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Monday, October 3, 2022

Sri Lanka is facing deep economic crisis — and why it must worry Pakistan

Nowadays Sri Lanka is in the midst of one of the worst economic crisis it has ever seen. For the first time Sri Lanka has defaulted on its foreign debts. 22 million people are facing 12 hour power cuts due to scarcity of food, fuel and other items. Inflation has reached to the all time high of 17.5%. Sri Lankan rupee has plunged to 349.72 against a single US dollar. Foreign exchange rate went in negative.

Now what is needed to be looked at is that this absolute meltdown didn’t happen overnight. This has many lesson for many countries primarily Pakistan as the country has dealt with such near crises several times in the past years.

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Pakistan has a fundamentally unsustainable growth model evident from the chronic balance of payment problem because for years its imports have outstripped its exports, resulting in a foreign exchange shortage that forces a boom-bust cycle.

Causes of Sri Lanka’s economic crisis

  • Foreign debt

Before swearing in, the new government had decided to not go to IMF. In their campaigns they promised alot and then after entering into the government they slashed the value added tax to half. Due to which they had to go to IMF in emergency and during the time its total debts reached to $35 billion.

  • Covid-19

The tourism sector contribute 10% to the total GDP of Sri Lanka. But due to Covid-19, flights were cancelled. Consumption went down. Tourism was completely stopped. So the revenue of Sri Lanka fell down drastically.

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  • China is a driver behind the crisis

A part of Sri Lankan people belief the Chinese investment engulfed the Sri Lankan economy with its debt trap diplomacy. According to this diplomacy a creditor country extends enormous debt to borrowing nation and when the borrower can not pay the money back they are at the creditor’s mercy. However, there is little truth to this as loans from China accounted for only about 10% of Sri Lankan’s total foreign debt in 2020 which is far more than that of loans from Japan’s 11%.

  • Climate change

Since 2016 there was a severe climate change crisis Sri Lanka has ever faced. Serious drought and floods had reduced the agriculture output and affected the food supply chain.

  • Foreign exchange reserves

A fall in the productivity of tea and rubber due to the ban on fertilizers lowered export incomes which led to decrease in demand of Sri Lankan goods and thus a vacuum created in international market that was filled by some other countries. In February 2022 inflation rose to 17.5%. Sri Lankan foreign exchange reserves fell to $2.36 billion and they will repay $4 billion in debt servicing and it is likely that government will seek IMF assistance.

  • Terrorism

The 2019 Easter bombings in Sri Lankan churches also was a big blow to the reputation of the country’s security which led to decrease in tourism.

  • Foreign direct investments

The foreign direct investments of Sri Lanka fall from 1.6 billion dollars in 2018 to $700 billion to 2019 and 2020. Currently, it is less than $500 million. It is also a blow to Sri Lankan’s total reserves.

These all factors dropped revenue from 450 million per month to $2 million per month. It gives a negative shocks to Sri Lankan economy. In February of this year, 2000 containers were at Sri Lankan ports but they didn’t have enough money to clear goods.

What will happen now?

In all probability, Sri Lankan will now obtain a 17th IMF loan to get hold over the present crisis. A deflationary fiscal policy will be followed which will further limit the prospects of economic revival and exacerbate the sufferings of Sri Lankan people.

Comparison with Pakistan

  1. In Pakistan the populist regime of Imran khan decreased the oil prices despite of its increase in international market. As done by the Sri Lankan president Gotabaya Rajapaksa.
  2. U.S. Federal Reserve increased its interest rate recently for the first time after 2016 which will result in dollar appreciation. It will negatively effect the foreign exchange reserves of Pakistan and further lead to the depreciation of Pakistani currency.
  3. In Pakistan foreign exchange reserves dropped from $22 billion to $15 billion and now it is $12 billion.
  4. Inflation rate is on its peak above 10%. It is likely that it will hit 15% in coming months.
  5. 52.3% of tax collection came from imports. When imports are on rise foreign exchange reserves decreases, dollar gets appreciated against rupee and results in the increase in current account deficit.
  6. The political crisis in Pakistan is same as that of Sri Lanka. The cabinet of Prime Minister Mahinda Rajapaksa resigned over night which didn’t follow the constitutional protocols and deemed it a shame. Similarly, in Pakistan the regime change operation happened over night.

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