Deconstructing the Sri Lankan Crisis: A Macroeconomic Fiasco
The Sri Lanka Crisis: Why Does It Matter?
The Sri Lankan crisis is a classic example to understand the events happening around us, that deserve our due attention. Let’s break the crisis into discrete components and analyse them from a macroeconomic parlance, so as to acknowledge why ignorance of basic macroeconomic principles invites havoc.
Economics: Micro vs Macro
We come across micro-economic use cases and instances quite often in our daily lives, given how it revolves around the behaviour of consumers and households and is intricately linked to our daily lives. Macroeconomics doesn’t stand very far in this regard. However, it continues to impress us with its importance and significance by regularly giving out economy-wide signals, sometimes good, but mostly bad nowadays.
One such example where these signals have grown out of proportions is the macroeconomic landscape of Sri Lanka.
The Macroeconomic Crisis in Sri Lanka
Sri Lanka, a tropical island country off the southern coast of India, houses 21.9 million people. An erstwhile peaceful country, enjoying the highest literacy rate (92.5%) among developing countries, has recently turned tumultuous against their President Gotabaya Rajapaksa’s mishandling of their economic situation. Ordinary Sri Lankans were left to deal with frequent shortages, soaring inflation and debilitating power cuts, sometimes even lasting for over 13 hours. Most critics argue that the reason for such a huge crisis lies in the economic mismanagement by successive governments which actually culminated with severe shortage of foreign currency which found the government unable to pay for essential imports, including fuel.
Sri Lanka is a classic example of a twin-deficit economy. It signals that the country’s national income falls considerable short of its national expenditure. This further indicates the fact that the production as well as consumption of tradable goods in Sri Lanka has been inadequate. It also suffers from a large public debt at around 110% of its Gross Domestic Product (GDP) of about $80.7 Billion. The inflation is around 15%, which is the highest since 2008. By all this, it won’t be an overstatement to say that Sri Lanka is suffering from it’s worst financial crisis since its independence in 1948.
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The Reasons behind the Sri Lanka Crisis
There are a plethora of reasons that can be attributed to the origin and subsequent aggravation of the crisis situation. Let’s break all these components down and analyse them in greater detail from a macroeconomic parlance
Having excess of External Debt from International Markets
External debt refers to the loans/funds taken from foreign lenders such as foreign commercial banks and governments, wherein the repayment has to be made in the currency in which the loan was taken. However, there are several risks attached to it:- affects long-term economic growth, it has long gestation periods, and an unexpected devaluation of domestic currency. It can also culminate into a vicious debt cycle where country takes on greater loans to service previous debt.
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Fast depleting Foreign Exchange Reserves
Foreign exchange reserves hold great importance when it comes to maintaining the value of a country’s currency. Once the reserves are exhausted, the Central bank of the country has no option but to devalue its currency.
Pandemic-hit Tourism Industry
For a country that looks upto tourism as a major source of its earnings, the pandemic spoiled the scene and hit these revenues hard. Consequently, lower tax collections, lower foreign inflows, lower job creation and capacity utilisation.
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Excessive corruption in government
Corruption acts as an inefficient tax on business, which raises production costs and hence, lowers the profitability of a business/project. Moreover, it leads to an unfair utilisation of tax revenues. All this lowers tax revenues and subsequently, economic growth of the country.
Decline in Agricultural Production due to ban on Chemical Fertilisers
In a bid to make Sri Lanka 100% organic, the Rajapaksa Government announced a total ban on chemical fertilisers, which left country’s 2 million farmers, which comprise of 30% of the country’s total labour force, in lurch. When agricultural sector makes up for such a great share of the total output, an outright ban was obvious to lower national income and kill jobs. Moreover, it also gave rise to the problem of severe shortages and soaring food prices.
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A Friend In Need is a Friend Indeed
All these combined, made it extremely difficult for Sri Lanka to recover/redeem itself from the economic lows it found itself in. However, as we say, a friend in need, is a friend indeed, India was the first to respond and also came to rescue during the financial crunch of its neighbouring country. India has provided $1.9 billion in currency swaps, credit lines, and loans apart from rice, diesel, and other major commodities as a part of its ‘Neighbourhood First’ Policy. Moreover, it is also open to rolling over an additional $2 Billion in various forms to the nation in various forms.
India’s stance seems justified since Sri Lanka’s instability could cause the instability in the entire sub-continent without affecting other countries as much.
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How to avoid macroeconomic crisis
This crisis is a classic case-study in what a country ‘must not do’ and why ignorance of basic macroeconomic principles can cause havoc. These are the takeaways from the Sri Lankan crisis
Countries must abstain from drying up their forex reserves
Despite the Covid-19 pandemic hitting the tourism industry badly with revenues falling as low as half a million dollar in December 2020, the government continued with sweeping tax cuts, abolishing seven taxes. This eventually downgraded the country in International Credit Ratings and it eventually dried up its reserves.
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Self-sustainability not at the cost of blanket ban on imports
Sri Lanka has a massive debt of $45 Billion. With a severe shortage of foreign currency vital to the payment of this tremendous debt, the government had no choice but to reduce imports and improve self-reliance, thus it placed an unscientific ban on the import of goods, causing dearth of goods domestically. So, while it didn’t achieve its goal of being self-sustaining, it had to subsequently import rice and other food grains.
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Countries must not resort to Fashionable Liberalism
On one hand the country is spiralling into an economic chaos, and on the other hand, the government is embarking on over ambitious projects like – being self-dependent, organic, huge tax-cuts etc. for a lucrative future. During a crisis situation, the policymakers must look for pragmatic solutions instead of populist ones. The cost of a wrong decision is extremely high here.
Sri Lankan policy makers have no choice except navigating a way out of this tight spot.
Thus, this event acts as a comprehensive guide which helps us understand how the basic principles of macroeconomics work in real-life and the events happening around us, that deserve our due attention.
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About The Author
Krishiv Agrawal is deeply passionate about product, marketing and entrepreneurship.
He secured All India 1st Rank in the DU JAT (Delhi University Joint Admission Test) and is studying B.com Hons. at Shri Ram College of Commerce.
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