Lampposts extinguished, Forex reserves depleted; What led to chaos?

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Sri Lanka’s economic crisis is deepening and the government is taking tough action, including imposing an emergency, to deal with protests over the country’s worst financial crisis in decades. The crisis is not sudden but it has been brewing for some time and rating agencies have also warned in the past.

The government has taken tough measures to deal with the economic crisis and the protests about it. He imposed a 36-hour curfew, declared a “state of emergency” to curb protests, banned social media and even turned off streetlights to save electricity, among other things.

The island nation of 2.2 million people has implemented power cuts of up to 13 hours a day as the government does not have sufficient foreign exchange reserves to pay for imported fuel. “We have already asked officials to turn off streetlights across the country to help save electricity,” Energy Minister Pavithra Wanniarachchi said.

The current economic crisis is the result of economic mismanagement by successive governments and has been accelerated by the significant tax cuts promised in the 2019 elections by Sri Lankan President Gotabaya Rajapaksa. Currently, Sri Lanka is unable to afford essential imports, including oil, which has led to power cuts lasting up to 1 p.m.

Foreign exchange reserves

Sri Lanka’s foreign exchange (forex) reserves have been depleted by 70% to $2.3 billion in February over the past two years, impacting the country’s ability to pay for its imports. It has debt payments of about $4 billion over the rest of the year.

Skyrocketing inflation

The country’s inflation rate is at a high level. Its retail inflation in February stood at 17.5%, the highest level since 2015, driven by rate hikes in the food (24.7%) and non-food (11%) categories. Inflation in January 2022 was 16.8%.

Inflation was further aggravated by Sri Lanka last month, which devalued its local currency and imposed import limits on hundreds of items, disrupting value chains and driving up prices at the consumption which were already very high.

Job losses

As a result of the COVID-19 pandemic, Sri Lanka’s tourism industry has been hit hard, hurting its foreign exchange reserve and leading to job losses. It also increased the number of poor people living in the country. According to a report by the World Bank, the share of the poor based on a daily income of USD 3.20 would have reached 11.7% in 2020 in the country, compared to 9.2% the previous year.

Aid for Sri Lanka

India on March 17 extended a billion dollar credit facility to Sri Lanka following an agreement signed between the two governments last month during the visit of Sri Lankan Finance Minister Basil Rajapaksa. A shipment of 40,000 metric tons of diesel from India arrived in Sri Lanka on Saturday, the fourth such assistance from New Delhi. Traders here have also loaded around 40,000 tonnes of rice to be shipped to Sri Lanka as part of a major food aid package.

The Sri Lankan government is preparing for talks with the International Monetary Fund (IMF) amid concerns over the country’s ability to repay its external debt. The country devalued its currency ahead of the talks.

First warnings

In 2019, the Asian Development Bank called Sri Lanka a “twin deficit economy”. “Twin deficits indicate that a country’s national expenditure exceeds its national income and that its production of tradable goods and services is insufficient,” she said.

In December 2021, rating agency Fitch downgraded Sri Lanka’s sovereign rating from “CCC” to “CC”. He said there was an increased likelihood of default in the coming months given the deterioration in the country’s external liquidity position, underscored by a decline in foreign exchange reserves.

The agency said the downgrade reflects its view of an increased likelihood of an event of default in the coming months given Sri Lanka’s deteriorating external liquidity position, underscored by a decline in foreign exchange reserves. in the face of high external debt payments and limited financing inflows. “The severity of financial stress is illustrated by high government bond yields and downward pressure on the currency.”

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