Understanding The Economic crisis of Sri Lanka- The Way Ahead

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Sri Lanka, a beautiful island country surrounded by the Indian ocean, Palk Strait, Gulf of Mannar lying in the vicinity of India and Maldives, is facing an acute economic crisis. A country known for its beautiful beaches, mountains, scenic beauty, tea, and warm smiles is grappled with a financial emergency.

Financial Crisis in Sri Lanka will have repercussions on the South Asian region especially India

The acuteness of the situation can be judged from the statement by President Gotabaya Rajapaksha. He recently declared an economic emergency and has called the army to manage the situation in the country through the supply of various essential goods. It is also noticeable that the government is dealing with three overlapping concerns:

  1. The deadly pandemic covid-19 and the resultant draining of resources.
  2. The global capitalist phase since 2007 is spiralling into a financial crisis and
  3. The domestic crisis country dealt with by Sri Lanka since its independence in 1948. Often resulting in political instability and violence.
The famous Sigiriya rock of Sri Lanka

Current economic turmoil in Srilanka :- 

On 31st August 2021, the country declared an economic emergency as the foreign exchange reserves were declining, even for basic necessities like food. Furthermore, under the Public security ordinance, various laws were imposed on essential goods to prevent hoarding critical food items like salt, sugar, and rice. Such is the severity of the condition in Sri Lanka.

There are various reasons which contributed to the economic decline:- 

The economic crisis of Sri Lanka has been exacerbated due to its rising debts

The decline in the tourism sector:

Is one of the foremost reasons for a declining economy in the current scenario. Sri Lanka is considered a bottle consisting of scenic hills and calming beaches. The tourism sector contributes highly to the country’s GDP, i.e. over 20%.

But due to the covid -19 and Easter Sunday terror attacks, it reduced drastically. Tourism was the third-largest foreign exchange generator for Sri Lanka. Still, after the covid pandemic, it has suffered significant losses. Due to this, forex reserves reduced over $7.5 billion in 2019 to $2.8 billion in 2021.

Scenic mountains, calm beaches, lush greenery, and wildlife have made Sri Lanka a top tourist spot.

Currency depreciation:

A significant depreciation of Sri Lanka’s currency is seen after a currency swap with China. It also puts pressure on the balance of the payment sheet. It has been depreciated by 8% so far. On the other hand, to increase the liquidity in the economy, the country has printed 800 billion new currency.

With this insane liquidity in the economy and rising demand for goods, the prices rise is obvious, posing another problem of the inflation cycle. This all added to the devaluation of the currency against the dollar caused imports to become costlier. As a result, debt increased and drained the country’s forex reserves. 

Elephants have a religious significance in Sri Lanka, they are worshipped and cared for.

Rise in prices:

Srilanka is heavily dependent on imports to meet the country’s primary food requirements. But with, the devaluation of the currency, fall of foreign exchange reserves, and excess liquidity made a massive hike in the prices.

In addition to this, the government banned chemical fertilizers to protect the environment, which resulted in an agricultural crisis threatening food security. In return, it reduced production, which added to the existing problem.

Tea cultivation constitutes an important export industry for Sri Lanka

Increasing debt:

The ratio of public debt to GDP was 109.7% in 2020, and its gross financing was around 18% of GDP, higher than other emerging economies. And according to various economic analysts, if this continues, Srilanka will drain its entire foreign exchange reserves in the next 2 years. 

Implications on relations with India:-

India and Srilanka have shared positive relations since the independence of the island country. It ranges from intellectual, cultural, historical to linguistic interaction.

India’s “neighbourhood first policy “in Sri Lanka is seen as “Sri Lanka first” foreign and security policy. However, the recent intervention of China in the Sri Lankan economy and the ongoing economic crisis has deteriorated the relationship between both countries.

Both the country, despite such excellent relations for 2500 years, also have some grave areas of conflict with heightened tensions:-

The Fisherman Issue and environmental concerns

The fishing industry is an important contributor to both Sri Lanka and India.

With overlapping territorial waters and close proximity of the two nations, Fisherman has always ventured into each other’s jurisdiction. Sri Lanka complains about illegal fishing in the Palk Strait by Indian fishermen.

Similarly, India has also accused Sri Lanka of illegal fishing in its territorial waters. The Sri Lankan government asked India to ban mechanized trawlers in the Palk strait to preserve the sensitive ecology of the region. However, this has severely affected the livelihood of Indian fishermen and is a cause of concern for the coastal states of India.

Read more about the environmental concerns of sea-bed mining here!

Katchatheevu Island Dispute

Katchatheevu Island is sandwiched between both nations

Another issue of dispute between both nations is Katchatheevu Island. It is uninhabited, which India gave to Sri Lanka in 1974 in an agreement called Kachchativu island pact”. Sri Lanka made this place sacred with the presence of a catholic shrine.

But Indian Tamil believes that this island belongs to India and has every right to work here. Thus inflaming the age-old sentiments and conflict between Sri Lankan Tamils, Tamils, and Buddhist majority Sri Lankan.

Significant Influence of China

China’s increasing interference with island nations has put major countries on alert against its debt trap policy.

China’s high-handedness on Sri Lanka’s economy has also caused trouble between India and Sri Lanka. China is Sri Lanka’s largest bilateral creditor, which amounts to 15%. Therefore, the Sri Lankan economy depends on China to balance its payment sheet and recover its debts. China has also overtaken India in export to Sri Lanka, which is 3 .8 billion in 2020, to India’s 3 .2 billion.

India’s strategy to help Srilanka during economic crisis:- 

Both the nations took four prolonged strategies to discuss initiatives on food and energy and help Sri Lanka in this grave economic crisis. The first strategy is lines of credit for food, medicines, and fuel. The purchases are granted by India. It’s a facility extended by a bank, organisation, or government to the customer to draw the maximum loan amount.

The second strategy includes the modernisation project of Trinco oil farms. It was developed by Britishers during world war 2 and is one of the deepest natural harbours in the world. 

Extending financial aid to Sri Lanka is the top priority for India

The third strategy includes a currency swap agreement. These agreements provide currency exchange on various terms and conditions, just like soft loans extended by international monetary organisations for structural changes.

The fourth strategy is Indian investment in various sectors which will further help Srilanka come out of this economic crisis.

Srilanka government response to crisis:- 

Mr. Rajapaksha’s decision to make Sri Lanka fully organic led to a significant drop in domestic food production of the country and further added to inflation. In addition, some of the decisions added more to the economic burden of the government, like the capping of food prices exceeding demand oversupply, which led to a shortage of goods. 

Tapping the food prices to slow down inflation can help the common people who are already reeling under the pressure of pandemic

The strong force used by the army also added to the problem rather than solving it. It leads to greater volatility in the prices of food items. Further, Srilanka also banned contracts. Trading of more than 200 rupees with the dollar also dropped the supply of essential items. 

Way forward:- 

Sri Lanka is strategically essential for India as it lies in the middle connecting the Palk Strait to the strait of Malacca. Moreover, India needs to maintain friendly relations with Sri Lanka due to several security reasons and growing proximity with China.

In terms of the Indian Navy, Sri Lanka is a crucial partner to New Delhi as switching naval fleets from the Arabian Sea to the Bay of Bengal, or vice versa takes through the island nation. 

Well-planned and strategically organised decisions should be taken by India to help the country achieve both financial and political stability in the long run.

To prevent the economic crisis from turning into a socio-political situation, the government has to work and seek some remedial measures. New Delhi should also help its neighbour more effectively to prove its presence in the Indian Ocean and counter Beijing’s growing interest in Sri Lanka.

India could send startup companies to the island nation and create more job opportunities in the IT sector to employ its youth. Regional associations like the Indian Ocean Rim Association and BIMSTEC should also cooperate for better cooperation. It’s often rightly said that assistance in a crisis has more weight than assistance given in normal circumstances. This could also be an epoch in the India-Srilanka relationship. 

About the Author:

Tanya Jain

Tanya and optimism go well with each other !! She is a shopaholic and loves to get on new trends. Besides this, Tanya has been a political science student and has a great interest in international affairs. Currently pursuing a master in the same from Delhi University, she is determined and hardworking. Tanya aims to make a space for herself and make contributions by interning with “The International Prism”, which acts as a podium to voice the concerns of the youth.

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