Sri Lanka Economic Crisis- UPSC Current Affairs

Why in the News?

Sri Lanka is facing an economic and political crisis, with protesters taking to the streets in defiance of curfews and cabinet ministers resigning en masse.

Probable Question

The Sri Lanka crisis presents an opportunity for India to regain strategic space in the island nation. Comment

Key Points

Background

• When Sri Lanka emerged from a 26-year long war in 2009, it was expected that economic growth would revive. 
• Possibly because of pent-up demand, Sri Lanka’s post-war GDP growth was reasonably high at 8-9% per annum between 2009 and 2012.
• However, the economy was on a downward spiral after 2013 as global commodity prices fell, exports slowed down and imports rose. The average GDP growth rate almost halved after 2013.
• During the period of the war, budget deficits were high. Further, the capital flight that accompanied the global financial crisis of 2008 drained Sri Lanka’s foreign exchange reserves.

Connecting Dots to Present

• According to an Asian Development Bank working paper - the present state of the Sri Lanka’s economy is due to a classic twin deficits economy.
• Further, the critics point out that the economic mismanagement by successive governments created and sustained a twin deficit – a budget shortfall alongside a current account deficit.
• But the current crisis was accelerated by deep tax cuts promised by President Rajapaksa during a 2019 election campaign that was enacted months before the COVID-19 pandemic, which wiped out parts of Sri Lanka’s economy.

Reasons for Economic crisis in Sri Lanka

• Dip in Foreign Exchange Reserves: In July 2021, forex reserves dropped from over $7.5 billion in 2019 to around $2.8 billion, owing to an underperforming tourism sector.

Image Source: Times of India

• Hasty Switch to Organic Farming: The Government’s ban on the use of chemical fertilizers in farming has further aggravated the crisis by dampening agricultural production which in turn caused a steep rise in the prices of essential commodities.
• Dependence on Imports: Sri Lanka’s high dependency on imports for essential items like sugar, pulses, and cereals aggravated the economic meltdown as it lacks foreign reserves to pay for its import bills.
• Russia-Ukraine war-induced inflation: The ongoing Russia-Ukraine war resulted in steep price inflation of crude oil, sunflower oil, and wheat.
  • Crude oil prices hit a record high in 14 years with prices soaring over $125/barrel at the height of the crisis.

What has been Sri Lanka’s Government's response?

• The Government of Sri Lanka is in talks with the IMF to find a way to pay off our annual loan instalments, and sovereign bonds. 
• However, it remains to be seen how the IMF will support Sri Lanka at this juncture, and to what extent its support might help the country cope with the crisis. 
• Further, Sri Lanka has also sought support from various bilateral partners, including India, by way of loans, currency swaps, and credit lines for the import of essentials.

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India’s Assistance to Sri Lanka in tackling the Economic Crisis

• Beginning January 2022, India has extended assistance totalling $ 2.4 billion — including a $400 million RBI currency swap, and a $500 million loan deferment.
• A diesel shipment under a $500 million credit line was signed with Sri Lanka by India in February 2022.
• Further, Sri Lanka and India have signed a $1 billion credit line for importing essentials, including food and medicine.
• However, there is growing scepticism in Sri Lankan media over Indian assistance “being tied” to India in inking key infrastructure projects in the island nation.

Conclusion

• The current Sri Lankan economic crisis is the product of the historical imbalances in the economic structure, the IMF’s loan-related conditionalities, misguided policies of authoritarian rulers, and the official embrace of pseudo-science.

News Source: The Hindu

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