After defaulting on its foreign debt last year, the nation is struggling with a rise in prices, scarcity of supplies, and depleted foreign currency reserves, and the bailout is expected to provide much-needed funding to address these issues.
On Monday, the executive board of the International Monetary Fund approved a bailout of four-year extended financing arrangement worth $3 billion for Sri Lanka, allowing for the immediate disbursement of $333 million to the financially troubled country, which could assist the nearly bankrupt nation in overcoming its worst financial crisis in over 70 years. The agreement, which has been in the works for almost a year, is a crucial lifeline for the country that owes billions of dollars in loans. The primary objective of the IMF loan is to tackle short-term debt sustainability and achieve macroeconomic stabilization.
What are the reasons behind Sri Lanka’s current crisis?
The ongoing crisis in Sri Lanka is attributed to several factors such as tax cuts, money creation, the Ukraine-Russia war, the COVID-19 pandemic, external debt, the decline in foreign remittances, as well as issues in the tourism and agricultural sectors.
Tax Cut & Money Creation
The Sri Lankan government under President Gotabaya Rajapaksa implemented large tax cuts, resulting in a decline in government revenue and an increase in budget deficits. To cover spending, the Central Bank began printing money in record amounts, ignoring IMF warnings that it could lead to an economic collapse. In April 2022, the CBSL printed a record-breaking amount of money, contributing to the already increased money supply in the financial markets
External debt
Sri Lanka’s foreign debt increased from $11.3 billion in 2005 to $56.3 billion in 2020, with debt servicing needs estimated at over $4.0 billion in 2021. The country’s debt crisis was primarily caused by domestic policy decisions and facilitated by Western lending and monetary policy. Sri Lanka’s foreign reserves fell to $1.9 billion in March 2022, with the government announcing an economic emergency due to inflation, pandemic restrictions, and falling currency exchange rates. Sri Lanka defaulted on its external debt of $51 billion on April 12, 2022.
Fall of foreign remittances
The Central Bank of Sri Lanka, under Cabraal, attempted to maintain the Sri Lankan rupee’s peg while continuing heavy money printing, which led to the market value of the rupee declining. This caused foreign workers to use unofficial channels to remit money, leading to banks running out of foreign currency and a significant reduction in official remittances. Cabraal then targeted merchandise and service exporters, forcing them to surrender their dollars and forcefully converting dollars in forex accounts of resident Sri Lankans who earn dollar salaries.
Tourism
Sri Lanka’s tourism sector, which represented over one-tenth of the GDP, was negatively impacted by the Easter bombings in 2019 and COVID-19 pandemic, resulting in a significant drop in its contribution to the GDP from 5.6% in 2018 to just 0.8% in 2020, despite the World Bank’s failed prediction of a recovery in 2021.
Agricultural Crisis
Sri Lanka’s decision to ban chemical fertilizers and agrochemicals in favor of organic farming resulted in economic losses of $425 million and a 20% drop in rice production, reversing the country’s previously achieved self-sufficiency in rice production, and forcing it to import rice for $450 million. The government abandoned its plan to become the world’s first organic farming nation in November 2021 due to rising food prices and protests against the plan.
Russo-Ukrainian War
The 2022 Russian invasion of Ukraine has worsened the economic conditions of Sri Lanka due to Russia being the second biggest market for Sri Lanka’s tea exports and the heavy reliance of Sri Lanka’s tourism sector on Russia and Ukraine, with both sectors being heavily affected
