Sri Lanka economic crisis explained: What is happening in Sri Lanka? All you need to know

Sri Lanka is in the midst of a severe economic crisis, with reserves decreasing and the government unable to afford the cost of essential imports. In 2021, the Sri Lankan government declared an economic emergency due to rising food costs, a sinking currency, and rapidly depleting forex reserves.

What is happening in Sri Lanka?

In a frightening event over the weekend, two men collapsed and died while waiting in different lines to buy petrol, according to the police, local media reported. The government ordered the forces to prevent violence from erupting at gas stations on Tuesday, March 22, when spontaneous protests erupted among vehicle owners queuing for gas.

In the midst of this economic nightmare, Sri Lanka's central government has looked to India and China for assistance as it tries to pull the country out of the crisis and calm public sentiment. The country's disintegrating economy is primarily due to a lack of foreign money, which has resulted in a large decline in imports of necessary goods.

The reason behind Sri Lankan economic crisis

Sri Lanka is significantly reliant on imported goods. Among other necessities, it imports fuel, food, paper, sugar, lentils, medications, and transportation equipment. Due to a lack of foreign cash, the country is unable to purchase (import) certain goods. Imports are so crucial that the government had to postpone exams for millions of pupils due to a lack of printing paper. Here are the five points that have affected Sri Lanka's economy severely:

• The pandemic has taken a toll on the country's tourism economy, which accounts for 10% of GDP. Due to the foreign exchange problem, several countries, including Canada, have recently issued travel restrictions to their citizens on visiting the island country. Such advisories from other countries are having a negative impact on business. The United Kingdom, India, and Russia are the main sources of inbound tourism to the island nation.
• The government's decision to prohibit the use of chemical fertilizers in order to transition agriculture to 100% organic had a negative economic impact. Experts predict that this legislation would have a tragic effect on agricultural development because organic farming reduces output by half. Moreover, the increased cost of staples like rice and sugar, allegedly due to "food mafia" hoarding, has exacerbated challenges.
• A massive foreign debt burden of approximately $5 billion with China alone is a major contributor to this crisis. Sri Lanka is repaying a $1 billion loan acquired from Beijing in 2021. It also owes a large sum of money to India and Japan. The country's foreign currency reserves were approximately $1.58 billion as of November, down from $7.5 billion when Gotabaya Rajapaksa took office in 2019.
• The supply of foreign exchange was harmed when forex reserves fell from more than $7.5 billion in 2019 to roughly $2.8 billion in July 2021, increasing the amount of money Sri Lankans had to pay to buy the foreign exchange required to import goods. As a result, the value of the Sri Lankan rupee has plummeted.
• Sri Lanka's reliance on imports for essential goods like sugar, pulses, cereals, and pharmaceuticals has compounded the country's issues, as the country lacks foreign currency to pay for import expenditures.

Inflation

According to Ashoka Ranwala, president of the Petroleum General Employees' Union, the situation in Sri Lanka is so dire that the government had to shut down its only fuel refinery because it ran out of crude oil stockpiles. Inflation, which topped 15.1% last month, is wreaking havoc on the economy. Food inflation has surged to 25.7%, according to government figures. For example, the price of a 400 gramme pack of milk increased by $0.90 over the weekend.

In addition, Laugfs Gas, Sri Lanka's second-largest gas supplier, raised costs by 1,359 rupees ($4.94) for a 12.5-kilogram cylinder on Sunday, according to a company statement. The current economic crisis in Sri Lanka is caused by a foreign currency shortage or a balance of payments (BOP) crisis. Simply put, BOP is the difference between all of the money that has entered the country and all of the money that has left the country during a given period of time.

Prime Minister Mahinda Rajapaksa revealed last week that the country will have a trade deficit of $10 billion in his address to the nation. This means that Sri Lanka imported more than it exported last year. As a result, the outflow of money exceeds the inflow, resulting in a foreign currency shortage over time.

Sri Lanka Tourism & Forex

After the series of terrorist bombings in Colombo in 2019, tourism was already on the decline. The COVID-19 epidemic exacerbated the situation. As a result, the foreign currency-earning sectors of the economy were decimated, resulting in a decrease in the inflow of foreign currency, which is utilised to make import transactions.

Due to COVID-19, even key export destinations like China and European Union countries encountered trading challenges, lowering Sri Lanka's foreign exchange revenues. Another consideration is FDI (Foreign Direct Investment) (FDI). FDI into Sri Lanka has declined to $548 million in 2020, according to government figures, from $793 million in 2019 and $1.6 billion in 2018.

When foreign direct investment (FDI) into a country falls, so does the foreign money in the country's reserves. Sri Lanka also refuses to accept a loan from the International Monetary Fund (IMF). Ajith Nivard Cabraal, the governor of the central bank, told reporters in January that the "IMF is not a magic wand." He had said, "At this moment, the other options are better than going to the IMF." He was referring to China when he said "other options."

China has been Sri Lanka's top bilateral lender and FDI source for the past two decades, but the latter's debt to the former has grown to over $2 billion and is due in 2022. In conclusion, Sri Lanka is experiencing a foreign currency shortage, which is significantly limiting its ability to import crucial goods. The recent failure of the tourism business, the failure to attract adequate FDI, and the refusal to take an IMF loan are all factors contributing to the current crisis.