Sri Lanka is reeling under an unprecedented economic crisis. After the resignation of President Gotabaya Rajapaksa, the Sri Lanka parliament is set to elect the new president through an internal vote on July 20, 2022. The former president fled the country a few ago after facing mass protests over the economic crisis. After protestors took over some of the government buildings in the capital Colombo, Sri Lankan Prime Minister and acting president Ranil Wickremesinghe declared a state of emergency. He ordered the country’s military to do “whatever is necessary to restore order”. There were also reports of imposition of curfew in some regions of Sri Lanka.
What is happening in Sri Lanka?
Protests in Sri Lanka’s capital Colombo have been going on since April this year. There are daily power cuts and acute shortages of fuel, food, and medicines. According to officials in the Sri Lankan government, there is not enough foreign currency to import fuel. The distribution of petrol and diesel remains restricted. In late June, the government banned the sale of petrol and diesel to non-essential vehicles for two weeks.
The government closed schools and offices. People were asked to work from home in order to conserve fuel.
What Led to the Crisis?
Sri Lanka does not have enough money to buy the goods that it needs to import.
In May this year, Sri Lanka failed to make an interest payment on its debt for the first time in its history. The failure to pay debt interest can heavily damage a country’s reputation and affect its borrowing ability.
The government claimed that the Covid pandemic led to the crisis. They argue that Sri Lanka’s tourism was badly hit by the pandemic. Tourism is one of the biggest earners of foreign currency and hence the crisis.
However, looking at the bigger picture, it will appear that it was the mismanagement by the government that led to the economic crisis.
Analysts had warned for years that Sri Lanka was headed towards an economic crash in absence of necessary economic reforms.
Protectionism in Sri Lanka.
Sri Lanka imports $3bn more than its exports every year. That is why it has run out of foreign currency.
The country has been a victim of its own policies. There have been policies that incentivized the local industry to focus on the production of goods for the domestic market. For decades, the government has protected the local industry. And imports have been disincentivized.
The idea behind this is import substitution. Import substitution is an economic policy of reducing dependency on imports. It replaces imports with domestic production.
The policy of import substitution and protectionism has incentivized the local industry in Sri Lanka to produce goods only for the domestic market. The industry, therefore, has not been able to become competitive in the global market. Hence, exports have been very low as compared to imports.
Mismanagement by the Government
Instead of carrying out economic reforms, the Rajapaksa government introduced controversial big tax cuts in 2019. The tax cuts lost the government an income of more than $1.4bn annually.
While the Sri Lanka government had recently taken some steps to fend off the crisis but these steps backfired.
In early 2021, the government made a sudden shift to organic farming. It banned the import of chemical fertilizers. Farmers were asked to use locally produced organic manure and fertilizers. The idea behind this ban was to preserve Sri Lanka’s foreign currency. However, the policy complemented the crisis. There were widespread crop failures in Sri Lanka. The country had to import food supplies. As a result, the foreign currency shortage became even worse. The ban was lifted after seven months but the damage was already done.
Lessons for Countries in Danger Zone
Globally, there are a large number of developing nations that are in the danger zone of going the Sri Lanka way. First, it was the Covid pandemic and now it is the Ukraine war that has badly affected most of the developing countries.
Pakistan is another country in South Asia whose economy is in chaos. Even though the country struck a crucial deal with IMF a few days ago but it is on the brink of a balance of payment crisis due to high energy import prices. Further, Pakistan’s rupee has weakened to a record low. The government as of now spends 40% of its revenue on interest payments. The current foreign currency reserves stand at a low of $9.8bn, which are hardly enough for five weeks of imports. Hence, the new government led by Prime Minister Shahbaz Sharif needs to tread with caution and cut spending.