A few millennia ago, most villages were economically self-sufficient. They produced everything the inhabitants needed. But modern nation-states are rarely self-sufficient despite the globe itself now being a village. They export their surplus. They earn and save foreign exchange reserves. And, they matter to cover their deficiencies. Sri Lanka’s current problem is that it does not have enough money to buy what it needs abroad.
Sri Lanka has requested a $1 Billion Line of Credit from India to cover the import of essential goods, Reuters news agency reported as the island nation battles its worst economic crisis in decades.
This is on top of the billion dollars that India has already pledged to bail out Sri Lanka, which is struggling to pay for essential imports including food and fuel.
How bad is that?
Its foreign exchange reserve has fallen by 70% since January 2020. Sri Lanka’s foreign exchange reserves fell to $2.31 billion in February, down $779 million from December 2021 to January 2022.
This has blocked its imports, leading to an acute shortage of several essential items. Its currency suffered a significant devaluation. His efforts to find generous global lenders were not very successful.
Sri Lanka’s debt burden has become unmanageable for the country if a proper bailout is not granted to the country by an international financial agency or group.
Sri Lanka is obligated to repay approximately $7 billion in debt in 2022. One of the debts is $1 billion in the form of international sovereign bonds which mature in July.
that of Sri Lanka public debt increased (according to projections) by 94% of its gross domestic product (GDP) in 2019 to 119% of GDP in 2021, the International Monetary Fund (IMF) announced in early March.
International rating agencies downgraded Sri Lanka’s credit rating. Market watchers fear Sri Lanka will not be able to service its $51 billion sovereign debt this year.
India has reportedly assured Sri Lanka that it will extend the line of credit to cover imports of essential items such as rice, wheat, wheat flour, pulses, sugar and medicines.
In addition to the two $1 billion credit lines, India earlier this year provided a $400 million currency swap and another $500 million credit line for the purchase of fuels.
This is in addition to the Chinese currency swap facility of $1.5 billion in 2021.
LIFE IN LANKA
The Lankans are going through a very difficult time. Its banks are unable to obtain dollars to finance imports of any kind, including food, fuel and medicine. The Covid-19 pandemic has only worsened its economic difficulties since January 2020, after which the spread of the coronavirus shocked the world into separate cocoons.
Prices have skyrocketed. Each of the past five months has seen a new peak in the inflation rate. In February, the inflation rate was set at 17.5%. Food prices have increased by 25%. This price increase occurred on January’s inflation rate of more than 14 percent.
The blocking of imports of basic necessities forced the government to resort to stricter rationing. For example, against one kg of milk per day, a Sri Lankan can now only buy 400 grams of milk per day.
Sri Lankan cities face daily power outages of more than five hours. Reports say people are being forced to queue for miles to get cooking gas cylinders and diesel fuel.
NOT THE PROBLEM TODAY
If Rome was not built in a day, a crisis does not happen in the blink of an eye. Sri Lanka’s economy has been experiencing structural problems for several years. The successive government took shortcuts to solve the problems.
For example, every government in the past 15 years has issued sovereign bonds with no provision for redemption. Its foreign exchange reserve has increased but not by exporting goods and services but by borrowing foreign currency. This left its foreign exchange reserve vulnerable to market shocks.
In 2019, the Sri Lankan government announced major tax cuts that ended up lowering its revenue. Its loan agreements with China have also contributed to this crisis. Most Chinese loans of more than $5 billion over the past decade have gone to low-return projects such as building ports, airports and coal-fired power plants.
During the Covid-19 pandemic, its overseas remittances plunged and the currency-boosted tourism sector all but collapsed. The tourism sector is one of the most profitable in Sri Lanka. But the sector took a hit after the Easter bombings in 2017. Before it could recover, the Covid-19 pandemic hit the world hard.
When the Covid-related restrictions started to lift, the influx of tourists was strong from Russia and Ukraine, amounting to around 25% until mid-February. The Russo-Ukrainian war and subsequent sanctions on the banking sector in Russia had a ripple effect on Sri Lanka. Its traditional tourism sources, India, China, the UK and Germany, have not recovered to pre-Covid levels.
The Covid-19 pandemic has exposed the vulnerabilities and put Sri Lanka in a situation where it seems to have no idea how to get out of this financial mess.