Sri Lanka economic crisis
What is happening with Sri Lanka’s economy?
Sri Lanka faces a severe crunch in its foreign exchange reserves, with only enough dollars to cover less than two months of imports. By the end of July, Sri Lanka had just $2.36 billion worth of forex, compared to $6.93 billion in August 2020. The Sri Lankan rupee has fallen by 7.5 per cent against the US dollar this year. The Central Bank of Sri Lanka recently increased interest rates in a bid to shore up the local currency—becoming the first central bank in Asia to tighten its monetary policies post the pandemic.
This, even as the country faces the prospect of repaying $1.5 billion of foreign bond payments in January and July. These payments are in part responsible for the crisis: In July, Sri Lanka paid off a $1 billion debt repayment from its foreign exchange reserves.
While Sri Lanka has long borrowed to cover the cost of development, it has for most of its history enjoyed low-interest concessionary loans. But, when Sri Lanka became a middle-income country, it started having to rely on alternative financing sources.
As a story in The Diplomat noted in February, by the end of 2019, 56 per cent of Sri Lanka’s foreign loans were commercial borrowings, mostly of International Sovereign bonds.
In a bid to stem the tide, Sri Lanka received 554.8 special drawing rights (about $800 million) from the International Monetary Fund. In addition, Sri Lanka’s central bank received $150 million via a currency swap agreement from Bangladesh.
The impact of the balance of payments crisis has translated into rising prices of commodities like sugar, rice, onions and potatoes, while long queues have formed outside stores because of shortages of milk powder, kerosene oil and cooking gas. While imposing rules against hoarding, the government has denied any food shortages. The wide-ranging measure is also aimed at recovering credit owed to state banks by importers.
Concerned over the mounting inflation, rating agency Moody’s placed the Government of Sri Lanka’s Caa1 foreign currency long-term issuer and senior unsecured debt ratings under review for downgrade.
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Reasons of food crisis in Sri Lanka
Depleting forex reserves, depreciating currency, rising food prices
Sri Lanka during the COVID-19 pandemic suffered a severe setback in its tourism industry which contributes to over 10 per cent of the country’s Gross Domestic Product (GDP) and brings in foreign exchange. A setback in the tourism industry of the country has resulted in the depletion of forex reserves from over %7.5 billion in 2019 to approximately $2.8 billion in July 2021.
Due to the depletion in the forex reserves, the country had to increase the amount of money to purchase the foreign exchange to import goods. This increase has led to the depreciation of the Sri Lankan rupee by approximately 8 per cent so far in 2021.
Since Sri Lanka heavily relies on imports to fulfill the basic food supplies in the country, the depreciating currency has further led to a rise in the price of food items.
Sri Lanka govt ban on use of chemical fertilizers in farming
The ban on the use of chemical fertilizers in farming by the Sri Lankan government has led to a reduction in the agricultural production sector. Rajapaksa in 2021 announced his plan to make Sri Lanka the first country in the world with a 100 per cent organic agriculture sector.
Experts noted that the push towards 100 per cent organic farming in a country like Sri Lanka could cut the production of tea and other crops by half and further aggravate the situation than the current one.
Why is Sri Lanka’s economy in trouble?
A number of factors have led to the current economic crisis in Sri Lanka. The tourism industry, which represents over 10% of the country’s Gross Domestic Product and brings in foreign exchange, has been hit hard by the coronavirus pandemic. As a result, forex reserves have dropped from over $7.5 billion in 2019 to around $2.8 billion in July this year. With the supply of foreign exchange drying up, the amount of money that Sri Lankans have had to shell out to purchase the foreign exchange necessary to import goods has risen. So the value of the Sri Lankan rupee has depreciated by around 8% so far this year. It has to be noted that the country depends heavily on imports to meet even its basic food supplies. So the price of food items has risen in tandem with the depreciating rupee.
What has been the government’s response to the crisis?
The Sri Lankan government has blamed speculators for causing the rise in food prices by hoarding essential supplies and has declared an economic emergency under the Public Security Ordinance. The army has been tasked with the duty of seizing food supplies from traders and supplying them to consumers at fair prices. It has also been given the powers to ensure that forex reserves are used only for the purchase of essential goods. The government has refused to end its aggressive push for complete organic farming claiming that the short-term pain of going organic will be compensated by its long-term benefits. It has also promised to supply farmers with organic fertilisers as an alternative. Further, Sri Lanka’s central bank earlier this year prohibited traders from exchanging more than 200 Sri Lankan rupees for an American dollar and stopped traders from entering into forward currency contracts.
Will Sri Lankan govt response solve the economy crisis?
The move to make Sri Lanka a country with a 100 per cent organic farming agriculture sector is expected to aggravate the economic crisis. It will reduce domestic food production significantly and cause a further rise in prices.
Other steps such as capping of prices of food items will cause severe shortages as demand exceeds supply at the price fixed by the government. People are already queuing up outside shops to buy essential goods due to a shortage of supplies.
Deployment of the army with the power to seize supplies from traders will take the incentives from the traders to bring in fresh supplies. This will further cause a drop in supplies and an increase in the prices of food items.
Further, the ban by the Central Bank of Sri Lanka on forward contracts and spot trading of Sri Lankan rupees at above 200 rupees to an American dollar may further fuel the crisis. Due to the ban, if a trader wants to pay more than 200 Sri Lankan rupees for an American dollar to import food or essential item will not be able to conduct the trade.