NEIGHBOURHOOD WATCH

PEARL IN DISTRESS

Faced with a slew of grim economic indicators, the tiny Island of Sri Lanka battles stoically to restore its equilibrium and secure a future for its people.

SYNERGIA FOUNDATION

RESEARCH TEAM

Since the start of the pandemic in 2020, the Sri Lankan economy, like all other economies around the world, has been faced with distress. However, the situation has taken a turn for the worse with the dawn of 2022. The double trap of low growth compounded by the rising debt burden has raised its ugly head. Sri Lanka has been facing twin deficits — fiscal deficit and trade deficit — during the major part of the last decade. Since 2014, its foreign debt level has been on the rise and reached 42.6 per cent of GDP in 2019. Towards the end of last year, Sri Lanka had declared an economic emergency after a steep fall in the value of its currency, the rupee, caused a spike in food prices. Authorities tried to take control of the supply of basic food items, including rice and sugar and set prices in an attempt to control rising inflation. The army was roped in to assist the civil administration, while poverty and unemployment levels rose to unprecedented levels, threatening a law-and-order situation. Despite the slow trickling in of foreign loans from friendly countries, the food and fuel crisis continues. The island nation stays blacked out for hours, as the National Electricity Board conserves precious fuel supplies, further impacting the struggling export-oriented industry.

A GRIM SITUATION

All economic parameters indicate a grim struggle looming ahead. As per World Bank estimates, nearly 500 000 citizens have slipped below the poverty line since the onset of the pandemic. This is rare for a country where the overall living standards were better than most other South Asian nations. Apart from the economic drag down of COVID-19, which shut the door on its flourishing tourism industry, experts call out the high government spending, tax cuts and debt repayments, especially to China, as having further eroded state revenues. The foreign exchange reserves dipped to their lowest levels in a decade. It must be recalled that China is a major investor in infrastructure and other projects in Sri Lanka, leading to a significant servicing obligation for an estimated $5 billion debt. To ease the situation, Beijing has agreed to smaller instalments being paid over a longer period.

In order to save on the fertiliser bill, which adds to the import burden, the government decided to stop the use of fertilisers and pesticides in favour of going organic. The transition in these troubled times has not proved successful and has contributed to the rising food prices and rationing of staples like sugar and lentils. The rationing, however, led to hoarding in the black market, and the military had to be engaged to seize goods from warehouses and enforce sale to state agencies. Even though the restrictions on imported fertilisers were lifted, the damage had already been done to agriculture production. In an effort at damage control, the government has promised to pay 40,000 million rupees ($200m) to farmers whose harvests were affected by the chemical fertiliser ban.

As a country heavily dependent on tourism, Sri Lanka has suffered acutely from the pandemic’s two-year-long travel bans. The World Travel and Tourism Council estimated that

Apart from the economic drag down of COVID-19, which shut the door on its flourishing tourism industry, experts call out the high government spending, tax cuts and debt repayments, especially to China, as having further eroded state revenues.

more than 200,000 people lost their livelihoods in the travel and tourism sectors, leading to a 2-per cent contraction in the GDP. The Island nation’s economy is largely sustained by imports. However, with foreign exchange reserves drying up, the shortage was not restricted to food items but also encompassed essentials like medicines and fuel. As per the Sri Lankan Central Bank, inflation was at 12.1 per cent at the end of 2021, with food inflation rising to 22 per cent.

A COOPERATIVE APPROACH TO RECOVERY

In response to Sri Lana’s economic distress, many neighbouring countries have stepped up to offer assistance through financial schemes as well as trade deals. China is Sri Lanka’s biggest lender and has invested heavily in infrastructure projects, including roads, an airport and ports. Critics have questioned the financial durability of these schemes by pointing out that the money was put away in ‘unnecessary schemes with low returns.’ The government defends these Belt and Road Initiatives (BRI) as the only way the country can grow in the future, when investments anywhere close to Chinese commitments are not forthcoming from the West or even its neighbour, India.

Other countries have stepped in too, including Bangladesh, which extended $200 million in a currency swap arrangement, making it a lender in the global economy for the first time. Iran also joined the party by signing an oil-tea pact which would settle off debt for past oil imports from Iran by paying off in tea. It is very encouraging that South Asia’s major power, India, has stepped forward to economically support Sri Lanka, despite a troubled year that saw Sri Lanka calling off a major Indo-Japanese deal to develop the strategically important Colombo port.

The Reserve Bank of India has agreed to a USD 900 million deal which includes the “deferment of Asian Clearing Union settlement of over USD 509 million and currency swap of USD 400 million”. “India’s economic package has averted an immediate economic crisis after settling of international sovereign bonds due on January 18. The swap of USD 400 million helped improve the gross reserves to an extent.

The Indian credit line of USD 1.5 billion will also ease shortages of essentials via imports from India,” explains leading economist WA Wijewardena.

All these efforts by the neighbours are aimed at winning some breathing space for the Sri Lankan government, while it implements economic reforms. The IMF is also expected to agree to a bailout package which could be a part of a long-lasting solution.

Milinda Moragoda is the Sri Lankan High Commissioner to India

“Tourism sector is the lowest hanging fruit and Indian tourists are biggest in number and contributing to the Lankan economy’s recovery after the pandemic. But it is not just the high-end tourism, Lanka has provisions for every type of tourists. We are inviting Indian investments in the tourism sector like real estate and port sectors. ”

Asanga Abeyagoonasekera is an international geopolitical analyst and strategic advisor from Sri Lanka.

Is Sri Lanka at risk of a sovereign bond default?

With foreign reserves enough to finance a few months of imports, the reserves fell from $7.5 billion to $3.1 billion. In the present, with $1.6b foreign reserves for imports with $7.3b required for debt repayment within the next year, many are even predicting the country may slide down even further in the months ahead. Moody’s downgraded Sri Lanka’s credit rating to CAA2 from CAA1, and the road ahead to attract investment will be challenging. Nishan de Mel, a Colombo based economist, assess ‘it may take up to 5 years for Sri Lanka to get its rating back up’. With the enormous foreign debt service burden to China to the tune of $5 billion, including many other nations and markets, the Sri Lankan economy will not be able to repay even with the present assistance from India, China and other countries.

Given that the emergency assistance provided by neighbouring countries are short-term relief measures and the loans will have to be paid back at high-interest rates, will it add to Sri Lanka’s debt load?

Yes, it will add to the present debt load. The bigger concern is if the present condition continues. There could be a people’s uprising, with signs already of heavy militarisation.

Assessment

An overreliance on tourism and imbalanced trade and debt issues have placed Sri Lanka in a fragile position. With the eyes of the world on it, Sri Lanka does not have any easy answers out of this imbroglio, and a serious economic revamp is on the cards as the government attempts to navigate the current situation.

Steady borrowing and financial assistance by its neighbours make the region heavily interdependent, with many countries having a stake in the country’s future. It could be a positive fallout as hopefully, it would nurture closer and more mutually beneficial relations between the countries of South Asia.