Crisis is upon Sri Lanka . Last week, President Gotabaya Rajapaksa decreed a state of emergency over food supplies, the dollar was being sold for over 230 Sri Lankan rupees on the black market (down from 216.55 Sri Lankan rupees on August 19), Sri Lanka was downgraded to CCC- by Standard & Poor rating agency (Fitch had downgraded the country to the present level back in November) and general panic is setting in.
The most immediate impact for the standard citizen is that the empty shelves in supermarkets and pharmacies, which are caused by the Sri Lankan government’s ban on imports. Import bans, something Sri Lankans became intimately (and involuntarily) conversant in over the course of the past year, are only a symbol of a way larger macroeconomic problem.
Sri Lanka’s depression isn’t one-dimensional, it’s a hodge-podge of internal and external factors, varying in degree of severity and as intertwined as a spider’s web. i will be able to therefore, to the simplest of my knowledge and understanding, document here the most causes and aggravating factors for anyone curious about this unfolding crisis.
VThe depression currently unfolding in Sri Lanka are often traced right down to a couple of leading and severe reasons.
It is perhaps no surprise that the primary reason mentioned is that of debt sustainability, or the shortage thereof. Although never new (economists have raised concerns as far back as 2019), it’s overtaken economic conversations in importance within the recent past. Debt sustainability, consistent with the International fund , refers to the government’s capacity to satisfy its current and future debt obligations without exceptional financial assistance or defaulting on its obligations.
By the top of 2020, Sri Lanka’s debt-GDP ratio was 101% and is predicted to rise to 108% by 2022. Between 2021 and 2025, Sri Lanka requires $4 billion-$5 billion annually to satisfy its foreign debt obligations.
This is next to impossible while Sri Lanka runs not only a whopping deficit but also a staggering balance of payments deficit (a balance of payments deficit means the worth of cash flowing out of the country is bigger than the worth of cash flowing in to the country). In July 2021, upon settling a $1 billion bond, Sri Lanka’s exchange reserves fell to a coffee $2.8 billion.
Sri Lanka would normally finance these deficits through borrowings, but with low credit ratings this is often now tons harder than it wont to be. within the recent past, Sri Lanka has relied on the issuance of bonds to finance such shortfalls, but the foremost recent issuances of Sri Lanka Development Bonds are undersubscribed, a sign of waning investor confidence within the country (if the downgrades by ratings agencies weren’t enough of a warning).
In the interim, Sri Lanka has resorted to short-term currency swaps with countries like China and Bangladesh. Such short-term fixes, however, come at high cost: they need short repayment periods, high interest rates and may generally only be used for specific purposes (such as for trade between the 2 countries).
This all makes an impossible situation even worse and despite much urging, the govt refuses to think about an IMF bailout plan. An IMF bailout plan would see Sri Lanka committing credibly to some serious austerity measures that might enable the reduction of Sri Lanka’s deficits gradually to sustainable levels. Despite the government’s stubbornness however, an IMF bailout seems inevitable, and would cause much needed (albeit unpopular) reform into the Sri Lankan economy.
The shortage of exchange within the country stems essentially from the need for Sri Lanka to services its debt. The financial institution notified banks in June 2021 that they’re going to not be lending dollars to banks, and instead for personal banks to hunt it call at the opposite markets. But, the rapid depreciation means those with dollars in hand, i.e. exporters, aren’t willing to trade it in. Instead, they’re holding onto it within the hope of a better rate (i.e. a more depreciated rupee).
No amount of coaxing seems to possess convinced many exporters to spare their dollars however, and therefore the exchange crisis continues. Under the IMF’s Special Drawing Rates allocation aimed toward helping countries get over Covid-19, Sri Lanka received an unconditional, non-debt inflow like $787 million. additionally , the country’s financial institution was also ready to arrange a couple of short-term currency swaps to temporarily increase its reserves to only over $3.5 billion.
However, this is often only like about six weeks to 2 months worth of imports, even less (or next to nothing) once you consider Sri Lanka’s upcoming debt settlements. Sri Lanka’s dollar denominated debt repayment obligations come up to $6.1 billion within the coming two years.
The financial institution of Sri Lanka follows a managed-float rate of exchange policy, meaning the rate of exchange is allowed to regulate to plug demand and provide , but within a pre-determined band. this is often to curb any excessive volatility. this type of policy means the financial institution has got to intervene when the speed threatens to interrupt the band, and therefore the bank does this using one among two ways: by using its dollar reserves or by adjusting interest rates.A
