How Lanka became a cautionary tale about a flawed economy

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The island nation’s economy was slowing even before the Covid-19 pandemic with high debt levels and a high budget deficit. The pandemic dealt a severe blow to the country’s economy as the crucial tourism sector collapsed under the weight of the devastating impact of the coronavirus. Growth contracted by 3.6% in 2020 and pushed thousands of people into poverty.
Foreign investment has dried up, exports have collapsed, inflation is high, job losses have increased, the external debt situation looks precarious, foreign exchange reserves are depleted and business confidence is low and there are signs of social tension. A controversial organic farming policy has hurt the agricultural sector, driving up food prices and causing shortages. The government canceled some of the provisions and promised to import chemical fertilizers, but experts say the damage was severe. The intensity of the crisis has increased with severe power cuts and energy shortages. Public transport was paralyzed due to fuel shortages. “The immediate causes of the current debt management difficulties are commercial loans obtained since 2007 for non-revenue generating projects.
The problem was compounded by the reckless tax breaks granted in 2019. Underlying all of this was a fundamentally unsound economy afflicted by twin deficits (budget and current account) which have not been addressed by any government since independence. . The self-inflicted reduction in state revenue over the past two years has resulted in the inability to manage the accumulated debt burden,” said Rohan Samarjiva, chairman of private think tank LIRNEasia. According to the International Monetary Fund (IMF), on the eve of the pandemic, the country was highly vulnerable to external shocks due to insufficient external reserves and high risks to public debt sustainability, exacerbated by the Easter Sunday terrorist attacks. in 2019 and major political changes. , including significant tax cuts at the end of 2019.

how serious is he Sri Lankais the debt problem?

Experts say the level of external debt stood at more than $35 billion in April 2021. Global ratings agency Moody’s Investors Service says a delay in the recovery of tourism receipts would weigh on the liquidity situation precarious foreign country of Sri Lanka. In November 2021, the country had $1 billion in foreign exchange reserves, covering less than a month of imports. While the central bank indicated that the reserves had increased from the end of December with the disbursement of one dollar. $5 billion swap agreement with the People’s Bank of China, reserve adequacy remains very low, with reserves around $2-3 billion versus $5-6 billion in foreign currency obligations due each year until at least 2025. -investment grade closed the door to global bond markets.

What is China’s role in this crisis?

“Since the early 2000s, China has become one of the main providers of commercial loans to Sri Lanka for infrastructure projects, including the Port of Hambantota. Some claim that by accepting such loans, Sri Lanka is now stuck in a ‘debt trap’. However, the debt trap is not entirely Chinese. About half of Sri Lanka’s external debt was owed to capital markets while China accounted for about 10% in April 2021, said Ganeshan Wignaraja, nonresident senior fellow at the Institute of South Asian Studies (ISAS) from the National University of Singapore. an article. Some experts such as Samarajiva claim that China’s loans are not cheap but represent only around 10-15% of the total outstanding debt. He says many of the Chinese loans have been used by the government for non-revenue-generating projects (Mattala Airport, Lotus Tower in Colombo).


The path to follow?

Calls have been made for political parties to present a common minimum program to develop a two-year recovery plan and prescriptions for carrying out deep and meaningful reform to revive growth. India has also offered significant humanitarian assistance. The IMF should relaunch discussions with Sri Lanka with a view to a possible aid program in the form of loans.
Discussions could begin in April when the Sri Lankan finance minister visits Washington. The IMF says economic prospects are constrained by Sri Lanka’s debt overhang as well as still-large fiscal and balance-of-payments financing needs. GDP growth is expected to be negatively affected by the impact of foreign exchange shortages and macroeconomic imbalances on economic activities and business confidence. Inflation has recently accelerated to 14% in January 20223 and is expected to remain in double digits over the coming quarters, exceeding the target range of 4-6%, as strong inflationary pressures have built up both on the supply and demand since mid-2021.
Under current policies and the authorities’ commitment to preserve tax cuts, the fiscal deficit is expected to remain large over 2022–26, which will further increase public debt over the medium term. Due to the persistent external debt service burden, international reserves would remain insufficient, despite the authorities’ continued efforts to secure foreign currency financing from external sources. It indicates that the outlook is subject to great uncertainties with downside risks.

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