermen were killed.
• Katchatheevu Island issue– In 1974, this uninhabited island was ceded to Sri Lanka on a conditional agreement called “Katchatheevu Island Pact”. As per the 1974 accord, Sri Lanka’s sovereignty over the island is recognized by the central government. However, the conflicts arose when it was claimed by Tamil Nadu that the island falls under Indian territory and the Tamil fishermen, believing it to be theirs, want to preserve the rights to fishing in that region.
• Since February 2021, the economic and political ties between India and Sri Lanka worsened, when from a tripartite agreementwas signed with Japan and India, for East Container Terminal Project at Colombo Port and later Sri Lanka backed out citing some domestic issues. As 60% of India’s trans-shipment cargo is handled by the Colombo Port, it becomes extremely crucial for India.
  However, later, under a public private partnership agreement, the West Coast Terminal was offered to Adani Ports and Special Economic Zones Ltd.

• The currency swap agreement signed between RBI and CBSL, the validity of which being 13th November 2022, India declined further renewal of it in the absence of an IMF program to address Sri Lanka’s microeconomic imbalances.
• Sri Lanka’s drift towards China for economic support, and also, viewing China as a reliable partner in enabling domestic economic development, is a cause of concern for India – especially, regarding China’s influence on the Indo -Pacific waters.

Colombo is important for India, since, of the total container cargo almost 70% is trans-shipped for and from India, mostly at terminals operated by China. India’s strategic interest will be threatened if Sri Lankan economic crisis continues for a longer time period.

There could be opportunities for China of increasing its dominance over the Indian Ocean region with the increasing economic crisis in Sri Lanka. If it is continued, India’s strategic interests will be adversely affected, and this crisis will push Sri Lanka further to align with Beijing’s interests.

Decreasing the foreign exchange reserves of Sri Lanka has deeply worried the Indian exporters about the payment of dues by the Sri Lankan importers. Banks are unwilling to discount letter of credit of Sri Lankan Banks as timely payments are not coming. In addition to this, the curbs on imports by the island nation and the depreciating currency rates may worsen the payment issue. The experts are of the opinion that along with the import-export affected by crisis, investments in development projects and areas such as tourism, petroleum retail, manufacturing, hotel industry, real estate are to take a hit too, if the situation worsens further. Since a long time, India had been exporting essential items to Sri Lanka, even though the island nation had stopped imports of non-essential items. Indian exporters have been greatly worried of non-receipt of payments against the exports done and the suspension of exports at the moment is expected as there is uncertainty about future payments.

• It is important for India to nurture the Neighborhood First Policy with Sri Lanka, though with caution, in order to preserve its strategic interest in the Indian Ocean region.
• Ways should be found out by India to boost up the people-to-people contacts.
• In the technology sector, India could create job opportunities by expanding companies of information technology in Sri Lanka. Such organization creates thousands of direct and indirect jobs, therby the service economy of the island nation could also be boosted.
• Leveraging Regional platforms such as BIMSTEC, SAARC, SAGAR and the Indian Ocean Rim Association to encourage cooperation in common area of interests such as marine sector development, IT and communication infrastructure, etc.

Conclusion

As we have seen, the Sri Lankan economy is struggling really hard for betterment, the country needs to control the rising cases of Delta variant COVID-19 or else, the economy is likely to weaken further. Risks to people’s lives, along with higher unemployment issues, poverty and hunger, closing business units – are also to worsen even more. There are proposed solutions in line with the global thinking currently existing across IMF, UN and World Bank – universal lifecycle package benefits to be offered to children, a broader support mechanism which will include older people, person with disabilities and also address the issue of employment, protection of health and supporting businesses. These packages will provide a major stimulus to the Sri Lankan economy, reducing the upcoming recession effects, where many businesses and producers may find a suitable market for their goods. The protection of human rights and development, in the long-run, will reduce losses of human capital and will enable the island nation to build labour force with such skill with which they could compete in the international markets. Additionally, to ensure minimal disruption for the market to move ahead in a better way, the vaccination coverage also needs to be increased.

Steps taken by the government such as making the nation 100% organic farming agriculture sector is being criticized by the farmers, fearing fall in domestic production leading to shortages of food supply and ultimately resulting in increasing prices even more. A balanced and judicious plan is required to combine conventional, organic, and organic-based agriculture methods. In addition to this, capping food prices by the government will cause severe shortages as here, demand will exceed supply.

In such a difficult time, strengthening trust in government is mandatory since, citizens should have a clear vision that their needs are taken care of properly by the government in an inclusive, transparent and easy manner.

It is true that the crisis is a real risk for the nation, but a solution is possible. While it may be very challenging for Sri Lanka to find funds to combat the situation, nothing more will have greater damage to families and the economy.

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