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Sri Lanka's Economic Crisis


Sri Lanka has been faced with a significant cost of living crisis recently, with many essential commodities being in short supply and other essential goods have shot up in price. Inflation was at 12% in December. The island nation in the Indian Ocean also has several other issues that are compounding on the problem, for example with a foreign exchange crisis and large sums of debts having to be paid.


There has been significant inflation for the prices of essential items, which has left Sri Lankan families struggling to cope. Some have even said that they are making less food due to the current situation. Others say that with their current monthly salaries, they can only survive the current costs of living for a few weeks. Sri Lanka’s food prices increased by a record 21.1% last month on a year-on-year basis. This includes significant increases in the prices of rice, wheat, coconut oil and milk powder. Furthermore, the price of a standard cooking gas cylinder has shot up by 85% over the past 4 months.


Similar cost of living issues is happening in other countries in the region such as India and Pakistan. However, it is more difficult in Sri Lanka due to their reliance on imports. This is because of their low production capacity making them a net importer of food and other commodities. An example of this is that the island’s dairy production industry isn’t large enough to match the demand of the whole nation, therefore they import milk powder.


It has become harder for Sri Lanka to import recently, partially as a result of their ongoing economic crisis, which has led to a depletion of foreign currency reserves. By the end of November, the reserve had been reduced to just $1.6 billion, enough to last a couple of weeks at existing consumption levels at the time. The significance of this reserve is that it is needed to pay for any external transaction and used with repaying debts. In order to save the remaining amounts of dollars in the country’s reserve, President Rajapksa imposed restrictions on imports of goods including food and some essential commodities, for example, milk powder and gas. This has reduced supply which has caused soaring prices and shortages. In addition to this, import costs have risen due to higher shipping costs caused by higher global fuel costs. The average cost of shipping a standard container from Europe to Asia has increased from around $2,000 in 2020 to over $10,000 last year. International agencies have warned that higher freight rates are threatening global economic recovery. A depreciation of the Sri Lankan rupee against the US dollar has also effectively made imports more expensive.


“We had to go into a restriction of imports because the pressure on our current account, as well on our trade deficit, was increasing due to the pandemic situation. But as a responsible government we need to manage it," Shehan Semasinghe, a Sri Lankan minister told the BBC.


The current foreign exchange crisis is also having a significant impact on debt repayments for the country. The nation has large amounts of borrowed money that has to be repaid including $6 billion in debt servicing by the end of the year. One major lender has been China who has invested billions into the island as part of its Belt and Road Initiative. They have invested in the development of critical infrastructure including major roads and ports, however, they have been criticised as luring poorer and developing countries into a ‘debt trap’. This means that China would lend money to a country, however, if they are unable to pay back the debts, China takes control of key assets. Often investments can be into projects with low returns. This was exemplified in 2017, when a billion-dollar port in Hambantota, Sri Lanka was leased to a Chinese state-owned firm after the Sri Lankan government struggled to handle their growing debts. Furthermore, if Sri Lanka were to default on its payments this year, it would worsen its credit rating making it harder for them to borrow money in the future.


The Sri Lankan government has made several plans to try and improve the current economic situation. Firstly, they have announced a $1 billion relief package to try and help with the cost of living crisis. This will increase pay for government employees, as well as give some financial aid to the lowest-income households. It will also offer a tax cut on some foods and medicine. They will also use this money to buy crops from farmers who suffered losses due to low yields following a ban of fertilisers imposed by the current government. Individuals of the opposition criticise this package as not dealing with the main problems: domestic inflation and the foreign exchange crisis. There is also fear among critics that printing more money may be used to pay higher wages and this will increase aggregate demand, therefore, having more inflationary pressure on the economy.


The government has also been negotiating bilateral deals with China and India for emergency support. Before the new year, a $1.5 billion currency swap deal with China was secured and this money is convertible into US dollars. This has increased the foreign reserve to $3.1 billion. Ajith Cabraal, the central bank governor of Sri Lanka, has said that levels will stay at a comfortable level throughout the year and that he is confident that they will be able to pay back all their lenders. It has also been stated by the central bank that they expect to get several foreign currency inflows at the start of the year. However, there are still speculations that Sri Lanka will have to default on its debt servicing this year. The cabinet is also contemplating asking the International Monetary Fund for a bailout for the tourism industry as demand has dropped by 90% due to the pandemic.

 

Written by Florian Mihindukulasuriya Thiserage


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