Sri Lanka’s economic crisis

(Mains GS 2 : India and its Neighborhood- Relations.)

Context:

• The  economic crisis in Sri Lanka is due to a serious balance of payments (BoP) problem as its foreign exchange reserves are depleting rapidly. 

High post war growth:

• In the 21st century Sri Lanka, economic fortunes are tied to the export of primary commodities such as tea and rubber, and garments. 
• It mobilized foreign exchange reserves through primary commodity exports, tourism and remittances, and used it to import essential consumption items including food.
• After a 26-year long war which ended in 2009, the economic growth of Sri Lanka was reasonably high as GDP grew at 8-9% per annum between 2009 and 2012. 
• However, the economy was on a downward spiral after 2013 as global commodity prices fell, exports slowed down and imports rose. 

Counter-cyclical fiscal policy:

• Due to a downward spiral, a counter-cyclical fiscal policy was ruled out, as the hands of the then Mahinda Rajapaksa government were tied by a $2.6 billion loan obtained from the International Monetary Fund (IMF) in 2009. 
• Further, the capital flight that accompanied the global financial crisis of 2008 drained Sri Lanka’s foreign exchange reserves. 
• The IMF loan in 2009 was obtained in this context, with the conditionality that budget deficits would be reduced to 5% of the GDP by 2011.

Approached the IMF:

• With no pick-up in growth or exports, and the continuing drain of foreign exchange reserves, the new United National Party (UNP)-led coalition government approached the IMF in 2016 for another US$1.5 billion loan for a three-year period between 2016 and 2019.
• The IMF’s primary condition was that the fiscal deficit must be reduced to 3.5% by 2020 and other conditionalities included a reform of the tax policy and tax administration; control of expenditures; commercialisation of public enterprises; flexibility in exchange rates; improvement of competitiveness; and a free environment for foreign investment.
• The IMF package led to a deterioration of Sri Lanka’s economic health as GDP growth rates shrank from 5% in 2015 to 2.9% in 2019 and investment rate fell from 31.2% in 2015 to 26.8% in 2019. 
• Savings rate fell from 28.8% in 2015 to 24.6% in 2019 and Gross government debt rose from 78.5% of the GDP in 2015 to 86.8% of the GDP in 2019.

Further shocks to the economy:

• In 2019, there were further shocks to the economy in the form of  the Easter bomb blasts of April 2019 in churches in Colombo led to the death of 253 people.
• Consequently, the number of tourists fell sharply leading to a decline in foreign exchange reserves. 
•  New government formed in 2019 led by the Sri Lanka Podujana Peramuna (SLPP) implemented a plan to slash taxes.
• Estimates show that there was a 33.5% decline in the number of registered taxpayers between 2019 and 2020, and close to 2% of the GDP was lost in taxes thus foregone. 
• Further, the COVID-19 pandemic in 2020 made the bad situation worse as the exports of tea, rubber, spices and garments suffered and tourism arrivals and revenues fell further. 
• The pandemic also necessitated a rise in government expenditures: the fiscal deficit exceeded 10% in 2020 and 2021, and the ratio of public debt to GDP rose from 94% in 2019 to 119% in 2021.

Organic farming:

• Sri Lanka annually spends about $260 million (or about 0.3% of its GDP) on fertiliser subsidies and most of the fertilisers are imported. 
• To prevent the drain of foreign exchange reserves, the Gotabaya government came up with a novel solution in 2021 and completely banned all fertiliser imports from May 2021 by declaring that Sri Lanka would overnight become a 100% organic farming nation. 
• This policy, which was withdrawn in November 2021 after protests by farmers, literally pushed Sri Lanka to the brink of a disaster. 
• Agricultural scientists wrote to the government that yields may drop by 25% in paddy, 35% in tea and 30% in coconut if chemical fertilisers were banned.

Policy failure:

• In February 2022, the IMF assessed that there was a “worse-than-anticipated impact of the chemical fertiliser ban on agricultural production”, which was likely to drag down the prospects of economic recovery. 
• As agricultural production fell, more imports of food became necessary but increasing imports was difficult in the face of foreign exchange shortages. 
• Thus, inflation rose to 17.5% in February 2022 and also a fall in the productivity of tea and rubber led to lower export incomes. 
• Thus, the organic farming policy, which aimed to soften the pressure on reserves, ended up straining them even further.

Conclusion:

• The current Sri Lankan economic crisis is the product of the historical imbalances in the economic structure, the IMF’s loan-related conditionalities, misguided policies of the government and the official embrace of pseudo-science.