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Sri Lanka’s Looming economic crisis
Everyday life for people in Sri Lanka has become a major challenge these days. Food, medicines and fuel are in high demand and are sold at a high price even if they are available.
The Covid 19 pandemic is being blamed, but the high depreciation on the Lankan rupee value is making things even worse.
The nation mainly depends on imports for food, and the currency being weaker makes it unaffordable to the general public.
Why exactly is Sri Lanka’s economy in trouble?
Sri Lanka’s finances are in a perilous state, as we all think the pandemic is not the main reason, the economy fell in trouble already before the pandemic. Between 2005 and 2015, Colombo borrowed billions from China, accumulating a mountain of debt. It was forced to hand over a port to a Chinese company after failing to keep up with payments. But Beijing is making more loans.
The government’s ban on the use of chemical fertilisers in farming has further aggravated the crisis by dampening agricultural production, which made it even worse.
What has been the Government’s response to the crisis?
The Sri Lankan government has blamed speculators for the surge in food prices, blaming them for stockpiling crucial supplies and declaring an economic emergency under the Public Security Ordinance.
The army’s mission is to seize food supplies from traders and distribute them to customers at reasonable prices. It has also been granted the authority to guarantee that foreign reserves are only utilized to buy necessities.
The government has refused to back down from its strong campaign for 100% organic farming, maintaining that the short-term costs will be offset by the long-term benefits. It has also committed to providing organic fertilisers to farmers as an alternative.
Sri Lanka’s central bank also restricted traders from exchanging currencies earlier in the recent year.
What can Sri Lanka do to overcome the crisis?
The World Bank report highlights four priorities for Sri Lanka to transform its economy, create more jobs and achieve a sustainable trajectory towards poverty reduction and shared prosperity.
- Increase agricultural productivity and earnings.
- Address the constraints to accessing remunerative non-farm jobs in rural areas.
- Support broader reforms to increase labour productivity and create jobs.
- Promote spatial transformation and strengthen inclusion.
Adding the fact that money printing to keep down interest rates amidst a credit spike will weaken the currency in a peg, is a law of nature, not a figment in the imagination of classical economists. This has to be fixed first of all.
The current administration has said it wants the rupee at a lower value equivalent to the US dollar. There is no harm in targeting an exchange rate as the most simple monetary policy imaginable, but the current money printing and open market operations will go completely against an external anchor. All the high performing East Asian nations target the exchange rate in their growth phase and many still do. Successfully targeting an exchange rate requires a complementary policy.
The Treasury is printing the lost money to make up for lost taxes that are creating foreign exchange problems. The stock market is booming due to low-interest rates and also the actual profits made by some firms. But foreign reserves are steadily declining. Boosting them with swaps is a temporary solution only. If Sri Lanka is not careful, not only can there be sovereign default but the central bank itself could go bankrupt from swaps.
Moreover, the foreign exchange problems are not due to a lack of tourism revenues. Lack of tourism or other export revenues will lead to an automatic collapse in imports when the salaries of the people in the sector are cut like in other countries including the Maldives.
One of the first steps is, the central bank should always roll over coupon payments as paper treasury bills or bonds instead of trying to pay cash by printing money.
Sri Lanka has to have a credible fiscal plan and monetary policy to regain stability and confidence.
In Sri Lanka, a rise in interest rates and opening of imports will allow taxes to flow back to the treasury, in a virtuous cycle. A sheer rise in rates would also allow all the debt repayments that are coming up for repayment to be paid with domestic debt sales which crowd out consumption and halt imports. However, that has its limits.
One fix that can stop future currency crises is to privatize energy utilities. In Sri Lanka, the power regulator failed to fix prices and instead resisted increases proposed by the utility so that is no longer a solution either.
Sri Lanka can be ‘pragmatic’ and come up with some plans that are partially compromised by illiberal ideology instead of a plan grounded on reason and a desire to expand the freedoms of citizens so that they can bloom and flower to their full potential.
It is always better to take precautionary action, rather than being pushed into a situation where there are no options. Whatever is done, the faster it is put into action, the better it is.