What led Sri Lanka into Economic Crisis and Way Forward

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Event Report

What led Sri Lanka into Economic Crisis and Way Forward

April 20, 2022

Lecture was organized by NIICE, Nepal. The speaker was Dr. Nishan De Mel who is currently executive director at Verité Research. Dr. Nishan talks about the downfall of the credit rating of Sri Lanka in April 2020. B- is the credit rating status of Sri Lanka, this is the rating where a nation is considered to be on the black list and lose access to International Financial Markets. Borrowing from the International Financial markets was done for the millennium, but after this credit rating dropped Sri Lanka lost this option for paying debts to the nation.  The central bank of every nation has a foreign reserve that is used for imports of foreign goods. Usually, every nation has this reserve of a minimum of 3 months. But in 2021 these reserves in the central bank of Sri Lanka had less than 1 month. Also, these foreign assets or reserves are in debt form, which means these assets are borrowed from other international bodies. The net foreign assets are brought down to 3.6 Billion, and this downfall began in July 2021.

Decisions That Paved the Path to Crises

The budget of some previous came up as the initial step towards the crises, this is so because the government took financial support from international financial support bodies, and maximum of these funds are used as the interest payback of previous debts. In this 89 percent (approx.) of the monetary funds are used in paying the interests of the previous debts.

There were major tax cuts, based on promises made during the elections by the leaders. The consequences are drastic for the economy of the state i.e., reduction of the personal income tax base by 42 percent, reduction of coverage of VAT by 71 percent (approx.), and if we add up the tax base in total it reduces by 33 percent from the total taxes earned by the government. Ultimately the government has 2 choices either to increase their credit rating in the international financial market or to make some policy changes to attract foreign investors. But surprisingly the government of Sri Lanka did nothing. This resulted in a decline of the foreign reserves up to 100 percent.

Later on, in February 2022, the government claims to have swap reserves of 3.6 billion, but the actual crust of that claim is that they only left out with only 2 percent of long-term foreign reserves swap, 29 percent of Dollar swap, and 68 percent of Chinese swap. But the twist is that this 68 percent of Chinese swap cannot be counted as reserves, because according to the central bank, assets can only be called reserves when it has exchangeability with some commodities. But these Chinese swaps can only work with China and not with other countries.

The Legitimate Stable Government

To overcome this crisis, all foreign institutions including the IMF, want to have negotiations and meetings with a legitimate government. The President is facing criticism from a major part of the nation, and the youths of the state are against the current government due to the one-family rule in the nation. But due to a lack of representation and a weak opposition, there is no choice left for the people.

Prepared by Rohan Kumar Gawale, NIICE Intern