Amidst its current foreign exchange crisis, Sri Lanka announced a state emergency in August 2021. Most banks in Sri Lanka are running short of foreign currency to finance the import of essential items. State revenue has fallen short by around the US $80 billion[i]. The Central Bank banned forward contracts and spot trading of rupee at a rate above 200 rupees to an American dollar[ii]. These led to further foreign exchange crisis in the island state. However, this situation did not emerge overnight. It is an outcome of several incidences such as the Easter bomb attacks in 2019, the spread of Covid-19 pandemic, and a series of policy decisions that did not deliver expected result. Sensing an impending crisis, the government tried to evade it by imposing a ban on imports of vehicles, edible oils, and a few more items earlier this year but that did not go in its favour. Among the several important factors leading to this crisis, some of the pivotal ones are analysed in this article.
The tourism industry which contributes around 10% of the state’s Gross Domestic Product (GDP) is at its worst, since the serial bomb blast incidents across Colombo in 2019. On 21April 2019, Easter Sunday, three churches and three luxury hotels in Colombo, were targeted by suicide bombers. Following the attack, tourists stayed away from Sri Lanka for a long time. Tourism dropped by up to 70%, hitting the Sri Lankan economy very hard. The lack of tourists led to a foreign exchange crisis, with reserves falling to US $2.8 billion at the end of July 2020 while shrinking the economy by 3.6%[iii] compared to the previous year.
Before normalcy could prevail and tourism could pick up, Covid-19 hit the world, including Sri Lanka. Though the first two phases relatively spared Sri Lanka, but the third wave swept across the entire island. Though Sri Lanka fared relatively better than other countries during the initial phase of the Covid outbreak, its major export destinations like China, and European Union countries were facing severe health emergencies. Therefore, Sri Lankan exports to these destinations were naturally interrupted affecting its foreign exchange earnings. Many garment factories, a major export item and a prime source of foreign exchange inflow for Sri Lanka, were closed for several months.
Except for construction, the Sri Lankan industry hardly received any Foreign Direct Investment (FDI) during the last few years. Adding to this, in March 2020, the Colombo Stock Exchange (CSE) experienced one of the largest one-day falls due to an outflow of foreign funds. A considerable volume of treasury bills and treasury bonds held by foreign investors reduced by 9.03% (Rs 8.236 billion) bringing the total to Rs 19.6 billion in foreign outflows during the first two weeks of the same month[iv]. The collapse of the stock exchange was obviously a consequence of Covid-19. The problem was aggravated with the drop in foreign remittances by US $2.7 billion during 2020 primarily because the Sri Lankans employed abroad were severely affected by the pandemic[v].
By now Sri Lanka was already going through a tough currency crisis. To tackle the cash crunch, the Sri Lankan Central Bank has printed Rs 800 billion over the last 18 months, thereby increasing liquidity in the economy[vi]. This infusion of money led to an increase in demand while keeping supply constant. This resulted in the basic economic problem of higher inflation which in turn led to the devaluation of the currency, making imports costlier and creating mountain pressure on foreign exchange reserves. Sri Lankan rupee started to depreciate against most major currencies from the first week of March 2020. In particular, it depreciated against the US dollar and reached Rs 198.46 (as of 30 May 2021), reporting one of the highest depreciations in its history[vii]. The current depreciation of the rupee essentially increased the country’s expenditure on its imports and resulted into a burden on its foreign debt.
Another reason for this foreign exchange crisis is the country’s high dependence on imports for its essential items. Sri Lanka relies almost entirely for its daily essentials such as sugar, pulses, cereals and pharmaceuticals on import and in this situation when the country is facing shortage of foreign currency to pay the import bills, there is also food shortage. The government’s sudden decision to practice organic farming and banning chemical fertilizers led to a significant drop in domestic food production and a steep rise in food prices.
All the above factors have pushed Sri Lanka to a deep foreign exchange crisis. It is now in a position, where it is mandatory for the government to seek external help to recover from the emergency. Now, it remains to be seen what steps it takes.
* Dr. Rahul Nath Choudhury is a Research Fellow at the Indian Council of World Affairs, New Delhi.
Disclaimer: The views are of the author.
[i] Central Bank of Sri Lanka.
[iii] ICRA, Sri Lanka. Available at: https://www.icralanka.com/research/midyear-economic-update-2021/ Accessed on 15.9.21
[iv]Deyshappriya, N R Ravindra. (17 Jul, 2021). Covid 19 and the Sri Lankan Economy. Engage-Economic and Political Weekly. Vol. 56, Issue No. 29
[v]Gunadasa, S (2020): Sri Lankan Government Responds to COVID-19 by Mobilising the Military and Helping the Financial Elite. World Socialist Website, Available at: https://www.wsws.org/en/articles/2020/03/18/sril-m18.html. Accessed on10.9.2021
[vi]Nirupama Subramanian (Sep. 9,2021) Explained: The perfect storm that has led to Sri Lanka’s national ‘food emergency’. Indian Express. Available at: https://indianexpress.com/article/explained/sri-lanka-food-emergency-debt-burden-7496044/ Accessed on: 10.9.2021
[vii]Deyshappriya, N R Ravindra. (17 Jul, 2021). Covid 19 and the Sri Lankan Economy. Engage-Economic and Political Weekly. Vol. 56, Issue No. 29