Sri Lanka is teetering on the economic edge, due to the pandemic-fueled financial crisis and the fallout from the war in Ukraine

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A unprecedented economic crisis takes place in Sri Lanka. And while the country’s problems have been brewing for years, the fallout from the crisis in Ukraine sent the island nation to the brink.

The Sri Lankan Rupee plunged to a record low against the US dollar. Annual inflation is in double digits. Import controls are in effect. And the country is on the edge of default.

As a result, power outages are common. Fuel, food and medicine – most of which are imported – are rare and rising prices put what remains out of reach for many Sri Lankans. Same printing paper is hard to find, forcing schools to cancel exams. The problems sparked the biggest protests Seen here for years. Troops were sent to quell them.

Sri Lanka is now turning to foreign aid for help, including its two largest trading partners. China plans offering $2.5 billion more above $2.8 billion already extended, and India has put in place $2.4 billion. And the government of President Gotabaya Rajapaksa is currently in negotiation with the International Monetary Fund and the World Bank for a larger aid package – something he had previously resistedto avoid the often onerous delays they require.

Inasmuch as economist and former civil servant at the Central Bank of Sri Lanka, I seen firsthand many of the policies that led to the current crisis. And now the economic, financial and political stability of Asia’s oldest democracy are all in danger if the government does not find a lasting solution.

From Civil War to Wild Growth

Sri Lanka, which gained independence from Britain in 1948, only recently emerged from a deadly and costly 26 year civil war.

The war has pitted the government army of this Sinhala-majority country against armed separatists from the Tamil minority. Civilians and civilian property were frequent targets.

Towards the end of the war, in 2006, the government tried to revive growth by borrowing massively and by attracting foreign capital by supporting the rupee. In the short term, the strategy worked. The economy boomed, pushing gross domestic product per capita from $1,436 in 2006 to $3,819 in 2014 – skip past sri lanka Ukraine, Philippines and Indonesia. This lifted 1.6 million people out of poverty – 8.5% of the population – and gave birth to a large middle class. By 2019, Sri Lanka risen in ranks of the World Bank’s “upper-middle-income” countries.

The designation lasted only a yearhowever, because all this growth has come at a cost. Sri Lanka’s external debt tripled from 2006 to 2012, pushing total public debt at 119% of GDP.

These policies were suspended for some time in 2015, which stabilized the economy at a lower growth rate, but the the debt continues to pile up.

Protesters hoist and throw loaves of bread to highlight rising food prices.
AP Photo/Eranga Jayawardena

Pandemic and war

Then the COVID-19 pandemic hit.

Tourists, who spent $5.6 billion in 2018 and played an important role in Sri Lanka’s balance $10 billion trade deficit, disappeared almost overnight.

This has dealt a severe blow to the economy, especially given a large tax reduction the previous year the state coffers exhausted. Just paying interest on this big debt took 72% of public revenue in 2020forcing the central bank to print more cash to avoid default, thereby fueling inflation.

Fortunately for the government and its citizens, Sri Lankans abroad kept sending home a vital lifeline for remittances, around $7 billion a year.

But in 2021, as much economists and analysts have urged Sri Lanka will seek international aid, central bank instead focused on borrowing from neighborsmaintaining the value of the rupee and restricting imports.

Export controls have caused shortages of essential goods like cooking gas and milk, and defense of currency depleted Sri Lanka’s foreign exchange reserves. Besides, remittances began to decline as the value of the rupee on the black market fell, leading people to avoid converting dollars to rupees at the official rate or through official channels. Annual inflation has been estimated up to 55%, against an official rate of 14%.

In March 2022, the repercussions of the war in Ukraine, which drives up international prices oil, wheat and many other raw materials, finally forced the government to change course. Beyond the effect on the cost of imported goods, the war also further threatens Sri Lanka’s tourism industry as flights to Moscow are now suspended. Before the war, Russians often accounted for the largest share Sri Lankan tourists, with Ukrainians not far behind.

The Sri Lankan authorities had little choice but to let the rupee depreciate, which expected to save billions dollars a year – and ask for help from the IMF. Sri Lanka will probably also have to restructure its high leverage – by requiring foreign bondholders to accept less than 100% of the value of their investments – to make it more sustainable.

A perilous situation

the the strategy can workbut the cost to Sri Lankans will be high for a long time.

More than 350 “non-essentials” items are now prohibited intended for import, including milk, oranges and household appliances.

And the limited supply of goods that remains is becoming more expensive every day. The price of cooking gas, for example, is almost three times higher than he was just five months ago.

Obtaining loans from the IMF and the World Bank, as well as short-term credit from China and India, could stabilize Sri Lanka’s economic and financial situation. But with growing protests and austerity measures demanded by lenders likely to prove unpopular, the government may struggle to survive for long.

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