Is Sri Lanka’s economy on the mend or going from bad to worse?

It is undoubtedly true that Sri Lanka, once a model for developing countries like Singapore, is facing its worst economic calamity since its independence in 1948. In fact, there are a plethora of reasons that could be attributed to the creation and exacerbation of the present crisis such as myopic decisions and economic mismanagement by successive governments, the huge tax cut in 2019, the COVID-19 pandemic, and the sudden drop in remittances from nationals, etc. This economic crisis deprived people of their essentials which created an unprecedented wave of spontaneous protests with people turning up the heat on the political leadership for abandoning them in a state of utter despair with prolonged power cuts and a dearth of essentials, including fuel and medicines. 

The massive public protests subsequently forced the political hierarchy to relinquish positions and appoint a new President, Prime Minister, and Cabinet and key personnel in charge of the country’s economy. However, the crisis is yet to be addressed despite changes in political leadership. 

It is highly unlikely that Sri Lanka will completely rebound and return to pre-pandemic numbers anytime soon. Nevertheless, it has to be noted that positive developments have taken place in terms of tourism, remittances, and exports.

Background

Sri Lanka’s economy was already exhibiting signs of decline even prior to the COVID-19 pandemic. In the last five years, growth and poverty reduction had slowed down with a restrictive trade regime, an unfavorable investment environment, periods of loose monetary policy, and an administered exchange rate. Sustained fiscal disparities, driven primarily by low revenue collections, coupled with tax cuts in 2019, have contributed to huge fiscal deficits, significant gross financing needs, and rapid growth in unsustainable debt.

In the year 2020, Sri Lanka lost access to global financial markets as a result of credit rating downgrades.  Without access to the market, Sri Lanka continued to pay for imports and repay its external debt with the help of state reserves and loans from the banking industry. The banking system's net foreign assets also decreased, reaching US$ -5.9 billion in June 2022. With shortages of fuel, medications, cooking gas, and other essential inputs for economic activity, the acute Forex liquidity constraint has been felt throughout the economy, especially since the second quarter of 2022.

Furthermore, Sri Lanka, which largely depends on tourism, trade, and remittances from nationals working abroad, has suffered greatly from the Covid pandemic and Russia’s war on Ukraine. It is evident that tourism and foreign remittances have long been Sri Lanka’s primary sources of revenue. From a high of $7 billion in 2014, remittances dipped to $5.49 billion in 2021. 

Tourism, an important engine of economic growth, sputtered because of the pandemic lockdowns throughout 2020. Even before the pandemic hit, Sri Lanka’s tourism industry had been hurt by the image of the country due to political unrest and tensions created in the aftermath of the Easter Sunday attacks. Sri Lanka’s tourism industry earned $4.4 billion in revenue but dropped to $200 million by 2021 with 194,495 tourist arrivals.

On the other hand, the sudden decision to ban fertilizer import at a time when most farmers were dependent on chemical fertilizers led to a drastic fall in crop yields and shortages, especially in tea – a top export – and rice, a food staple. Rice production declined by 20 percent, forcing Sri Lanka to go from self-sufficiency to rice imports.

Recent development and progress of IMF bailout

It is apparent that poorer households are the ones to bear the brunt owing to food inflation, job losses, limited fertilizer supply, and drop-in remittances. In August 2022, year-over-year inflation hit an all-time high of 64.3 percent. Besides, in the first half of 2022, the goods trade deficit decreased by 18.6% year-on-year as exports, particularly textiles, expanded faster than imports, which were primarily financed by Indian financial assistance totaling about US$3.8 billion.

Besides, the Sri Lankan government recently announced that since the country’s Treasury is facing a serious financial crisis, the expenses of all ministries would be cut by five percent in 2023 as per the instructions of President Ranil Wickremesinghe.

As far as the tourist arrivals in 2022 are concerned, a total of 719,978 tourists have arrived in Sri Lanka with the month of March seeing the highest arrivals as 106,500. Although the numbers started to decline since then due to tensions in the country, the arrivals substantially increased in December to 91,961, which is the second highest in the year. 

Meanwhile, in light of the economic abyss, Sri Lanka was compelled to plead for financial assistance from foreign nations and financial institutions like International Monetary Fund (IMF) and Asian Development Bank (ADB). According to reports, Sri Lanka owes more than $51bn to foreign lenders, including $6.5bn to China, which has begun discussions about restructuring its loans. 

The good news is that Sri Lanka is on course to win approval for a desperately needed $2.9 billion loan from the IMF. Besides, the IMF has stressed the fact that Sri Lanka needs to restructure its debts with China and other creditors as part of the bailout agreement. Against this backdrop, the G7 group of countries - Canada, France, Germany, Italy, Japan, the UK, and the US had conveyed support towards Sri Lanka's attempts to reduce its debt repayments while the World Bank has agreed to lend Sri Lanka $600m, and India has offered at least $1.9bn. 
However, Sri Lanka is in limbo as the IMF is yet to make a final decision with respect to the $2.9 billion loan.

According to Sri Lanka State Minister of Finance, Shehan Semasinghe, the Government of Sri Lanka is expecting the IMF board approval within the first quarter of this year. 

“We are at the final stage of providing the certification from the official creditors. The International Monetary Fund is performing a pioneering mission in restoring the economy of this country. We have taken all necessary actions to obtain the approval of the Board of Directors of the IMF. We are confident that we will be able to get board approval within the first quarter. We are currently in the final stages of obtaining the financial certificates from our bilateral creditors,” State Minister told the media.

Meanwhile, it is said that the United States has the largest single voting bloc among IMF Member Nations with over a 16 percent voting share. Many major decisions by the IMF require supermajorities of either 85 percent or 70 percent of its membership. For those decisions requiring 85 percent of member agreement by voting share, such as the adjustment of quotas, compulsory withdrawal of member nations (effectively expulsion), or amendments to the IMF’s Articles of Agreement, the United States enjoys effective veto power.

As such, any country seeking support from IMF will have to tackle the pressure exerted by the US with regard to the economic reforms. The condition is applicable to Sri Lanka has well. In this context, Sri Lanka State Minister of Finance Shehan Semasinghe recently held discussions with U.S. National Security Council (NSC) Senior Director for South Asia Eileen Laubacher with respect to the shared goals of economic recovery and stability for Sri Lanka.
Discussing the main impacts from the decisions taken, the State Minister emphasized that the country is on the process of long-term economic stabilization with the new reforms in systems and transparency. He further expressed his gratitude towards U.S for their continuous support for the needs of the country. 

In response, Director of NSC said that US government will always support to Sri Lanka as the discussion has given more focus on the shared values of democracy, promoting economic development, improving the global environment, and 75 years of partnership between the US & SL, including their support for Sri Lanka and our people in the time of need.

Sri Lanka in 2023  

Even though there is a welcome improvement in terms of long queues at fuel and gas stations, tourist arrivals, exports, and downward inflation compared to what was witnessed a few months ago, economic experts are of the opinion that Sri Lanka is not out of the woods and thus, the crisis may see a boom by March 2023. 

This becomes evident with the outlook of the World Bank for South Asia where it stipulates that the region continues to be adversely affected by spillovers from Russia’s invasion of Ukraine, rising global rates, and weakening growth in key trading partners. 

Further, the regional growth is estimated to have slowed down to 6.1 percent in 2022 and is projected to slow further to 5.5 percent in 2023 – below the projections on global spillovers – before picking up to 5.8 percent in 2024.

According to the World Bank, in some economies in the region such as Sri Lanka and Pakistan, the deterioration in economic conditions has led to a substantial rise in poverty. “For example, more than, one-third of the population is food insecure, from less than one-tenth in 2019,” it stated.

The World Bank also signifies that Sri Lanka’s output is expected to contract further in 2023 by 4.2 percent. Sri Lanka’s output fell by 9.2 percent in 2022 as the government ran out of the foreign exchange needed to cover food and fuel imports. 

On the other hand, in the context of the upcoming Local government election, which is just around the corner, a Sri Lankan State Minister recently said that money will have to be printed in order for the election to be held amidst the current economic crisis. “If the election is held, it will be a ‘world record’, the Minister said. When a statement of this nature is made by a government minister, it demonstrates the gravity of the economic condition of Sri Lank in 2023.

Meanwhile, with regard to the zero-COVID policy introduced by China, a Sri Lanka medical expert said that based on the sequencing data released so far from China, the COVID-19 outbreak in China was not due to a new variant. “However, there is a new variant of the XBB series (XBB.1.5), which has emerged in the USA. This seems to be rapidly spreading in the countries it has been detected in. China has not reported any new variants so far. Thus, Sri Lanka’s health authorities are on alert,”

The expert further stated that the reason why China was seeing such a massive outbreak was due to several reasons which included that only a minority of Chinese have had the natural infection in the past.

“In Sri Lanka and the rest of the world, the vaccination rates in adults are very high and many adults in Sri Lanka have had the booster dose as well. In addition, the majority in Sri Lanka and elsewhere have been naturally infected,” the expert added.

In conclusion, it is evident that Sri Lanka needs to have big shoes to fill in order to do better in 2023 economically, politically, and socially. However, the conditions are not as conducive as it was expected. According to economic experts, Sri Lanka is yet to experience the worst part of the crisis this year, which could definitely be more detrimental to the livelihood of the people of Sri Lanka. Thus, the government of Sri Lanka should assess the conditions well and take appropriate and prudent decisions to mitigate the looming challenges.