Table of Contents
INTRODUCTION
A country with a good financial plan will always have a good GDP and grow economically and globally. For this reason, a balanced budget is necessary, when the accounting statement of the country is not balanced, it leads to several national and vital obstacles. that is why it is always said that “Financial matters are the backbone of the Country”
Besides having a balanced budget, a county could have a budget deficit or a budget surplus.
A budget deficit occurs when the expenses of the nation exceed the income of the nation. a budget surplus is a situation where the income of the nation exceeds the expenses of the nation.
Financial analysis of Sri Lanka’s present situation reveals that the country is currently facing its worst and first sovereign default since its independence. The article shows the issues faced by the Sri Lankan Government in the reconstruction of the economic crisis.
THE SRI LANKAN FINANCIAL CRISIS
Sri Lanka is facing the worst economic crisis since its independence in 1948.
The Sri Lankan economy has completely collapsed, as then-Prime Minister Wickremesinghe declared a few weeks ago. But this economic meltdown is not a surprise: Years of mismanagement have been exacerbated by several external shocks and the Rajapaksa’s unwillingness to seek help from the International Monetary Fund (IMF) earlier. Everything that could go wrong with the economy has: Sri Lanka faces budget and current account deficits, hyperinflation, a devalued currency and a huge sovereign debt that it can no longer pay.
After the civil war ended in 2009, then President Mahinda Rajapaksa took out massive foreign loans to pay for war expenses and, more importantly, to start flashy infrastructure projects to attract tourism and reward cronies. In a vicious cycle, the government had to turn to foreign lenders, such as the Chinese, to help service already existing debt because they had limited foreign reserves. Rather than focus on economic reforms that might increase those reserves, the Rajapaksas implemented several tax cuts to shore up political support.
The 2019 Easter bombings and the COVID-19 pandemic ravaged tourism, Sri Lanka’s main source of foreign revenue. Adding insult to injury, Gotabaya decided to in 2021 to ban chemical fertilizers to make Sri Lankan farming “all organic” — a move that devasted the tea industry, Sri Lanka’s main export crop. The fertilizer ban (which was finally reversed) and global grain shortages due to the war in Ukraine have made the country more food insecure. The Rajapaksa’s economic plan turned out to be a series of missteps and false bravado that led to the collapse of a once vibrant and economically promising South Asian nation.
Whoever takes control of the government, they will have to work out an IMF program as soon as possible and negotiate to restructure loans held by China, India, Japan and commercial lenders. Without a government in power, IMF loans will take longer to finalize, leaving Sri Lankans in dire need of food and fuel aid because they have no foreign reserves to purchase these items.
Sri Lankans have taken to the street in record numbers to protest economic hardships.
In the face of severe economic hardships marked by power blackouts, shortages of fuel, cooking oil and food, protesters have been demanding the resignation of the Rajapaksa-led government since March 2022. Tens of thousands of Sri Lankans have taken to the streets of Colombo, and while that included some opposition politicians, most protesters are average Sri Lankans from all ethnic backgrounds. While concentrated in Colombo, there have been small protests in solidarity across Sri Lanka as almost all citizens are facing serious challenges
The Rajapaksa government collapsed and left the country in political disarray.
The roots of the current political crisis are directly tied to the actions of former President Gotabaya Rajapaksa and his family, including his brothers former Prime Minister Mahinda Rajapaksa and former Finance Minister Basil Rajapaksa. Gotabaya came to power in 2019, and in 2020 his party, the Sri Lanka People’s Front (SLPP), was able to consolidate its supermajority in parliament on a banner of populism and Sinhalese nationalism.
Bypassing the 20th amendment to the constitution, Gotabaya was able to consolidate an unprecedented amount of power in the executive presidency. His dictatorial tendencies were matched by nepotism, corruption, the elevation of retired military officers into almost every sector of government, and serious accusations of human rights violations during the Sri Lankan civil war. But in the end, it was his (and his family’s) terrible governance and mismanagement of Sri Lanka’s economy, especially during the pandemic, that led to the economic crisis in the fall of 2021
Sri Lanka’s political and economic future is uncertain, but there are significant problems to tackle for whoever takes charge.
Wickremesinghe has asked parliament to undertake the constitutional process to elect a new president. Parliament will convene on July 16 and begin the process to elect a new president from among their ranks, with the election likely on July 20. Following negotiations with all political parties, it is likely that a compromise candidate will take up the presidency (possibly opposition leader Sajith Premadasa or even Wickremesinghe). An all-party coalition government will try to lead Sri Lanka through IMF negotiations to finalize economic relief and set the stage for fresh general elections.
None of the current parliamentary leaders, most notably Wickremesinghe, enjoy much popular support, and protesters have opposed an all-party government because the Rajapaksa’s SLPP would still have a majority. Instead, they are calling for an interim government to prepare for elections.
The most pressing priorities for the next government, in addition to the economic and humanitarian woes, will be finding a peaceful way to resolve the ongoing protests and unrest, seeking some political buy-in from the country’s polarized ethnic communities, and likely amending the constitution to undo the executive presidency
Sri Lanka’s economic and political collapse sends a wake-up call to other countries and highlights the perils of sovereign debt in an era of geopolitical competition.
Sri Lanka’s sovereign debt is held by many countries, most notably China, India and Japan. China holds about 10% of Sri Lanka’s debt, and this has often been used as an example of “debt trap diplomacy.” The reality is more complicated — China indeed has not been willing to forgive any of Sri Lanka’s debt during this crisis and the structure of its bilateral debt comes with opaque restrictions and little relief. Additionally, if you count the debt held by Chinese banks, such as EXIM Bank of China and the China Development Bank, the percentage of Chinese-held debt is closer to 26%.
But by far the largest portion of Sri Lanka’s debt is held by commercial institutions, per official government statistics. Over the last 20 years as Sri Lanka’s debt has gone from low-interest rate concessionary lending from the World Bank or the Asian Development Bank to mostly commercial loans held by private banks at much higher interest rates. In 2019, 56% of Sri Lanka’s debt was held by commercial lenders, compared to only 2.5% in 2004. Much of this debt was used for large infrastructure projects that did not yield the returns to justify the loans.
This high level of foreign debt undergirds the crisis, and in a post-pandemic world is a wake-up call for several similarly placed countries in Asia and Africa. On the same day that Gotabaya fled Colombo, Pakistan, which is experiencing similar challenges, reached the final stages of an IMF deal that will hopefully pull it back from the brink.
Sri Lanka has been an arena for competition for India and China (and to some extent Japan), all of whom have historic relations with the island nation. The Rajapaksa regime claimed close relations with China, but ultimately India was most helpful in the crisis. This year, India has sent over $3.8 billion to Sri Lanka, in the form of currency swaps, loans, and food and fuel aid.
Even before this week’s acute political disarray, India had pledged a comprehensive plan to increase economic and infrastructure ties between the two nations, a move is seen as a reassertion of its historic influence in Sri Lanka and as a counter to growing Chinese influence. Other members of the QUAD alliance (the United States, Australia, and Japan) have also announced various levels of support for the Sri Lankan economy.
Last month at the G-7 Summit, President Biden announced $20 million of additional humanitarian assistance for Sri Lanka, bringing the total U.S. commitments in 2022 for economic and humanitarian assistance to $32 million. It is likely that the United States and other QUAD allies will increase their relief packages for Sri Lankans.
FAQ
How serious is the crisis?
- Sri Lanka’s debt-laden economy has “collapsed” as it runs out of money to pay for food, fuel, and medicine.
- The island is relying on help from neighboring India, China, and the International Monetary Fund (IMF).
- Wickremesinghe, who took office in May, said the economy was heading for “rock bottom
- Sri Lankans are skipping meals as they line up for hours to buy scarce fuel and cooking gas.
- The government owes $51bn and is unable to make interest payments on its loans.
- Tourism, an important engine of economic growth, sputtered because of the pandemic.
- The country’s currency has collapsed by 80 percent, making imports more expensive and worsening inflation.
- The finance ministry says Sri Lanka has only $25m in usable foreign reserves and needs $6bn to stay afloat for six months.
- The result is a country on the edge of bankruptcy, with hardly any money to import fuel, milk, medicine, and even toilet paper.
What did the government do?
- Despite the rapidly deteriorating economic crisis, the Rajapaksa government initially held off talks with the IMF.
- For months, opposition leaders and experts urged the government to act but it held its ground, hoping tourism would bounce back.
- Much of the public’s anger is focused on President Gotabaya Rajapaksa and his brother, ex-Prime Minister Mahinda Rajapaksa.
- In April 2021, the president banned imports of chemical fertilizers, a move that decimated staple rice crops, driving prices higher.
- Eventually, the government sought help from India and China – regional powers jostling for influence over the island.
- India says it provided support worth over $3.5bn this year.
- China intervened less publicly but said it supports the nation’s efforts to restructure its debt.
- Sri Lanka eventually opened talks with the IMF.