Explained: How Sri Lanka’s economic crisis spun out of control
Sri Lankan Prime Minister Mahinda Rajapaksa resigned on Monday after weeks of public protests demanding the resignation of the Rajapaksa brothers.
Rajapaksa spokesman Rohan Weliwita said the 76-year-old had sent his resignation letter to his younger brother, President Gotabaya Rajapaksa, paving the way for a “new unity government”.
Amid escalating anti-government protests, Rajapaksa’s government last week declared a state of emergency for the second time in five weeks, but public discontent has been simmering.
The worst economic crisis since 1948
The Sri Lankan economy is facing one of the worst economic crises in its history since its independence from Britain in 1948, resulting from poor management of public finances and untimely tax cuts, in addition to the impact of the Covid-19 pandemic.
A severe shortage of foreign currency had prevented the Rajapaksa government from paying for essential imports, including fuel, leading to debilitating power cuts that could last up to 1 p.m.
Huge piles of foreign debt, a series of lockdowns, runaway inflation, shortage of fuel supply, falling foreign exchange reserves and currency devaluation have had a negative impact on the country’s economic growth.
The nation is now on the brink of bankruptcy. Last week, Finance Minister Ali Sabry said Sri Lanka had only $50 million in usable foreign exchange reserves.
Sri Lanka was due to pay $7 billion of its external debt this year out of nearly $25 billion it must pay by 2026. Its total external debt is $51 billion.
The government has approached the International Monetary Fund (IMF) for a bailout and will begin a virtual summit with IMF officials on Monday aimed at securing emergency aid.
What led to this crisis
Sri Lanka’s economy was struggling even before the Covid pandemic hit. The closures have further compounded its woes and have hit the informal sector hard, which accounts for nearly 60% of the country’s workforce.
The country’s foreign exchange reserves have fallen 70% in the past two years to about $2.31 billion, leaving it struggling to pay for essential imports including food and fuel.
The financial crisis also resulted from a critical foreign exchange deficit, preventing traders from financing imports.
Tourism, one of the country’s main sources of foreign exchange, has been hit hard due to the Covid pandemic. In addition, remittances from Sri Lankans working abroad have also declined sharply.
The country finds itself with foreign exchange reserves of about $2.31 billion in February alone, even as it faces debt payments of about $4 billion for the rest of the year.
“The reason for the shortage is not a shortage of commodities but a shortage of dollars,” Dhananath Fernando, chief operating officer of the Colombo Advocate Institute think tank, told Reuters news agency.
The $4 billion debt includes a $1 billion international sovereign bond that matures in July.
Job losses, power cuts disrupt life
Job losses have become a common occurrence in almost every household. In addition, declining incomes have led to rising poverty rates.
According to World Bank data, the share of poor people based on a daily income of $3.20 is estimated to have risen to 11.7% in 2020 – or by more than half a million people – against 9.2% the previous year.
The government had identified 5 million families with “the fragile financial situation of low-income households” and granted them an allowance of Rs 5,000 during the Covid-19 lockdowns.
But that only helped briefly, with the latest economic crash – aggravated by the Russia-Ukraine conflict that has driven oil prices soaring – serving another punch and making scenes of desperation increasingly common. and panic.
(People have taken to the streets to protest the challenges they face due to the shortage of essential items)
Shortages have reached such levels that exams for millions of students across the country have had to be postponed due to lack of paper and ink.
As oil prices soared during the Russian-Ukrainian conflict, Sri Lanka’s fuel stocks are running low. Authorities have announced that nationwide power cuts will increase to about four a day as they cannot supply enough fuel to power stations.
Fuel shortages have led to long queues at gas stations and power cuts across much of the country. A severe shortage of diesel has shut down several thermal power plants, causing power outages across the country.
Fuel prices have also risen frequently, with gasoline up 92% and diesel 76% year-to-date.
People in the country are also facing shortages and runaway inflation, after the country sharply devalued its currency in March.
The crisis caused in part by a lack of foreign exchange has meant that the country cannot afford to pay for imports of basic foods and fuel, leading to acute shortages and very high prices.
The government ran out of money for vital imports; commodity prices have soared, leading to severe shortages of fuel, medicine and electricity supplies.
In March, the country’s central bank raised interest rates to stem growing inflationary pressures and urged the government to consider measures such as cutting non-essential imports and raising fuel prices to reduce pressure. on the struggling economy.
Retail price inflation in February reached 15.1%, while food inflation reached 25.7%, the highest in a decade. The Central Bank of Sri Lanka (CBSL) aims to keep inflation in the 4-6% range over the medium term.
The sudden rise in prices of major commodities has left many people at the mercy of subsidies as all essential items are in short supply due to import restrictions imposed by the currency crisis.
The Sri Lankan rupee has depreciated 33% against the US dollar in the year to April 1, 2022.
Taking into account exchange rate fluctuations between currencies, the Sri Lankan rupee depreciated by 31.6% against the Indian rupee, the euro by 31.5%, the pound sterling by 31.1% and the Japanese yen by 28.7% during this period.
The Central Bank of Sri Lanka, with immediate effect, set an exchange rate limit of 230 rupees to the dollar against a limit of 200-203 that had prevailed since October.
In December, CBSL announced a series of measures, including providing an additional 10 rupees per dollar as an incentive, but this had limited impact as remittances fell by 61.6% in January to 259 million, up from $675 million a year earlier.
(With agency contributions)