Economic crisis in Sri Lanka: Sri Lanka’s economy crushed by war in Ukraine | International Business News
Hit by soaring oil import costs and a drop in tourism revenue, Sri Lanka is racing to avoid a default amid dwindling foreign currency holdings. With inflation already at 15% – the worst in Asia – the conflict is only making things harder for the tropical island off the southern tip of India. Fuel shortages and blackouts of up to seven hours have become a daily routine, while the wait is getting longer at petrol stations where prices have jumped nearly 50% this month .
The authorities are struggling to contain the crisis. They raised interest rates, devalued the local currency and clamped down on non-essential imports. But with a measly $2 billion in foreign exchange reserves and $7 billion in debt payments due this year, the battle is getting uphill. This week the government finally abandoned its reluctance to ask for help from the International Monetary Fund and President Gotabaya Rajapaksa pledged to fulfill Sri Lanka’s obligations.
“Asking for help from the IMF is the most feasible way out of the crisis,” said Mumbai-based Bloomberg Economics economist Ankur Shukla. “The Russian-Ukrainian war has aggravated the already fragile situation of external balances, widening the gap between external financing needs and available sources of financing.”
One of Europe’s worst conflicts since World War II could not have come at a worse time for Sri Lanka, which is still recovering from a brutal 30-year ethnic conflict that ended in 2009. The country of South Asia has sought to revive growth ever since, spending millions on tourism infrastructure, until the pandemic dealt a blow to its plans. The crisis also shows how Russia’s war endangers some of the fragile developing economies and jeopardizes decades of efforts to lift millions of people out of poverty.
In South Asia, other vulnerable countries include Bangladesh, the Maldives, Nepal and Pakistan, Shukla said. Although direct trade and financial ties with Russia and Ukraine are limited, “price and supply shocks are powerful,” he wrote in a March 9 memo.
With a population of around 22 million, Sri Lanka is a net importer of goods ranging from medicine to fuel. In December, petroleum products accounted for about 20% of inbound shipments and the cost jumped 88% from a year earlier. Rising oil prices this year add to the burden.
The country has also paid off the foreign debt it accumulated to help rebuild an economy battered by the bloody civil war between the majority Buddhist Sinhalese and a predominantly Hindu Tamil minority. This emptied its foreign exchange reserves.
Another sensitive point concerns income from tourism. About 30% of visitors this year came from Russia, Ukraine, Poland and Belarus, and war threatens to turn off that tap. Sri Lanka earned $3.6 billion from tourism in 2019 before the pandemic reduced it to less than a fifth two years later, according to official data.
The central government’s foreign debt stood at $32 billion in November. Optimism that the government will soon reach a deal with the IMF has already spurred a rally in the country’s dollar bonds. An offshore bond due 2030 soared to 49 cents to the dollar from a record low of 38.9 cents on March 9, while the one-year probability of default fell to 18.2% from 31.3% at the end of December , according to data compiled by Bloomberg.
The country’s international bonds must be restructured by July because Sri Lanka lacks the resources to pay the billion dollars owed that month, Citigroup Inc. said in a February note.
Besides rising borrowing costs and devaluing the rupee, Sri Lanka’s Central Bank Governor Ajith Nivard Cabraal has also called for restrictions on non-essential imports of around 300 items, electronics apples, and increases in fuel and electricity prices.
“The government seems to be responding positively and that would help steer the economy towards calmer waters at a time of unprecedented global challenges,” Cabraal said by phone last week.
Yet for ordinary Sri Lankans, the pain is real. Civic groups held vigils highlighting rising costs, while the main opposition party held a mass rally in the capital Colombo on March 15 demanding the resignation of President Rajapaksa. The protests pose no immediate threat to his government, which holds almost two-thirds of the majority in parliament.
Sugath Chaminda, 44, said he spent around 10 hours refueling his auto rickshaw, after being pushed back by numerous petrol pumps which had run dry. He then spent more time looking for a bottle of cooking gas, which was also in short supply.
“I don’t know what the government is doing to bring us to this situation,” he said in Colombo.
Part of the inflation push is also self-inflicted. Last year, the government banned imports of chemical fertilizers as part of an ambitious plan to promote organic farming. This caused a nutrient shortage, leading to crop failures and protests, prompting the government to reverse its decision in November.
Sri Lanka also approached China and India for bilateral lines of credit to avoid an IMF bailout, but negotiations were complicated by the war in Ukraine. In the past, policymakers have generally viewed some of the IMF’s conditions as binding, leading to a reluctance to engage with the agency.
Rajapaksa said Wednesday his government had weighed the pros and cons of working with the IMF, which has advocated a “credible and coherent strategy” to restore macroeconomic stability and debt sustainability.
Restructuring is needed because debt levels are too high, said Kenneth Akintewe, head of Asian sovereign debt at abrdn in Singapore.
“The country has no history of defaults, but that also means it has no experience in the restructuring process,” he said. “On top of that, the relationship with the IMF has been fractured. This leaves room for missteps along the way.