Causes of the Sri Lankan economic crisis

Sri Lanka is facing its worst economic crisis since its independence. It urgently needs foreign exchange reserves to repay past debt and import essential goods. There is a state of chaos with power cuts lasting up to 12 hours, a shortage of basic necessities in hospitals, a lack of paper to take school exams and no fuel at gas stations. From 1983 to 2009, the 25 years of civil war in Sri Lanka had a massive impact on its foreign exchange reserve. The war was predicted to have cost $00 billion, nearly five times the Sri Lankan GDP (2009). The shortage of foreign exchange reserves in the country is due to the myopia of the ruling government. Sri Lanka has a huge public debt of around 110% of its GDP. The Sri Lankan rupee hit a record high against the US dollar. This is due to the government’s significant tax cuts, which have affected government revenue and fiscal policies. To cover the budget deficit, the government started printing more money, which further increased its inflation rate from 15.1% to 18.7%. The Sri Lankan rupee was at 299.95 against the US dollar on April 5, 2022. Experts conclude that the rising imports of the country’s essential goods (sugar, pulses, cereals and pharmaceuticals) are one of the reasons for the decline in foreign exchange reserves. In 2019, the then newly formed government promised to revive the growth of the Sri Lankan economy and reduce value added tax (VAT) on the grounds that a lower tax rate would attract more consumer spending which would pay them the incurred deficit. But the pandemic disrupted the cycle of increased consumer spending and led to a failure of VAT tax cuts.

This led to a sharp reduction in government revenue. In April 2021, in order to revive the decline in the foreign exchange reserve, President Gota-baya Rajapaksa announced a complete shift to organic farming banning all chemical and inorganic fertilizers. Part of the national economy is devoted to the import of chemical fertilizers. Instead, it had a negative effect on the economy, causing huge economic losses. The decision to switch to organic farming over the next decade was a good idea, but the overnight switch had a negative impact. The conversion of tea production and other agricultural products to organic farming led to a drop in yields which led to a loss of 425 million dollars. Sri Lanka, which was self-sufficient in rice production, ended up importing rice within six months. Tea used to be a major export product which accounted for 16.57% of total export revenue, but not anymore. The negative effects on the economy, continued protests and rising food prices caused the government to reverse its decision in November 2021. The 2019 Easter Sunday bombings and the Covid pandemic resulted in a slowdown in tourism, which represents 12.9% of GDP. The sector showed no signs of recovery until November 2021, when the government lifted quarantine measures for vaccinated visitors. The war between Russia and Ukraine has further accelerated the weakening of the economy as 25% of tourists come from Russia and Ukraine. Sri Lanka also faces a labor shortage. In 2018, Malik Fernando, head of the Tourism Skills Committee industry body, said the country needed 100,000 more employees in the tourism sector over the next three years. Currently, Sri Lanka has $2.3 billion in foreign exchange reserves. This is insufficient to pay the $7 billion foreign debt obligations and the $1 billion International Sovereign Bond (ISB) payment for 2022. The World Bank, however, hopes the economy will recover although there are will have many challenges.

(Gupta is Assistant Professor, Department of Humanities and Management, and Kansal is a first year Computer Science, Madan Mohan Malaviya University of Technology, Gorakhpur. Opinions expressed are personal.)

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