Sri Lanka’s economic crisis explained

Sri Lanka’s economy is facing a crisis due to serious balance of payments (BoP) problems. Its foreign exchange reserves are depleting rapidly. It is becoming increasingly difficult to import essential consumption items. The country is unable to repay the old debt. This article is an attempt to trace the proximate causes of the current crisis and to document the roles of various groups and organizations in its creation.

Of course, the roots of the crisis can be traced back to colonialism and Sri Lanka’s post-war development path, but we must stick to the last decade for our purposes. Even in the 21st century, Sri Lanka’s economic condition remained linked to exports of primary goods and clothing, such as tea and rubber. It raised foreign exchange reserves through primary commodity exports, tourism and remittances, and used it to import goods of essential consumption, including food.

When Sri Lanka emerged from a 26-year-long war in 2009, economic growth was expected to resume. Perhaps due to stagnant demand, Sri Lanka’s post-war GDP growth was much higher at 8-9% per year between 2009 and 2012. However, after 2013 the economy was on a downward trajectory as global commodity prices fell, slowing exports. And imports increased. The average GDP growth rate almost halved after 2013. A counter-cyclical fiscal policy was rejected, as the hands of the then Mahinda Rajapaksa government were tied by a $2.6 billion loan received from the International Monetary Fund (IMF) in 2009. The duration of the war, the budget deficits were high. In addition, capital flight coupled with the 2008 global financial crisis depleted Sri Lanka’s foreign exchange reserves. The IMF loan was obtained in 2009 with the condition that the budget deficit would be reduced to 5% of GDP by 2011.

With no pick-up in growth or exports and continued withdrawal of foreign exchange reserves, the new United National Party (UNP)-led coalition government approved another US$1.5 billion in debt for a period of three years between 2016. Contacted the IMF in 2016. and 2019. The IMF’s condition was that the fiscal deficit should be reduced to 3.5% by 2020. Other terms include reforms in tax policy and tax administration; control of expenditure; commercialization of public enterprises; Flexibility in exchange rates; improve competitiveness; and a free environment for foreign investment.

The economic condition of Sri Lanka worsened due to the IMF package. The GDP growth rate fell from 5% in 2015 to 2.9% in 2019. The investment rate fell from 31.2% in 2015 to 26.8% in 2019. The savings rate fell from 28.8% in 2015 to 24.6% in 2019. Government revenue shrank by 14.1%. GDP in 2016 grew to 12.6% of GDP in 2019. Gross government debt increased from 78.5% of GDP in 2015 to 86.8% of GDP in 2019.

New shocks to the economy

In 2019, the economy suffered two more setbacks. Firstly, the Easter bombings of April 2019 in Colombo churches killed 253 people. As a result, there was a sharp decline in the number of tourists leading to a decline in foreign exchange reserves. The blasts dealt a severe blow to the prospects of economic recovery.

Secondly, the UNP-led government was replaced in November 2019 by a new government led by Sri Lanka Podujana Peramuna (SLPP), headed by Gotabaya Rajapaksa. The SLPP had promised lower tax rates and wider exemptions for farmers during its campaign. On the surface, these promises appeared to be different from the IMF package. However, in the absence of a concrete policy option for the IMF’s neoliberal package, these promises were hollow.

Gotabaya Rajapaksa was quick to implement the ill-advised plan to reduce taxes. In December 2019, the Value Added Tax (VAT) rates were reduced from 15% to 8%. The annual limit for VAT registration was raised from LKR 12 million to LKR 300 million. The annual income limit for exemption of personal income tax was raised from LKR 500,000 to LKR 3,000,000. Nation building tax, payment tax and economic service fee were abolished.

Estimates show that there was a 33.5% drop in the number of registered taxpayers between 2019 and 2020, and close to 2% of GDP was lost to taxes. GST/VAT revenue was halved between 2019 and 2020.

In 2020, the COVID-19 pandemic made the situation worse. Exports of tea, rubber, spices and clothing suffered losses. Tourist arrivals and revenue declined further. The pandemic also necessitated an increase in government spending: the fiscal deficit exceeded 10% in 2020 and 2021, and the ratio of public debt to GDP increased from 94% in 2019 to 119% in 2021.

Sri Lanka spends about $260 million annually (or about 0.3% of its GDP) on fertilizer subsidies. Most of the fertilizers are imported. To stop the withdrawal of foreign exchange reserves, the Gotabaya government came up with a novel, but completely bizarre, solution in 2021. All fertilizer imports were completely banned from May 2021, and it was announced that Sri Lanka would become 100% organic overnight. Farming nation. This policy, which was withdrawn in November 2021 following farmers’ protests, literally pushed Sri Lanka to the brink of a disaster. Agricultural scientists were unanimous in warning the Gotabaya government of the potential harm from the organic agriculture policy. He wrote to the government that if chemical fertilizers were banned, the yield of paddy could drop by 25 per cent, in tea by 35 per cent and in coconut by 30 per cent.

fertilizer ban fiasco

Scientists proved right. In February 2022, the IMF assessed that there was a “greater-than-anticipated impact of the chemical fertilizer ban on agricultural production”, which was likely to curtail the prospects for economic recovery. As agricultural production declined, more imports of food became necessary. But increasing imports was difficult due to lack of foreign exchange. Thus, inflation rose to 17.5% in February 2022. Also, export earnings declined due to decline in productivity of tea and rubber. And thus, the organic farming policy, which aimed to ease the pressure on reserves, made them even more stressful.

The current Sri Lankan economic crisis is the product of historical imbalances in the economic structure, the IMF’s debt-related terms, the misguided policies of authoritarian rulers and the official embrace of pseudoscience. The future also looks bleak. The government can once again approach the IMF for a new loan with new terms. With the global outlook looking dim, a renewed push for such a deflationary policy will not only limit the prospects of economic revival, but will also add to the suffering of the people of Sri Lanka.

(R. Ramkumar is Professor, Tata Institute of Social Sciences, Mumbai)