What happened in Sri Lanka & the situation today

11 Jul 2022  Read 5984 Views

The island country Srilanka with a population of 22 million, which was once seen as a model for a developing economy, is experiencing the worst crisis in 70 years.

They are facing a crisis for essential services, soaring inflation, hospitals running short on medicine, fuel shortages leading to long queues at refuelling stations & frequent blackouts; all because of a record low foreign exchange. 

Protests everywhere in the country resulted in eight being killed, with the most recent incident of citizens ousting the country’s President along with clips of hundreds of people inside the official residence going viral, after which President Gotabaya Rajapaksa resigned.

What led to this?

Sri Lanka’s public finances were weakened by successive uncompetitive governments’ mismanagement.

In 2019 when Rajapaksa’s government took over, deep tax cuts were enacted to spur growth. VAT was slashed to 8% from 15% to boost government revenues by 65million. Corporate tax was increased to 30% from 24%. These measures resulted in the country losing 10 lakh taxpayers in the last two years and caused annual public revenue losses of about ₹800 billion.

In 2020, the COVID pandemic hit the global economy, which wiped out the most lucrative tourism industry of the country and impacted much of Sri Lanka’s revenue base, remittances from nationals working abroad dropped, and the base was further weakened by inflexible foreign exchange.

Following the situation, the credit rating agencies downgraded the country’s credit ratings from 2020, concerned about the government’s inability to repay the enormous foreign debt, which restricted the country from international financial markets.

In April 2021, the country announced a ban on imports of chemical fertilizers and focused on organic farming, which dropped its production (30% annual drop in paddy yields) and thus increased grain prices leading to inflation.

Given the circumstances, the government relied heavily on its foreign exchange reserves, eroding them by more than 70% in two years.

What is the situation today?

Today, the country owes $51 billion as loans and cannot even make interest payments on its loans. The currency has collapsed by 80% and has weakened in value with respect to the dollar (1$= 350 Srilankan rupees). Inflation reached 54.6% last month and could rise to 70% as per the central bank.

The debt crisis is partly blamed on the projects built on Chinese loans that made no returns.

The UN World Food Program says that nearly 9 out of 10 families are skipping meals, 3 million are receiving humanitarian aid, Sri Lankans seeking passports to go overseas in search of work is growing, and interestingly government officers are given an extra day off to allow them time to grow their own food.

The country defaulted on its debt payment last month for the first time in its history.

What did the government do?

Though for months, the opposition leaders and financial experts urged the government to take action. But, the government hoped tourism would bounce back and the recovery process would begin.

With the rapidly deteriorating economic environment, the Rajapaksa government initially held off talks with the IMF.

They sought help from regional superpowers - India and China, that have traditionally pushed hard for influence over the strategically located island.

India has extended billions of dollars in loans to help pay for vital supplies. New Delhi promised $4 billion in loans and has already extended around $3.8 billion this year.

China has intervened less publicly but said it supports efforts for the island nation to restructure its debt.

Earlier in 2022, Rajapaksa asked China to restructure repayments on around $3.5 billion of debt owed to Beijing.

They also received $300- $600million from World Bank to buy medicine and other essential items. 

What next?

India is willing to extend its assistance to its neighbour beyond its $4bn promise behind its ‘Neighborhood first’ policy.

However, President Rajapaksa’s decision to step down is likely to add to the country’s political and economic uncertainty.

Sri Lanka’s constitution dictates that when a President resigns, the country’s Prime Minister assumes the role. But incumbent Ranil Wickremesinghe has said he too, would stand down. It is, therefore, likely that the parliament speaker, Mahinda Yapa Abeywardena, would assume temporary charge of the country.

The parliament must choose the next President within a month, and it’s unclear whether members will be able to elect someone who can gather the support of the majority.

The country is also in the middle of talks with IMF for a lending arrangement. IMF and other countries have urged Sri Lanka to reach a political settlement at the earliest possible because a stable government would help the country’s ability to negotiate an agreement and implement policy recommendations better.

About the Author: Himanshi Nandanwar | 2 Post(s)

Himanshi is a Content writer at Finology Legal, a passionate learner with Masters in Sociology and core interests in worldly affairs.

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