Sri Lankan Crisis- The Classic Debt Trap Case Study

All imports and no exports make a country debt-ridden. This may sound like the old school proverb we all knew. However, the above one-liner is very apt to explain the economic situation of India's neighbor Sri Lanka. We may have been very engrossed with the Russia Ukraine war for the past couple of months, but it's hard to imagine how an economic crisis may even become worse than any other war being fought between nations. Recently an emergency was declared in Sri Lanka, social media applications were banned from being used, a police curfew was ordered and all steps were taken to bring down the protests being made by the citizens. In this article, I am going to delve a little deeper into this issue and provide my insights on how it can be tackled best to revive the economy and reduce further people from fleeing to other countries.

Just to give a brief snapshot about some numbers, the inflation has increased by over 25% in past one month, the Sri Lankan rupee has been devalued by over 50% from 1 dollar equivalent to 200 rupees to 1 dollar now equivalent to 300 rupees. The foreign reserves have reduced to only 2.3 billion dollars, and the debt to GDP ratio has increased from 94% in 2019 to 119% in 2022. The reported price of essential commodities like cereals, sugar, and milk has increased drastically, and long queues are being noticed in front of petrol and diesel stations with the shortage in supply. 1 kg of rice and 1 litre of milk cost 290 rupees and are expected to hit around 500 rupees in the next few months if steps are not taken. The price of the gas cylinders which are getting the supplies once a week increased from 3000 to 4200 Sri Lankan Rupee. As reported by a news channel, the family income of one family increased from 30,000 Sri Lankan rupees to 83,000 Sri Lankan rupees. 10 refugees have already been spotted and rescued in refugee camps in Tamil Nadu, and as per an intelligence agency over 2000 refugees are expected to flee to India in the next few months. Now enough with the numbers, let us try to understand what were the causes of the crisis.

Causes of this massacre

1. Bye Bye Tourists

Sri Lanka, an island nation for a long time had been heavily dependent on tourism for its economic growth. In fact, in 2018, it recorded the highest number of tourist visits at 2.3 million, however unfortunately the pride did not last long. In April 2019, there were a series of bombings, where some churches were destroyed, and it was popularly known as the Easter Bombings, 45 foreign nationals were killed in that event, and then obviously major toll on tourism took after March 2020, since the inception of the pandemic. Tourism which used to contribute around 12-13% to the economy declined drastically, hence resulting in economic decline.

2. Reduction in Tax Increased Debt

The newly elected Rajapaksa government promised to revive economic growth and decided to reduce the VAT(Value Added Tax), in order to increase public consumption. However, lockdown due to covid never allowed the people to spend much which can add to the economy. The policy was not properly planned before its execution, hence instead of increasing public consumption, it increased Sri Lanka's debt as the revenue of the government decreased.

3. So-called "Master Stroke"

The government decided on an instant transition to organic farming by banning the use of fertilizers and pesticides. While organic farming has its own benefits, without fertilizers and pesticides the production can fall by 20-30%. This made Sri Lanka a net importer of rice and tea, which is used to export earlier. It had to spend over 400 million dollars to import rice, and as net exports play a key indicator in GDP growth, there was a sharp decline seen here as well. The transition to organic farming should be a gradual step, where the nation can cope with slight decreases in reduction.

4. The Chinese Debt Trap

China has played its part while giving loans to complete infrastructure projects like ports, dams, roads etc. but later occupying the places if a country is not able to repay the loan back. A similar series of events happened here as well with excessive debt from China. For example one of the international ports was built taking a loan of 1.3 billion dollars from China and later as debt repayment could not be done, 70% of the stake was taken over by the Chinese merchant port. The debt continually increased, and a major part of the government revenue went into debt repayment only.

Recommendations and Strategies (Opinion)

Now coming to the revival part, let me say this before you assume anything. I am not an expert out here, nor do I have any formal qualification in economics or international business, hence the strategies I suggest here may not be the perfect ones, however, it is from the analysis I made studying the causes. Broadly it can be solved in two ways, one which can be done in the short term is by increasing the foreign reserves to allow imports for a greater period of time, and secondly by reducing debt, which may only be possible in the long term, once the country starts earning enough revenue. So let us look at how Sri Lanka can act to revive the growth and bring its economy back to normal.

• Tourism seems to be the backbone of the economy, hence take the best steps to revive tourism, for eg. give free visas to friendly countries, highlight and promote places of cultural significance and UNESCO identified sites. Also, ensure proper mechanisms to prevent the spread of covid. As previous incidents of Easter Bombings may still frighten tourists to visit the nation, ensure proper security to give tourists a safe and seamless travel experience.
• Overseas employment contributes highly to foreign exchange reserves. As per 2015 data, 90% of the expatriates went to the Middle East. So, one way to increase it is to train the graduating students and people of that age to find a job overseas which will not only help in increasing the foreign reserves but also remove people from the hassle of unemployment.
• Encourage foreign direct investments as much as possible, particularly in the manufacturing of daily essential commodities. There is a strict measure which needs to be taken to reduce and finally remove imports and become self-sufficient for basic amenities.
• Political sentiments are playing a huge role in the unrest and protest caused by the citizens, which ultimately led to the declaration of emergency. Since there is a huge demand from the citizens, the President should consider resigning or help in the formation of the new government, and take all steps to fulfil the needs of the citizens. In that way, the extra cost incurred in stopping protests may diminish.
• As per past records, China has always been a country that let others fall into its debt trap, and Sri Lanka became the victim too. Sri Lanka should take help from friendly nations like India to repay the Chinese debt, and let countries like India invest in its economy to bring back the status of tea, apparel and other top industries. The 2.4 billion dollar credit, along with the 400 million currency swaps should be utilized in the best way possible.
• Strict steps should be taken to remove corruption like the food mafia who are attempting to sell basic amenities in the black market at skyrocketing prices.

I hope Sri Lanka, our friend will be able to get out of this disastrous crisis of bankruptcy very soon with the help of India and other nations and utilize the credit line in the best way possible to earn the maximum revenue and repay back most loans and also increase the foreign reserves exponentially. Not far are those days, when again Sri Lanka gets full of tourists, and we back in India enjoy the overseas cricket tour to Sri Lanka. If you agree or disagree with any of my recommendations, please do comment. :) I would be curious to know about your feedback.