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Lessons from Sri Lanka’s economic crisis

APPremium
AP

  • With runaway inflation, unsustainable debt and a hamstrung tourism sector, Sri Lanka’s economy is facing its worst crisis in over 70 years. Recently, the island nation lifted its state of emergency. Mint scans the road ahead.

What caused the crisis?

Twin deficits — a budget shortfall and a current account deficit — led to Sri Lanka’s economic crisis. Agricultural productivity fell, especially in tea, which is the country’s lifeline. Sri Lanka produces 300 million kg of tea annually, exports 97% of it, and this accounts for 50% of the total global trade of orthodox tea. Meanwhile, the tourism sector was badly damaged by the covid-19 pandemic. The war in Ukraine boosted oil import costs and led to a further dip in tourism revenue; 30% of tourists this year were from Russia, Ukraine, Poland and Belarus. Critics also blame tax reforms for the fall in revenue.

Were government policies at fault?

Sri Lanka’s push for organic farming might have led to a fall in farm productivity; yet, from a long-term perspective, it was a step in the right direction to preserve soil fertility. As proven by the Laffer’s Curve, tax reforms should have resulted in a revenue windfall, except that the implementation was faulty. International trade relations are a two-way traffic — one cannot expect exports to go up due to reduction in export duty alone while imposing a blanket import ban. (Import curbs on 369 items were lifted on 1 June). Getting trapped in China’s infra loans was a major policy fault.

What is the way out? 

India has extended close to $3.5 billion by way of credit lines for food, medicines, fuel and other essentials, and given loan deferments etc. However, ultimately, Sri Lanka has to rely on an IMF package for managing its Balance of Payments crisis. Obviously, IMF might insist on wholesome economic reforms as it did in 1991 for India. However, ultimately, it would facilitate revival of the economy.

What is the state of its economy now? 

Sri Lanka is grappling with a shortage of medicines, petrol, cooking gas, basic necessities and other essentials, and its worst political, financial and economic crisis. With the cumulative trade deficit for the January-March 2022 period at $2.4 billion, a balance of payment crisis and usable foreign exchange reserves position dipping to less than $50 million in May first week, the country has been forced to suspend payments on foreign loans, of which approximately $7 billion are due this year.

Are there any lessons for India?

In terms of economic fundamentals, there is no comparison. However, India should work towards being self-reliant, especially in production of essentials such as oilseeds, fertilizers and renewable energy, imports of which can prove to be a drain on forex reserves.  India also needs to seriously ponder over organic farming from a long-term perspective. India had also taken the right step by not getting into China’s trap. 

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH

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