What’s behind Sri Lanka’s economic crisis?

Sharine Silva, a hair and makeup artist in Colombo, struggles to make ends meet as prices of essential items are skyrocketing in Sri Lankawhich has faced one of its worst economic crises in decades.

“There is no fresh milk or powdered milk for tea. Formula prices are exorbitant,” said Silva, a mother of two.

“It looks like a war where we have to ration our food now. It seems so silly considering our times,” she added.

Soaring inflation, weak public finances, untimely tax cuts and the Covid-19 pandemic, which have hurt the important revenue-generating tourism industry and foreign remittances, have disrupted the Sri Lankan economy over the past few months.

Food prices, for example, have soared 25% in the past month alone.

Shortage of food and fuel

Meanwhile, the country’s foreign exchange reserves have fallen by around 70% since January 2020 to around $2.3 billion (€2.1 billion) in February, even as it faces debt payments of about $4 billion over the remainder of the year.

Sri Lanka’s current reserves are barely enough to pay for about a month’s worth of goods imports.

A shortage of foreign currency means the country struggles to import and pay for essentials like fuel, food and medicine.

These challenges have led to cuts in electricity production, with only four hours of electricity a day, and long queues outside gas stations.

Even the newspaper and printing industries have been hit by a severe shortage of printing equipment, forcing publications to be cut back and school exams to be postponed.

Prasad Welikumbura, a social and political activist in Sri Lanka, said daily wage earners have borne the brunt of the crisis.

“It’s really difficult for people like taxi drivers and tuk-tuk drivers,” Welikumbura told DW.

The economic pain has caused growing anxiety and frustration among Sri Lankans, with many accusing the government of mismanaging the economy.

Lower taxes and pressure on public finances

The economic emergency poses a daunting challenge to President Gotabaya Rajapaksa, who came to power in 2019 promising rapid economic growth.

During his presidential campaign, Rajapaksa pledged to nearly halve the 15% value added tax and scrap some other taxes to spur consumption and growth.

The tax cuts have led to the loss of billions of rupees in tax revenue, putting additional pressure on the public finances of an already heavily indebted economy.

Then came COVID, which dealt a heavy blow to the tourism sector, which accounts for more than 12% of the country’s total economic output.

Sri Lanka’s public debt, which was already on an unsustainable trajectory before the pandemic, is estimated to have fallen from 94% in 2019 to 119% of GDP in 2021.

“The tax cut and the subsequent addition of more money through central bank financing have significantly worsened the inevitable crisis,” said Chayu Damsinghe, an economist at the Frontier Research group.

India, China and the IMF to the rescue?

To solve the economic problems, the government of Rajapaksa has restricted the imports of several items which have been declared “non-essential”.

He also approached India and China for help.

It was reported on Monday that Colombo has requested an additional $1 billion line of credit from India to import essential items, after Sri Lankan Finance Minister Basil Rajapaksa signed a $1 billion line of credit. dollars with New Delhi earlier this month.

In addition to the lines of credit, India extended a $400 million currency swap and a $500 million line of credit for fuel purchases in Sri Lanka earlier this year.

Meanwhile, Sri Lanka has asked China to restructure its debt repayments to help weather the financial crisis. The country is also in talks with China for additional credit support of $2.5 billion.

Despite bilateral deals, economists say Sri Lanka will either have to restructure its debt or approach the International Monetary Fund (IMF) to negotiate a relief package.

After initially refusing to knock on the doors of the IMF, Rajapaksa’s government recently said it would start discussions on the global financial situation to find a way out of the crisis. Rajapaksa is expected to fly to Washington, DC next month to begin negotiations on a bailout.

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