Sri Lanka: Trouble in Paradise

Sri Lanka: Trouble in Paradise

Context: With long lines for fuel, cooking gas, essentials in short supply and long hours of power cuts, the public has been suffering for months. The raging public anger spilled onto the streets last week leading to nationwide protests, and a subsequent declaration of public emergency in the island nation by President Gotabaya Rajapaksa.

• In the days that followed, the President removed his brother and Finance Minister Basil Rajapaksa from his post.
• Facing the heat from public, all Cabinet ministers resigned en masse on 3^rd
• On 5^th April, the new finance minister Ali Sabry resigned – just a day after being sworn in.
• The ruling coalition, headed by President Gotabaya Rajapaksa, lost its majority in Parliament as proceedings began on 5^th for the first time since the state of Emergency was imposed.
• At least 41 lawmakers walked out of the alliance against the backdrop of nationwide protests.

Factors that led to severe economic distress:

• Pandemic led to job losses and reduced incomes. All key foreign exchange earning sectors, such as exports and remittances, along with tourism, were brutally hit.
• Declining Foreign Reserves: Fears of a sovereign default rose by the end of 2021, with the country’s foreign reserves decreasing to $1.6 billion. But Sri Lanka managed to keep its unblemished foreign debt servicing record.
• Government Inaction: The lack of a comprehensive strategy to respond to the crisis then, coupled with certain policy decisions including the government’s abrupt switch to organic farming widely deemed “ill-advised”, further aggravated the problem.
• Sri Lanka’s Fertiliser Ban: In 2021, all fertiliser imports were completely banned and it was declared that Sri Lanka would become a 100% organic farming nation overnight.
• Shut-down: Garment factories and tea estates could not function, as infections raged in clusters.
• Fuel shortage: Sri Lanka is also facing five-hour rolling electricity blackouts as thermal generators have run out of fuel.
• Food hoarding: The government declared emergency regulations for the distribution of essential food items. It put wide import restrictions to save dollars which in turn led to consequent market irregularities and reported hoarding.
• Downgraded rating: Three international rating agencies have downgraded the island since late last year, on fears it may not be able to service its $51 billion sovereign debt.
• Spiralling debt: The debt issue did not begin in 2020. Since the end of the ethnic war in 2009, Sri Lanka was struggling to keep its economy afloat.

Lessons learnt from crisis:

• It would be best to raise domestic tax revenue and shrink government expenditure to limit borrowing, particularly sovereign borrowing from external sources.
• Thus, there is a need for ambitious fiscal consolidation based on high-quality revenue measures, raising income tax.
• The country’s heavy dependence on imports for essential goods should be reduced like sugar, pharmaceuticals, fuel, pulses and cereals worsened the crisis.

India’s Response

India recently extended a $1 billion credit facility to Sri Lanka to assist the island nation through its worst foreign exchange BOP crisis and enable it to procure food, medicines and other essential items.

Conclusion

• There is a need to step up our people-centric developmental activities while scrupulously staying clear of any interference in Colombo’s domestic affairs.
• However, nurturing the ‘Neighbourhood First’ policy with Sri Lanka is important for India to preserve its strategic interests in the Indian Ocean region.

Value Addition

What is a credit facility?

• A credit facility is a type of loan.
• It allows the borrowing party to take out money over an extended period of time rather than reapplying for a loan each time it needs money.

What is Line of Credit (LOC)?

• A line of credit (LOC) is a preset borrowing limit that can be tapped into at any time.
• The borrower can take money out as needed until the limit is reached, and as money is repaid, it can be borrowed again in the case of an open line of credit.

Can you answer the following question?

• How did Sri Lanka get here? What triggered the crisis of this scale and what is the way out of this dire situation?