Naisha Khanna is a second year student of B.A. Global Affairs at the Jindal School of International Affairs and is currently a content writer for Arthaniti – JGU’s Economics Society.
Credit: AFP Photo
A crisis unlike any other they have experienced before, described by The Guardian as “the worst in living memory”, has befallen Sri Lanka. Devastating images and tales of the dearth of supplies have emerged. The country is now unable to adequately import essential items like food and fuel. Their current reserves are estimated to be enough only for another month of goods imports. The suffering of the average Sri Lankan is visibly clear, as several are fleeing the country in search of a haven. A humanitarian crisis has arisen from, and accompanies, the economic disaster. Widespread hunger, fuel shortages, and power cuts now characterize the life of the Sri Lankan citizen. So dire is the situation that exams have been cancelled for lack of paper, and hospitals are unable to carry out commonplace surgical procedures. Daily wage laborers, marginalized groups, and fringe dwellers of society are the ones bearing the brunt of this crisis. On 2nd April the President declared a nationwide public emergency. Turmoil has engulfed the capital, with protestors caught in strife against the military.
How has the island nation reached this tragic juncture, and what can the international community do to mitigate the distress faced by the Sri Lankans? This crisis presents an opportunity for us to critically examine certain foundational concepts upon which a state’s economic wellbeing rests and allows us to analyze how the international community might step in to aid the distress-stricken state. How well do the ostensibly solid mechanisms of the international order perform when faced with a crisis of such mammoth proportions? The fate of a population of 21 million relies largely on the assistance of the International Monetary Fund, whom the President Gotabaya Rajapaksa has reluctantly turned to after exhausting all other available options, but to no avail. What can this international organization do in such a situation? The trajectory of events in Sri Lanka must be understood to answer these crucial questions.
The foreign reserves of the island nation have fallen below $1 Billion dollars. Since the start of the month of March, there has been a steady decline in the value of the Sri Lankan rupee. Its value has plummeted by 45% in a mere one month. Looming over the heads of the regime are the due debt repayments. $4 Billion dollars are due to be paid this year, of which $1 billion are due in June. Default seems inevitable. One might say that the defining feature of the crisis is the immense debt burden upon Sri Lanka. Debt of this sort has been categorized as ‘unsustainable debt’ by the International Monetary Fund. Let us delineate what is meant by this term. Debt sustainability refers to a situation where the debt undertaken by a country seems to be consistent with their ability to pay. Debt of this sort might be considered healthy debt, a necessary aspect of the overall development of a state. In such a case, the returns from incurring debt should offset the total cost of the debt. Debt taken for the purpose of financing productive ventures and infrastructure might be considered sustainable since the gains from these projects would cover the costs of the debt and provide significant returns too. Further, the President admitted that the country faces a trade deficit of $10 billion dollars. A trade deficit arises when a state has imports in excess of their exports. This situation causes a paucity of foreign exchange, which in turn makes it harder for a state to fulfill their debt obligations. This broadly describes the situation in Sri Lanka too. Only $2 billion dollars as foreign exchange reserves remain with Sri Lanka.
Origins of the Crisis
The roots of the issue can be traced back to 2012, when Sri Lanka’s GDP began to steadily tumble. The global rise of commodity prices entailed a decline in Sri Lanka’s primary exports: tea, rubber, and garments (a characteristic of its economy attributable to its colonial past). Two watershed events in 2019 caused drastic setbacks to the Sri Lankan economy, significantly altering the economic trajectory of the nation. The first of these two events is the Easter Bomb blasts in which three hotels and three churches in Colombo were targeted. The demise of 253 people in these bomb blasts affected the tourism sector. In the aftermath of the tragedy, the inflow of tourists fell significantly. An 18% decline in the number of tourists was seen, which had direct implications for the foreign exchange reserves of the country. The other defining event was the President’s decision to reduce VAT rates from 15% to 8% in December 2019. Sri Lanka had one of the lowest indirect tax rates before the onset of the Pandemic. The spread of the Pandemic lead to the government increasing their expenditures. Increased expenditures combined with the sudden fall in revenue amounted to a fiscal deficit of more than 10%. The International Monetary Fund, in February 2022, presented their analysis of the situation, stating three causes of the fiscal deficit: the tax cuts prior to the pandemic, the weak revenue performance, and the surge in spending during the pandemic. Rajapaksa’s experiments with organic farming in May 2021, in which he banned all chemical fertilizers, exacerbated the problem. The decrease in imports of chemical fertilizers was intended to improve the foreign exchange reserves of the country. Instead, agricultural production was adversely impacted. The food shortage that this created still persists, and in fact has grown exponentially. The food shortages sparked inflation, necessitating greater imports of food products. Thus, the policy proved to be counterproductive to its aim.
The IMF- a boon or bane?
From 2016 to 2019, Sri Lankan economists and policy makers were already constrained in their functioning by IMF conditionalities. In 2016, Sri Lanka entered into a 36-month agreement with the IMF for $1.5 billion US dollars. The IMF put forth the condition that Sri Lanka must reduce their fiscal deficit to 3.5% by 2020. By 2019, it had become evident that the policy recommendations of the IMF, while seemingly sound on paper, had wreaked havoc upon the Sri Lankan economy. The growth rate drastically declined, and public debt grew by 30%. Rajapaksa’s successive policy decisions added fuel to the fire. The Sri Lankan population did not bode well under the advice of the IMF. Their association with the IMF however is no recent phenomena. Sri Lanka’s tryst with the IMF began in the 1970’s. The state is regarded as the first South Asian nation to embrace neoliberalism. The institution is once again being heralded as the panacea to Sri Lanka’s woes. K. Amirthalingam, Professor of Economics at the University of Colombo, laments the fact that Sri Lankan economists and other international agencies are once again recommending turning to the IMF. He believes a radical departure from their previous policies is needed. At best the IMF could provide relief of $2 billion or $3 billion, while the trade deficit in 2021 was $8.1 billion. Those advancing borrowing from the IMF as a solution believe that such a loan will allow Sri Lanka to borrow from International Markets again in order to bridge the trade deficit until the tourism regains traction. Prof. Amirthalingam contests this theory, instead positing that the cost of borrowing will be too high for Sri Lanka in light of modified global conditions, such as the Federal Reserve in the United States preparing to raise interest rates.
A thorough examination of the events that transpired prior to Sri Lanka’s economic collapse allows one to assess the best course of action for states to avoid reaching the brink of disaster. This serves as a lesson in policy making for states and tells citizens when to be wary. The trajectory of events outlined above allows us to answer the aforementioned questions of how one might reach this juncture. It raises important questions regarding the efficacy of international organizations. At a time when the purchasing power of people is already negligible, it seems imprudent and inconsiderate to follow this course of action. Furthermore, it is safe to anticipate that the IMF will impose conditions such as asking the government to cut expenditure and raise taxes. The debt crisis which plagues Sri Lanka will only be perpetuated by continuing to borrow in the capital markets and rolling over debt.
Comments