Sri Lankan Economic Crisis Explained & Important Updates On The Case
- Business Finance
Andrey Ivanov- 0
- 21 minutes read
The Sri Lankan economic crisis has been a major event in the past couple of days where the people of Sri Lanka are going through the worst scenarios of product price hikes, electricity issues, low -no funds and much more. In this article, we will know how Sri Lankans are dealing with it, the Sri Lanka political crisis explained, what steps the government has taken, how the situation evolved and all related information.
How India Came To Know About The Sri Lanka Economic Crisis?
The Indian coast guard had seen 16-17 people coming towards India just a few days ago and attempting to enter India without any proper documents. The coast guard nabbed them and enquired the reason for doing so. The people stated that they have no money for their survival, prices of almost everything have shot up, where the prices of food have risen by three times.
They are having difficulty in acquiring LPG and acquiring petrol or diesel is even challenging for them. People have to stand in long queues and people are dying in the queues trying to get petrol and diesel. Even electricity is hardly available where it is provided just for 4 times each day.
Thus, this Sri Lankan economic crisis can be stated as a “Man-Made Economy Crisis”.
Sri Lankan Economic Overview: History From The Rise To Fall
Back in 1948, Sri Lanka became independent. Following this, all the countries were considering Sri Lanka optimistically. However, the country is a strategic location for export. It is the largest producer and exporter of rubber, tea and coconut. This made the Sri Lankan government feel that the future is promising. In this context, two issues that existed required a solution.
- 90% of the export came from the Sri Lankan plantations, i.e., from rubber, tea and coconut. Thus, the plantation sector of Sri Lanka required diversification. If diversification was taken seriously, it would have ensured safety of the country if there was any problem related to plantations. However, the government failed to solve this issue and thus in 1955, the prices of rubber and tea exponentially went down in the international market which resulted in the decline in income from the export. Following this, the Sri Lankan government for the very first time faced the “Forest Reserve Crisis”.
What Is The Forex Reserves And Forex Reserves Crisis?
The Central Bank of any country possesses some assets in the form of foreign currencies. Thus, to increase the forex reserves, the country has to increase exports, which will offer assets to the country in the form of foreign currencies. The fact is that the Forex Reserves is primarily used for the import of things as if one is purchasing anything from the foreign countries, he/she needs to pay for the thing in the native or fiat currency of the foreign country.
The Forex Reserves Crisis occurs when import is greater than the export. In such a scenario, the country does not possess currency to pay for the imports.
- The money coming from the export required to be used for the development. Back till 1960, only 10% of the money coming to Sri Lanka from export was utilized for the development of the country. The remainder was used in the welfare schemes most probably following the promise that the government might have had during the election. Some of the things were even given for free. It was thought that the Sri Lankan government never plans for the long-term. Thus, there were very limited funds for the development.
In 1977, the government had even failed to invest the money in the welfare schemes. The government had also taken loans to pay for the welfare schemes. The government had realized that this kind of situation would be happening soon and that it would require some fast actions. Thus, in 1962, it had already formed a National Planning Council so that it could bring some plans that would benefit the country in the long term. With the newly elected government, the National Planning Council was sidelined as the government primarily focused on giving away freebies.
In 1977, the government understood the mistake they had been making and thus it took some steps to rectify it. Some of the major steps that government took in 1977 included –
– Focused on the development of the country.
– Introduced several schemes for the entrepreneurs so that businesses expand in the country.
– More FDI or Foreign Direct Investments were included.
– Food subsidies were eliminated.
People started to accept the changes and in the next five years, the country had enjoyed a lot of development. The growth rate that was stuck at 2% per year went up to 6% per year during 1977 – 1983. At this time, the international media was considering Sri Lanka as an investment opportunity. Tourism also increased during this time. So, the total number of tourists in the year 1977 was somewhere below 2 lakhs but raised to over 4 lakhs by 1982. This made the income from tourism rise three times.
Diversification in export was also introduced during this time. The dependency of the country on plantation was eradicated and the garment export that was 2% was brought to 16%. This means that the Sri Lankan government has started to work on the two issues that were initially overlooked and the results were much more prominent.
Thus, in 1982 the government felt that the future of the country was much brighter. But, in July 1983, some massive incidents started to occur that the government could not resist. The country was under pressure owing to the financial crisis and the country was forced to increase the taxes a couple of times.
Sri Lanka’s Economic History: The Civil War
From July 1983, a civil war broke out in Sri Lanka. Owing to the Civil War, the money that was meant for the development of Sri Lanka had to be diverted and used for the defense. Until 1982, the defense expenditure of the government was 4.4% of the total governmental expenditure. It had to be increased from 1983 onward and by 1996, it had reached 21.6% (Defense Budget).
Due to the Civil War, the plans of bringing in the multinationals were also ruined. With great difficulty, the Sri Lankan Government had convinced Harris Corporation and Motorola to start their operations in Sri Lanka. Both of these companies were amongst the biggest electronic companies at that time. Infact, the Harris Corporation had already built half of their plant where around 1850 people were supposed to receive jobs.
As soon as the Civil War broke out, the Harris Corporation decided to leave the remaining plant as it was and stated that they would not operate in Sri Lanka. Following this, Motorola also refused to come to Sri Lanka. Bank of Tokyo and Sony also had their plans to operate in Sri Lanka but they canceled their plans. The Civil War continued till 2009 and till then, none of the major corporations was ready to operate in Sri Lanka.
We can see that the Financial Crisis is not a new thing for Sri Lanka. Till date, the IMF or the International Monetary Fund have bailed off Sri Lanka for 16 times. However, the crisis that Sri Lanka is facing currently is a lot different.
What Caused The Sri Lanka Economic Crisis?
You might want to know why Sri Lanka is facing crisis? Here is what you need to know.
It happened back in the year 2005, when a new government was appointed in Sri Lanka. Very rapidly, they had started taking loans for various developments in the country. Meanwhile, the government placed a proposal that they are looking forward to developing Hambantota Port. This port was important from an export point of view. Hence, the proposal first went to the United States. The government urged for some debt as they want to build the port and for that they require some loans.
Following this, the Americans consulted some analysts on this matter and attempted to know whether that port can generate enough revenue for the Sri Lankans to repay the debts. The US analysts mentioned that the port is not viable. The port does not seem to generate that much revenue to clear the debts. Therefore, the US people denied help to Sri Lanka.
After this, Sri Lanka approached India with the same proposal. India, too, consisted with the analysts and researched on this matter. The Indian government also stated that the port is not viable and it will not be able to generate revenue so that they can clear the debts. India has furthermore advised the Sri Lankan government to not waste financial investment in such a project. Things would not work out as they would want.
Sri Lankans were stubborn about it and desperately wanted to make it. Following this, they went to China with their proposal and this is where they got trapped.
The Chinese Game Of Acquisition: The Debt-Trap Diplomacy
The Chinese are not that dumb to invest in an unviable project. But according to them, it was a strategic location. With the past records, you can see that China has already invested heavily in the Indian neighbouring countries. This is not because China wanted the development of the neighbouring countries, but in order to gain entitlement to some important locations and control them.
The Chinese told Sri Lankans that they would grant them a loan for the port but that would be subject to some conditions. The condition is the port that the Sri Lankans are desperate to build will be made solely by a Chinese company. This will enable the Chinese to build it as their plans and offer future benefits. And the second condition was if the Sri Lankan government fails to repay the debt, then the port will be handed over to the Chinese government on lease.
And like everyone calculated, the port failed to perform too well and the loan remained as it is. The Chinese government asked the Sri Lankan government to hand over the Hambantota Port under their control for a lease period of 99 years. There was no option left for the Sri Lankan government and thus, they handed over the port to China. It did not stop here. Following the incident, whatever infrastructure projects and development occurred in Sri Lanka, 70% of the projects were funded by China.
What Is The Chinese Policy?
The Chinese possess a simple three step policy: Help, Fail and Control. So, first they would pretend to help a country in need. Later on, they make sure that those projects fail badly and then they control those failed projects. The Chinese did the same thing everywhere. In Pakistan as well, they have made some heavy investments and most of the things have failed there. But in return, they have gained some benefits and they have acquired control of those projects. They have built a lot of highways as well as corridors via Pakistan.
Thus, it can be stated that the Chinese are more inclined towards gaining control over any country. In the past decade, the Chinese have heavily invested in Bangladesh, Sri Lanka, Pakistan, Nepal and Maldives. Until 2006-2007, they had also invested heavily in India. But, as their truth came out in bright light, the Indian government and India preferred to stay far away from them.
In doing this, the second benefit that China enjoys is that they increase their trades in those places. They export a lot of things to those countries. Sri Lanka used to trade extensively with India. But now, China has almost reached that level.
Economic Crisis In China-Aided Other Countries & India’s Smart Move
Speaking of Maldives, in 2008, India’s trade was 3.8 times more than China with the Maldives. And currently the Chinese are trading more with the Maldives. The same conditions are prevalent in Bangladesh, Nepal and Pakistan as well. Today, a similar kind of economic crisis is going on in these places. They do not have money for food and other things. Thus, it is an intentional attempt of the Chinese to fail a country so that they can gradually gain control of that country in their hands.
Here in this case, everything happened simultaneously. The bad experience with the Chinese occurred at the same time and they took a lot of loans for their development. Currently, whatever the Sri Lankan government is earning, 83% of that money is going in the repayment of the debt and thus nothing much is left after that.
Thus, seeing this condition, India has made a very smart move. They have extended $1 billion of credit to Sri Lanka so that they can import food and medicines from India. The Indian government is attempting to help Sri Lanka further to make stronger bonds between India and Sri Lanka and also this will ensure some future trade benefits with Sri Lanka.
The Current Sri Lankan Economic Crisis
The current condition of the government is such that they cannot repay the debts. Therefore, recently, some of the officials of the Sri Lankan government reached out to the Chinese government. The Chinese government asked them to hold on. They said that as per their control, whatever decisions are required to be made, they will let the Sri Lankans know soon.
The current problem that Sri Lanka is facing is of the Forex Reserves. Owing to the Covid-19 situation and following the bomb blast in Colombo in 2019, the number of tourists suddenly dropped immensely. Thus, the revenue generated from the tourism industry of Sri Lanka and the forex reserves from the tourism have declined massively.
The garment export from Sri Lanka primarily goes to the United States, Canada and to some of the other European countries. The income generated from that source also dropped by 60%. From the mark of $5 Billion, the revenue dropped to $1.5 – $1.7 Billion. Owing to this, the forex reserves also went down.
However, the country still requires imports like fuel and other things. So, for importing petrol, diesel and other fuels, Sri Lanka does not have enough forex reserves. This is why 2km long queues can be seen in the country and then people are not getting them easily. The prices of the products are also rising owing to the lack of forex reserves.
Major Events Following The Sri Lankan Economic Crisis
What is in Sri Lanka news today? Below are the timeline of the major events (till the time of writing) that took place following the major economic crisis in Sri Lanka:
4th of April, 2022
- Trading had halted on the Sri Lanka stock exchange following the 5.9% plunge. Sri Lanka’s Colombo Stock Exchange said it has halted trading of shares for 30 minutes due to a sharp fall in the benchmark share price index.
- State of emergency was still in place following the curfew lift.
- Sri Lanka set for a new cabinet and protests.
- Ministers resigned as the Sri Lankan Economic Crisis escalated.
- The Sri Lankan Central Bank governor resigned.
- The Sri Lankan president invited all parties in parliament to join the government.
- President Rajapaksa sacked brother, finance minister Basil Rajapaksa amidst the economic crisis.
- President Rajapaksa announces 4 new ministers in cabinet.
- Sri Lanka’s Central Bank held a monetary board meeting.
- Sri Lankan shares extend losses with the worst economic crisis.
- Sri Lanka Central Bank postponed monetary policy review.
- President Rajapaksa held political meetings even as public protests continued against the shortages of essential goods and electricity power cuts.
5th of April, 2022
- Sri Lanka caught in a ‘strategic debt trap’.
- A Sri Lanka emergency health situation has been declared owing to the severe drug shortage in the country.
- Sri Lanka govt to lose the majority in parliament.
- The Sri Lanka President mentioned he declined to resign.
- A day after his appointment, the finance minister of Sri Lanka mentioned that he is resigning.
- The Sri Lankan lawmakers called for the appointment of an interim government to solve the crisis.
- The ongoing line of credit to Sri Lanka touched $1.5 billion after the Sri Lankan government sold everything to China.
- Sri Lanka has temporarily closed its embassies in Iraq, Norway, and Australia.
6th of April, 2022
- Sri Lankan President revokes state of emergency.
Key Takeaways
Thus, under the Sri Lankan economic crisis, the main problem of export diversification, dependence on 2-3 sectors and spending Sri Lanka currency or the funds from the Forex Reserves in development works, that the Sri Lankan government was facing since 1948 has not been solved yet. This is the reason every 5-10 years, Sri Lanka faces this crisis of which the current scenario is one.
The main learning a country has to take from the Sri Lankan Economic Crisis is that a country cannot expand much completely relying on the debts and that it must have an organic earning and expand it. The second lesson is that if you are seeking help from someone, you have to bear in mind the character of the lender. The advantage the Chinese have taken putting Sri Lanka in danger is a major example of this.
