Sri Lanka’s looming economic crisis

INTERNATIONAL/ ECONOMY

• GS-2: India and its neighbourhood
• GS-3: Economy and issues relating to planning, mobilization, of resources

Sri Lanka’s looming economic crisis

Context: Sri Lanka’s external reserves dropped to $1.6 billion in November 2021, triggering alarm in different quarters. Foreign reserves draining so rapidly could only mean that a sovereign default is imminent. 

• American credit rating agency Fitch downgraded the island nation to a ‘CC’ rating, which is the lowest rating prior to default. 
• Despite its mounting foreign debt over the years, Sri Lanka has never defaulted until now. 
• The current economic meltdown – marked by a persisting dollar crisis, soaring living costs, and a possible food shortage this year – is threatening to dent that record. 

What is the Sri Lankan Government’s response? 

• Last week, the Governor of the Central Bank of Sri Lanka said the country’s foreign reserves stood at $3.1 billion at year-end, apparently including the $1.5 billion currency swap cleared by China earlier this year. 
• On January 5, 2022, Governor said the Central Bank has earmarked $500 million to repay an international sovereign bond maturing on January 18. 
• The Rajapaksa administration has expressed confidence about being able to meet its debt obligations this year, despite its Balance of Payments problem. 
• Meanwhile, Finance Minister on January 4 announced a $1.2 billion package for “economic relief” that includes a special allowance for government employees. 
• The Government almost entirely blames the pandemic for the current crisis. 
• It is true that all major revenue earning sectors of Sri Lanka – exports [mainly garments, tea and spices], tourism and inward worker remittances – were severely impacted by the pandemic, but some commentators argue that the pandemic only exacerbated an older crisis, didn’t create one. 

What are the immediate challenges? 

• Contrary to popular narratives, Sri Lanka’s external debt is dominated not by Chinese loans, but by market borrowings, by way of international sovereign bonds, which amount to nearly half of the country’s total foreign debt. 
• Following the $500 million that the Government is preparing to repay later this month, another $1 billion is due for repayment in June. 
• Meeting the repayment deadlines this year would mean that Sri Lanka might be left with no dollars to import essentials —be it food, fuel, or medical supplies. 
• That too when the country may have to import more food this year, if agricultural production drops by half, as paddy farmers and tea growers widely predict, following the Government’s overnight switch to organic farming in May 2021. 
• Already, there are frequent instances of consumers not finding milk powder – which is largely imported – and other essentials in the stores. 
• A shortage of LPG cylinders persists, following a spate of explosions reportedly owing to a change in the chemical composition of the gas. 

What are the options before Sri Lanka? 

• The main political opposition, think tanks and most mainstream economists are advocating that Sri Lanka negotiate a programme with the International Monetary Fund (IMF), restructure its external debt, and mobilise bridging finance for the interim. 
• But the Government maintains it can tide the crisis without resorting to an IMF loan and is counting on other options. 
• IMF agreements usually come with specific conditions for the borrower, including greater transparency on how the money is spent. Transparency has never been a strong point of a Rajapaksa regime, as per critics. 
• Those opposing the IMF route, argue that such a deal invariably entails austerity measures that will target social services and welfare programmes, further aggravating poverty that is growing since the pandemic. 

Can India help? 

• Sri Lanka has repeatedly sought financial assistance from India since the pandemic struck – by way of a debt freeze, a currency swap and more recently, emergency Lines of Credit for importing essentials. 
• Government has reiterated that India “has always stood by” the Sri Lankan people, and Sri Lanka is an important part of India’s ‘Neighbourhood First’ policy. 

Connecting the dots:

• India’s 1991 Balance of Payment Crisis
• Currency Swap Agreements