Sri Lanka's Impending Economic Crisis
Bad COVID management policies hindering tourism recovery in Sri Lanka: The tourism industry in the country brings in around $3 billion to $5 billion in foreign exchange annually. However, the country’s mismanagement of the Covid-19 outbreak has severely affected its recovery. Unfortunately, despite having the lowest number of tourists visiting Sri Lanka in recent years, the country is still on the red list of travel agencies in several of its top markets. In July 2021, only 19,300 tourists visited Sri Lanka, which is less than 1 per cent of the country's annual tourist count. Even if it manages to double this number by the end of the year (which it can do by 2022, according to the country's officials), it would still only be 2 per cent. Vietnam’s tourism industry suffered an 80 per cent drop in 2020 due to the global financial crisis. The authorities are doing their best to boost the confidence of the travelers. In 2020, a bio-bubble was formed in Ukraine to attract tourists. Although the country's tourism authorities were not involved in the project, it was organized by a private entity. The priority for tourism recovery in Sri Lanka is to arrest the spread of Covid, especially Delta variant. This will help avoid a muted performance in 2022 as well.
Sri Lanka and China:
Due to China's growing distance from Sri Lanka, its relationship with the island has changed significantly. While it has been an ally during the post-independent period, its involvement has been minimal. The growing ties between China and Sri Lanka have been widely attributed to the country's growing economic and financial ties. This is despite the military ties that have also grown. After becoming a middle-income country, Sri Lanka was heavily exposed to the effects of the balance of payment crises. The government’s response to these issues led to the country's dependence on China. There are many claims about the improving relationship between China and Sri Lanka, but it is essential to investigate the underlying factors that have led to this development. Much of the discussion about the relationship between China and Sri Lanka has focused on the country's increasing reliance on Chinese loans. While this is often portrayed as a sign of China's increasing commitment to Sri Lanka, it is also widely believed that the country is in danger of becoming a Chinese debt trap. The growing China-Sri Lanka economic partnership is being widely promoted through three main avenues: trade, investment, and debt. While Sri Lanka is mainly focused on getting its hands on Chinese loans, this does not reflect the country’s true economic potential. Over the last decade or so, China has been Sri Lanka's second-largest foreign lender. It has heavily financed various infrastructure projects, such as the Colombo-Katunayake expressway and the Hambantota port. As of 2019, China owned a significant portion of Sri Lanka's foreign debt stock. Most of the loans that it obtained were for infrastructure development projects. In 2021, China agreed to provide a 10 billion renminbi (RMB) currency swap to help Sri Lanka overcome its foreign currency shortage. This shows the country’s increasing reliance on foreign loans to avoid a severe financial crisis. In 2018, Sri Lanka obtained a $1 billion loan from China Development Bank. In 2020, it got another $500 million from the CDB. China's support for Sri Lanka's external sector security is evidenced by the country's loan facilities and currency swap. Aside from being a vital part of Sri Lanka's economic development, Chinese investments have also contributed to the country's infrastructure development. The two projects involve the construction of a port city in Colombo and a port in Hambantota. The proposed port city project has raised concerns among various political parties. The opposition claims that the project could threaten the country’s sovereignty. In 2020, China became the top importer of goods in Sri Lanka, surpassing India which had been the country's largest source of imports. China's growing presence in the country has also helped boost Sri Lanka's foreign exchange reserves. Although the trade war between China and India has affected some of its consumers, it has not affected the overall imports of both countries. For instance, in 2020, the total imports of China decreased by 8 percent, while those of India went down by 19 percent. Due to the nature of the goods that they import, Sri Lanka's textile industry is very dependent on China. In fact, since the 1990's, China has become the main source of raw materials for its garments and textiles. In terms of merchandise exports, the majority of Sri Lanka's textile and apparels are made up of raw materials that are cheaper than those from other countries. This is the main reason why Sri Lanka has started importing these goods from China.
Does Sri Lanka’s Economic Crisis Poses Any Challenges to India?
The 2020 Sri Lanka foreign and security policy reflected the country's growing confidence in India's ability to provide security and stability. More than 60% of Sri Lanka's exports go to India. The country's free trade agreement with India was signed in 2000. Through our partnership with Colombo, India has always been focused on developing social infrastructure projects that benefit the local population. Through various Indian government-backed lines of credit, India has provided about $2 billion to Sri Lanka for various projects, including the construction of a railway network in the country. From 2005 to 2019, India's foreign direct investment (FDI) inched up to around $1.8 billion. It mainly went into various sectors such as hotels, tourism, and retail. India’s commitment to Sri Lanka’s security and development has been acknowledged by the country’s new government. India is a major investor in Sri Lanka. Its development partnership with the country has always been focused on projects related to education, health, housing, and industrial development. Concessional financing of over $ 2 billion has been provided by Indian government to Sri Lanka through various Indian financial institutions. These lines of credit have been used for various projects, including infrastructure development, defence equipment procurement, and connectivity. In July 2018, the RBI had agreed to convert $400 million into Indian rupees through a currency-swap arrangement with the CBSL. In July 2019, India's Reserve Bank signed a currency-swap agreement (SCA) with Sri Lanka's Central Bank for the smooth execution of $400 million in withdrawals. In February 2021, the CBSL settled the facility with the Reserve Bank of India. However, since the agreement was valid until 2022, India declined to renew it due to the country's current macroeconomic situation. On August 31, 2021, the Sri Lanka government declared a state of emergency due to the country's acute shortage of foreign exchange reserves. The CBSL then raised its policy rates to address the situation. The devastating terrorist attacks in 2019 have severely affected the tourism industry in Sri Lanka. The earnings of the sector, which are mainly funded by foreign direct investment, halved in 2020 after reaching a record high in 2019. Sri Lanka’s financial distress has become more alarming in recent years due to the country’s deteriorating liquidity position. Its public debt-to GDP ratio has reached 109.7%. After the country's $1 billion international bond settlement in July 2021, its gross reserves declined to $2.8 billion. Its external debt-to-GDP stood at 62% in 2020. As of June 2019, China was the largest creditor of Sri Lanka's public sector. Its loans to the country amounted to 15% of the country's external debt. Several loans have been granted to Sri Lanka by Chinese institutions. These include a $1.4 billion loan from the China Development Bank and a $1.4 billion dollar loan from the People's Bank of China. Due to its strategic location, China has heavily invested in infrastructure in Sri Lanka. In May, the country passed a law that will allow for the establishment of a special economic zone near the Colombo Port. As the Sri Lanka economy worsens, it may align its policies with those of China. This could help it avoid becoming averse to Beijing’s interests. Nurturing India's interests in the Indian Ocean region will be important if the country is to maintain its strategic position in the region. Through these platforms, India and Bangladesh could collaborate in various areas of mutual interest, such as agriculture, marine and technology. Both countries could also enhance their efforts in addressing climate change.
By the end of July, Sri Lanka's foreign exchange reserves were just over $2 billion, less than three months of imports. The country's current account deficit is expected to reach around 10% by the end of the year. The Sri Lanka rupee has fallen by around 7.5 percent against the US dollar in the past year. The country's central bank has also raised interest rates to support the local currency. Even as Sri Lanka faces a debt repayment of over $1.5 billion in January and July, it has managed to avoid a crisis. The country's foreign exchange reserves have already been depleted. Since its independence from Britain in 1948, Sri Lanka has been able to borrow heavily to finance its development. But, as its economy became middle-income, it started to rely on other financing sources. As of 2019, almost half of Sri Lanka's foreign loans were commercial, mostly due to the issuance of international bonds. In addition, the central bank received $150 million from Bangladesh. The crisis in the balance of payments has raised the prices of various commodities, including rice, onions, and potato. It has also led to long queues outside stores due to shortages of cooking oil and milk powder. Due to the rising inflation, which has affected the government's ability to service its debts, ratings agency Moody's placed Sri Lanka's long-term and senior unsecured debt ratings on review for downgrade. Moody's Investors Service placed the Caa1 long-term foreign currency rating of Sri Lanka on review for downgrade due to the country's mounting inflation. Due to the rise in the cost of essential goods, especially food, the government has blamed the traders for causing the prices to skyrocket.
Conclusion
The president’s drive to make agriculture fully organic is likely cause a major drop in production and raise prices significantly. Also, the various measures taken by the government to address the crisis may actually worsen it. The cap on food prices can cause severe shortages as the demand exceeds the supply. This issue can also lead to long lines at food stores. The army's strong-arm tactics can also have unintended effects. When used properly, these weapons can make the army more effective. This can lead to a spike in prices for essential goods. It can also lead to a drop in supplies and higher prices. The decision by the Sri Lanka's central bank to ban the forward contracts and the spot market trading of the rupee against the US dollar may affect the country's essential supplies. Since the central bank has restricted the use of foreign exchange in the spot market, it has prevented many traders from carrying out their usual business. Without forward contracts, many traders may be reluctant to import essential supplies. This country needs to focus on increasing its export revenues and not on trying to reduce its imports. Doing so will not only help Sri Lanka's economy but also help minimize its dependence on foreign supplies. Aside from increasing the country's exports, focusing on increasing the revenue from services has significant potential. In 2019, Sri Lanka's total services exports reached $7.4 billion, which is a net inflow of $2.8 billion. Despite the potential boost to the economy that tourism can provide, the country still has a long way to go in developing its infrastructure and destination development. Doing so will prevent over-tourism and make the country more attractive to visitors. Unless the government can secure a willing lender or pass a tax amnesty bill, it seems that going to the IMF is inevitable. The reforms that would be needed to be implemented under the supervision of the Fund are very necessary.
Pic Courtesy-Tomas Malik at unsplash.com
(The views expressed are those of the author and do not represent views of CESCUBE.)
