Just about 3400 kilometers away from New Delhi, its neighbour in the Indian ocean, Colombo, is roiling under one of the worst economic crises it has faced. Sri Lankans are fleeing the country due to food shortages and skyrocketing prices of essential items. Prices of milk powder are as high as Rs 790 for 400 grams, while rice is at Rs 290 a kilogram, V S Sivakaran, an activist based in Mannar, told The Indian Express. These prices are expected to heat up further and rise by upto 50% in coming days. Similarly, prices of petroleum have jumped by 88% in comparison to last year, burdened by skyrocketing oil prices amid the Russia Ukraine crisis, according to a Bloomberg report.
The shortages of essential items such as fuel, food and medicines is forcing people in the country, specifically gig workers and daily wagers, to flee the country. On Tuesday, 16 Sri Lankan nationals, all Tamils in the northern part of the island nation, reached Tamil Nadu in two batches. They gave away their limited savings to manage a boat ride to Indian shores, according to reports in Indian media. Inside the country, fuel pumps are running dry, forcing people to queue-up for hours. According to a Reuters report, a man was stabbed to death in an argument with the driver of a three-wheeled vehicle as tensions over scarcity of supplies have led to sporadic violence. In a separate incident, three elderly men died while queuing to buy fuel in sweltering heat.
Initially hit by the COVID-19 pandemic, the situation in Colombo has worsened after Russia attacked Ukraine last month. The Sri Lankan economy depends on imports for essential items. However, it has depleted its foreign exchange reserves, and thus does not have enough cash to pay for imports. Earlier this month, its government limited imports of 367 non-essential items, including fish, footwear and wine. Add to that there is growing concern among rating agencies and economists that the country would not be able to pay its $1 billion ISB (International Sovereign Bonds) dues which are maturing in July.
Colombo battling with high debt and low foreign exchange reserves
However, the problem did not start in 2020. Since the end of ethnic war in 2009, the island nation is struggling to keep its economy afloat. It started taking up loans and issuing bonds to keep its foreign exchange reserves intact. In 2018, it took debt worth $1 billion from China. Sri Lanka leased its Hambantota port to China which helped it to boost foreign currency reserves and bridge its fiscal deficit.
In April 2020, after the pandemic hit, it took another $500 million loan from Beijing in order to strengthen its forex reserves. It also upsized that loan. India has also helped the country to finance its essential needs. India offered $ 1 billion in credit lines to supply essential commodities for procurement of food, medicine and other essential items. In February, it signed a $500 million credit line with India to import fuel.
The country relies heavily on tourism revenues. In fact tourism accounts for 10% of its GDP. But attacks in the country in 2019 dented its tourism sector. Tourism dropped by 50% after the Easter bombings. And to add to the fire, with the pandemic hitting the world, tourism further came to a standstill. “Since early 2020, the Sri Lankan economy has suffered significant losses in foreign exchange earnings; revenue from tourism alone dropped by $3 billion over the first eight months of 2021, compared with the same period in 2018,” according to Asian Development Bank report.
Sri Lanka, through repeated cycles of borrowing since 2007, has piled up $11.8 billion worth of debt through ISBs, which makes up 36.4% of its external debt, according to a Reuters report. While, Foreign direct investment (FDI) into Sri Lanka decreased to $548 million in 2020, compared to $793 million in 2019 and $1.6 billion in 2018, according to the International Trade Administration.
Global rating agencies cut Sri Lanka’s sovereign rating to junk
Amid its balance of payment crisis, global rating agencies such as Moody’s, S&P and Fitch have all downgraded Sri Lanka’s sovereign ratings. In January, S&P Global Ratings cut Sri Lanka’s sovereign credit rating deeper into “junk” territory, to ‘CCC’ with a negative outlook, citing rising repayment pressures and “uneven access” to financing. Last year both Fitch and Moody’s downgraded Sri Lanka’s sovereign ratings to junk category on increased probability of a default event in coming months.
Fitch said it downgraded Sri Lanka in the light of Sri Lanka’s worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows. While Moody’s said last year, the country had failed to come up with a comprehensive debt repayment plan.
Why is Colombo not seeking IMF’s help to restructure its debt?
Sri Lanka has so far relied on loans from countries such as China, India, and Japan, and institutions such as the Asia Development Bank and World Bank. Though rating agencies as well as experts suggest that the way out for Sri Lanka is to seek debt restructuring from the International Monetary Fund (IMF), which the country has refused to do so far. This is because if the country agrees to get its debt restructured, it would have to comply with IMF directives on increasing income tax and having an independent central bank. However, last week, Sri Lanka said it will work with the IMF to take action to increase its foreign exchange reserves.
The central bank clarified that help would not be in the form of debt restructuring. “I have decided to work with them after examining the advantages and disadvantages,” the country’s President Gotabaya Rajapaksa said in an address to its 220 lakh people, according to Reuters.
“We must take action to increase our foreign exchange reserves. To this end, we have initiated discussions with international financial institutions as well as with our friendly countries regarding repayment of our loan installments,” he added.
“The outlook (of Sri Lanka) is subject to large uncertainties with risks tilted to the downside. Unless the fiscal and balance-of-payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits,” the IMF said earlier this month.