How is India and IMF helping SriLanka

India’s closest neighbor Sri Lanka is facing its worst economic crisis since gaining independence in 1948. The economic emergency was declared in Sri Lanka in 2021 as the food crisis worsened after banks ran out of the forex reserves to finance the imports. The terrible phase of the crisis continues since there has been nationwide protest over shortages of essential items, soaring inflation, power cuts and recent resignation of the Prime Minister Mahinda Rajapaksa amid widespread protest in the country. While the pandemic was the biggest blow to the country’s which is highly dependent on tourism, there were several other factors contributing the economic uncertainty.  We take a quick look at what caused the crisis and how external agencies, allies such as International Monetary Fund (IMF) and India are trying their best to help the Sri Lanka in this tough situation.

Economic shocks prior to pandemic

Just before the covid-19 engulfed the world, major economic shocks for the Sri Lanka’s economy were series of bomb blasts in churches and luxury hotels in April 2019. The blast led to major decline in the tourists’ arrivals into country. Another major setback was the massive tax cuts by then newly elected government under President Gotabaya Rajapaksa that caused budget deficit and loss of tax revenue resulting in downgrade of the sovereign credit rating and making it difficult for the country to raise money.

Pandemic shaken the tourism industry and decline in foreign remittances

Sri Lanka had vast dependency on tourism and foreign remittances which were badly hit by the coronavirus crisis.  As seen in the chart below, the receipts from tourism declined sharply to $1.08 billion in 2020 (1.3% of gross national product [GNP]) from $4.59 billion in 2016 (5.6% of GNP) according to world data statistics. (See chart below)

Source: Worlddata.info

In addition, international migrants and their remittances have been major force driving Sri Lanka’s foreign exchange earnings. The workers’ remittances dropped to a 10-year low at $5.49 billion in 2021. Decline in the remittance due to leakage through grey market wherein foreign workers went on remitting money through unofficial channels causing Sri Lankan banks to run out of foreign currency and foreign remittances to crash.  Sri Lankan Central Bank tried to keep the currency pegged at 200-203 Sri Lankan rupees to a dollar since September 2021. However, a dollar was changing hands at about 250 Sri Lanka rupees through unofficial channels. Officials are trying hard to offer incentives to migrant workers who remit funds through official channels to curb the illegal transfer and restock depleted foreign exchange reserves.

Agriculture crisis and spike in inflation due to Russia-Ukraine war

The agriculture sector was severely impacted by the government’s decision to ban all chemical fertilisers in 2021 in a bid to make agriculture 100% organic. The decision was reversed later on but the interim ban caused major drop in the productions of tea, rice, sugar leading major economic losses and imports of these goods.

The economic crisis in Sri Lanka intensified further with the onset of the Russia-Ukraine war that has led to sharp jump in the oil prices. In addition, Sri Lanka was dependent on both these nations for tea exports and tourism which was hit hard by war. All the above factors had already caused major strain on forex reserves leading to shortages and rising inflation as the economy was unable to pay for the essential imports.

External debt

While the island nation had its tourism booming and major infra projects making the headlines few years back. The country had seen a massive rise in its external debt as the country was borrowing heavily from the international markets.  A closer look at the external debt stocks shows international capital markets accounted 47% share, followed by Asian Development Bank (13%), World Bank (9%) and countries like Japan (10%), China (10%), India (2%) and others (9%).  Despite growing opposition, beginning 2022 the country repaid US$500 million international sovereign bonds. However, last month it announced that the country will default on its external debt of $51 billion.

Helping hand extended by IMF, India and China

Given the unsustainable rise in the debt levels and insufficient foreign exchange reserves, Central Bank of Sri Lanka (CBSL) and the government is seeking help from IMF, India and China. IMF senior officials met Sri Lankan delegation and had fruitful technical discussions to implement credible and coherent strategy to restore macroeconomic stability. India has also extended support to its neighbour of about USD 2.5 billion in the past three months according to the Ministry of External Affairs including credit facilities for fuel and food. Over 270,000 metric tonnes of diesel and petrol have been delivered to Sri Lanka since March and around 40,000 tonnes of rice have been supplied under the recently extended USD 1 billion credit facility by India. China too is extending emergency aid including supply of the food, production materials and other essentials. China also provided $1.5 billion swap $1.3 billion syndicated loan to the government. Amid the wide spread protest and violence in Sri Lanka against government handling of the crisis, several developed nations like US, UK and Europe too have raised their concerns and urged to the find long term solutions to economic and political challenges.  We continued to hope Sri Lanka will be able to overcome the crisis and draw a roadmap to recovery with the help of the neighbours and IMF.