Published:  09:48 AM, 17 May 2022

Sri Lanka's Financial Services Paralyzed the Economy

Sri Lanka had bad situation turned worse with two economic shocks in 2019. First, there was a series of bomb blasts in churches and luxury hotels in Colombo in April 2019.The blasts led to a steep decline in tourist arrivals with some reports stating up to an 80% drop and drained foreign exchange reserves. Second, the new government under President Gotabaya Rajapaksa irrationally cut taxes. The island nation of Sri Lanka is in the midst of one of the worst economic crises it's ever seen. It has just defaulted on its foreign debts for the first time since its independence, and the country's 22 million people are facing crippling 12-hour power cuts, and an extreme scarcity of food, fuel and other essential items such as medicines. The country relies on the import of many essential items including petrol, food items and medicines. Most countries will keep foreign currencies on hand in order to trade for these items, but a shortage of foreign exchange in Sri Lanka is being blamed for the sky-high prices. Post-independence from the British in 1948, Sri Lanka's agriculture was dominated by export-oriented crops such as tea, coffee, rubber and spices. A large share of its gross domestic product came from the foreign exchange earned from exporting these crops. That money was used to import essential food items. Over the years, the country also began exporting garments, and earning foreign exchange from tourism and remittances. Any decline in exports would come as an economic shock, and put foreign exchange reserves under strain.

Sri Lanka frequently encountered balance of payments crises. From 1965 onwards, it obtained 16 loans from the International Monetary Fund (IMF). Each of these loans came with conditions including that once Sri Lanka received the loan they had to reduce their budget deficit, maintain a tight monetary policy, cut government subsidies for food for the people of Sri Lanka, and depreciate the currency. But usually in periods of economic downturns, good fiscal policy dictates governments should spend more to inject stimulus into the economy. This becomes impossible with the IMF conditions. Despite this situation, the IMF loans kept coming, and a beleaguered economy soaked up more and more debt. The last IMF loan to Sri Lanka was in 2016. The country received US$1.5 billion for three years from 2016 to 2019. The conditions were familiar, and the economy's health nosedived over this period. Growth, investments, savings and revenues fell, while the debt burden rose.A drop in tourist numbers and tax cuts led to further economic pain. Value-added tax rates were cut from 15% to 8%. Other indirect taxes such as the nation building tax, the pay-as-you-earn tax and economic service charges were abolished. Corporate tax rates were reduced from 28% to 24%. About 2% of the gross domestic product was lost in revenues because of these tax cuts.In March 2020, the COVID-19 pandemic struck. In April 2021, the Rajapaksa government made another fatal mistake. To prevent the drain of foreign exchange reserves, all fertiliser imports were completely banned. Sri Lanka was declared a 100% organic farming nation. 

Sri Lanka Medical Association has warned that if the hospitals are deprived of vital drugs and medical tools, the casualties will be far worse than from the pandemic. SLMA also sounded an alarm, We are made to make very difficult choices. We have to decide who gets treatment and who will not. While fuel shortage accompanied by escalating prices has led to a panic situation, power cuts and disruption in financial services paralyzed the economy. As reports from the domestic and international sources suggest, the primary cause of the tottering economy is horrid mismanagement of the financial system and rampant corruption resorted to by the ruling coterie led by the Rajapaksa family. The island nation's foreign currency reserves have dwindled over months, if not years, and the import-dependent sectors of the economy, including food and fuel, have suffered the most. However, the ruling dispensation and its benefactors laboured to justify everything related to the meltdown pointing to the "consequences of the pandemic and the bombings of churches." But the pandemic is not an exclusive problem of the island nation. Also, bombings were not alien to Lanka in the 80s, 90s, and even in the first decade of the new century. They did not affect tourism and foreign remittance in any significant way amid long years of civil war and violent ethnic conflicts. Reports of a deepening crisis in Sri Lanka's economy were already available much before the Easter bombings and the outbreak of the pandemic. But most of them sought to analyse it from the point of view of draining foreign exchange reserves and external debts.

The wrath of the protesters across the country has mainly been targeted at Rajapaksa, the country's strongman president who was elected in 2019 on the back of a fierce nationalist agenda. Part of Sri Lanka's most powerful family, and in charge of the military during the final years of the civil war in which he is accused of committing war crimes he was long the most feared man in national politics. In the past two years, he amended the constitution to strengthen his own executive powers and five of his family members took up senior government posts, including his brother Mahinda, who is prime minister. But his government's devastating economic decisions since taking power including scrapping austerity measures when he came into power, cutting taxes to just 8% of GDP, printing vast amounts of money pushing up inflation, refusing to restructure the country's mounting foreign debt and using up all the foreign reserves have now made him the most derided man in Sri Lankan politics. The rallying cry of the protests has been Gota go home, a reference to his dual US citizenship. His entire cabinet resigned last week and more than 40 politicians defected from his ruling coalition to become independent, with one warning that "if we don't act now, there will be a river of blood in the country". But Rajapaksa has insisted he has no intention of resigning. It's evident he can't run a government, said Thiyagaraja Waradas, 35, a senior lecturer at the University of Colombo attending a rally organised by the LGBT community. The president must go: it's the only way.

Rayhan Ahmed Topader is a Researcher and Columnist.

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