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Explained: Why is Sri Lanka on the Verge of Bankruptcy?

Spending hours waiting in ques have become a norm across Sri Lanka, starting with rice, milk, and sugar powder, now cooking gas, and petrol and diesel are falling short in supply. The shortage is the result of the government’s inability to pay for the imports in dollars.

Ever since the pandemic, Sri Lanka’s economy has been in a steep downfall. Many residents have suffered due to pandemic-related lockdowns and closed borders. In addition, restrictions on exports and the lack of tourists have slowed down the country’s economic growth.

Now Sri Lanka has canceled school exams for millions of students, but the reason this time is not COVID19, but the nation has run out of printing papers to conduct the examinations.

“School principals cannot hold tests as printers are unable to secure foreign exchange to import necessary paper and ink”

Depratment of Education, Sri Lanka

The country is facing its worst economic crisis since independence.

So, which sector has been hit the hardest? What is behind the worsening financial condition? And can the island nation recover from the losses?

Hiking Inflation and Food Prices

For several months food prices in Sri Lanka have surged, and inflation has skyrocketed, hitting a record high at 20%. It is primarily due to depleted foreign funds and poor harvest.

With the aim to make Sri Lanka the first 100% organic food country, the government banned the import of chemical fertilizers and pesticides without any notice.

Though it was revoked later, the ban had a devastating impact on crop production, which heavily depends on agro-chemical, leading to a sharp surge in food prices.

Skyrocketing Fuel Prices

Sri Lankan woke up to an unprecedented rise in petrol and diesel price, crunching the country into a deeper economic crisis.

The Lank Indian Oil Corporation (LIOC) in Sri Lanks has increased the price of petrol and diesel by about 50 Sri Lankan Rupees (LKR) and 75 LKR, respectively. As a result, for the first time in the country’s history, a liter of petrol is now 250 LKR, while a liter of diesel has touched the 200 LKR mark.

Children using kerosene oil lamps to study during long power outages in Colombo. Source: Al Jazeera

The LIOC statement attributes the historical fuel price rise to the depreciation LKR value. LKR’s value has fallen twice against USD in the last seven days, initially to 230 Rupees to one USD, and further to an exorbitant 260 LKR to a dollar.

The statement also highlights the full embargo of Russian oil and other essential products, further complicating the matter. The already looming danger of supplies being cut as there is a sharp rise in the price of crude oil is threatening to reach never before seen levels.

Sri Lank: Falling Deeper into Debt

With high government spending, crawling growth, and enormous foreign debt of 35 billion USD, Sri Lanks is one of the highest debt ratios. Furthermore, as the rating agencies ranked the country down over sovereign default, global bankers have been depleting quickly.

One of the few countries still financially supporting Sri Lanka is China. China has been building a major port in the island country and powering many construction projects. As a result, Chinese debt accounts for almost one-fourth of the country’s total debt.

Source: Al Jazeera

In a bid to resolve its worsening foreign debt prices, the government of Sri Lanka has decided to seek a bailout from the International Monetary fund, intending to shore up its external reserves.

The Deepening Economic Crisis of Sri Lanka

For months, Sri Lanks has been facing an acute economic crisis. And now, standing on the verge of collapse, the world bank estimated over half a million Sri Lankans have fallen below the poverty line since the pandemic began.

The world is losing confidence in Sri Lanka’s economic crisis, thus furthermore solidifying the bankruptcy situation. As a result, Sri Lanka is on the brink of bankruptcy with an acute shortage of essential goods.

The Last Resort for Sri Lanka

Sri Lanka must ensure access to raw materials and food rather than focusing solely on fuel. Globally, countries are stockpiling grain and exploring alternative business deals with Russia in response to the crisis.

There are few options available to Sri Lanka to mitigate the effects of deteriorating food security and raw material access. In addition, due to wheat and rice being substitutes, high wheat prices may negatively impact rice demand.

Domestic production can only be adequate if inputs, such as fertilizer are not in short supply. Due to the current foreign exchange crisis, Sri Lanka can’t handle shocks effectively. Markets will not trade promptly as long as the foreign exchange crisis persists.

If Sri Lanka wishes to restructure its debt, it may be best to obtain dollar inflows from multilateral institutions. Furthermore, predetermined prices for food can be negotiated with friendly countries, and forwarding contracts can be made for raw materials and fuel.