The bewildering scenes are emerging from Sri Lanka. With the country declaring a state of emergency and the president tendering his resignation thereafter, protestors were seen going on a rampage and vandalising several buildings. The protesters also entered President’s Palace and the Prime Minister’s residence had been set on fire.
Sri Lanka is struggling with an unprecedented economic crisis that has led to a critical shortage of foreign exchange in the country, caused spiraling inflation and shortage of essential supplies, and brought thousands onto the streets in protest. The island nation is facing acute food and electricity shortages and is neck-deep in recession.
–The country has incurred massive debts, borrowing steadily from international agencies, international markets, and of late, China, to finance various unnecessary or economically unviable projects.
–The government set out on an ill-advised tax-cutting spree. The move reduced the country’s tax base and tax revenue, as well as the government’s room to maneuver.
–With the onset of the pandemic, the tourism sector came to a grinding halt. The sector contributed to more than 12% of the GDP prior to the pandemic and was the fifth-largest source of foreign reserves. It employed more than a million people.
–The government banned the import and usage of synthetic fertilizers and pesticides. The complete and instant shift to organic farming had devastating consequences for a country with an agrarian population of over 60%. Within six months, the domestic production of rice, the country’s staple food and a crop in which the country had achieved self-sufficiency fell by 20%. The government was forced to import rice, and the prices went up by 50%.
–Moreover, the overnight organic shift damaged the country’s tea production massively. Tea was its primary export, and its largest source of foreign reserves.
–The Russia-Ukraine war sent oil prices spiraling.
–All along, the government has printed more money, only worsening the inflation.
COMPARING THE SITUATION WITH INDIA
–Former Sri Lankan Prime Minister had orchestrated the merciless genocide of Tamils thereby winning the backing of the majority Sinhalese.
–Lockdown closed down many small and medium businesses. GST is affecting small businesses badly.
–Soaring prices, a high budgetary deficit along with growing debt to GDP ratio, high unemployment, low investment, and depressed demand – that is the murky side of India’s economic scenario. It has led many to make gloomy predictions of India going the Sri Lanka way.
–The impending danger in this situation is the very high rate of inflation: the wholesale inflation rate almost doubled in a year to touch 14.55 percent. This is compounded by the rising global inflation which is likely to further impact India.
–In India, domestic debt makes up nearly 95% of the aggregate public debt, while external debt constitutes a very little share of the total public debt. The external debt to GDP ratio declined to 19.9 percent at the end-March 2022 from 21.2 percent at the end-March 2021. In Sri Lanka, it’s exactly the opposite. Nevertheless, persistent accumulation of public debt, even by domestic means, might still result in higher policy uncertainties – reduction of essential revenue expenditure – and affect economic growth adversely, in addition to its impact on various macro variables such as interest rate, inflation, investment, etc, in India.
–If public debt funds are wasted on relatively unproductive activities, it affects productivity. This is where things got difficult for Sri Lanka, where it ended up borrowing excessively to finance its domestic expenditure and could not generate enough domestic growth over time – and domestic tax revenue – to pay off what it owed in foreign currency denominations.
–Global uncertainty has triggered episodes of short-term capital flight across regions, particularly across the developing world, including India, where foreign investors have pulled their money out within a shorter span of time from emerging markets.
–The Russia-Ukraine war clearly has had an adverse impact on India’s Balance of Payment (BOP) position and supply chain so far. Also, India’s current account deficit (CAD) climbed to a 9-year high of $23 billion in the December 2021 quarter.
–The war and the overhanging effect of COVID-19-induced supply chain bottlenecks have hit India’s external sector in two ways.
–The weakening of India’s external sector performance weighed on its forex reserves kitty and the valuation of the Indian rupee. The rupee depreciated against the US dollar from 75.4 in December 2021 to 78.14 in June 2022, and now in July 2022, it’s 80.03.
Sri Lanka’s economic crisis may be quite different in both nature and form, from India’s current macroeconomic problems, over-dependence on tourism is also less, but India has its own bottlenecks that it must pay attention to.
India may see tough times ahead and must tread cautiously. India hasn’t gotten out of the woods yet, but the situation hasn’t become uncontrollable.
There are lessons India can take from the Sri Lanka situation in the context of political economy and the dangerous combination of centralised, populist politics pursuing ad hoc economic policies.
–BY YOGITA KADU