Sri Lanka nears crisis | Business Standard Editorials

Clipped from: https://www.business-standard.com/article/opinion/sri-lanka-nears-crisis-122032101382_1.html

More help needed for the island nation’s faltering economy

Sri Lanka’s education authority announced on Friday that school examinations scheduled for this week stood cancelled for a majority of the country’s students because “printers are unable to secure foreign exchange to import necessary paper and ink” to produce examination papers. This is just the latest way in which the island nation’s debt crisis has begun to impact the daily life of all Sri Lankans. This comes after months of power blackouts and double-digit inflation. A combination of factors —the debt overhang from the long and protracted civil war, irresponsible governance in the years since the end of the civil war, and finally the tourism crunch caused by the Covid-19 pandemic —have all been partly responsible for the straits in which the country now finds itself. But the final push has been provided by the Ukraine crisis and the sharp blows Russia’s invasion has caused to foreign exchange markets and commodity prices. The country has even been forced into a U-turn on its relationship with the International Monetary Fund (IMF). After some members of the cabinet initially objected to IMF negotiations, with one even reportedly threatening to resign, President Gotabaya Rajapaksa finally announced last Wednesday that the country would enter into discussions on a bailout.

The country’s external debt position is severe. In January, the finance minister —Basil Rajapaksa, the president’s brother —had estimated that Sri Lanka would have to manage payments of about $7 billion, including both principal and interest, due on the loans. Its hard-currency reserves were just over $2 billion at the end of February, but usable reserves may be even lower, according to some analysts. Meeting the most proximate requirement, the repayment of a $1-billion bond in July, is particularly difficult. Confidence in the country and its government is not high. The Rajapaksas are partly to blame for this state of affairs. Irresponsible tax cuts after their election victory in 2019 — of value-added tax on average from 15 per cent to 8 per cent, for example —reversed efforts on fiscal consolidation made by the previous administration. Spending too increased, and, as a result, when the pandemic hit, the fiscal deficit was already close to 7 per cent of gross domestic product (GDP). The government, which had taken a strong stand against IMF recommendations that it approach a more dynamically stable tax-to-GDP ratio, found it politically inconvenient to reverse course until last week, even as the country’s debt headed to junk ratings and locked it out of financial markets.

While there is no question that the Sri Lankan leadership bears responsibility for the country’s problems, that does not mean that the rest of the world can ignore it. India provided a $1-billion line of credit last week, taking its financial assistance to $2.4 billion in the last three months, but more will be needed. The IMF and other creditors will have to do their part. But the most systemic response can come only from the US, which must examine how it can use central bank liquidity swaps to add some confidence to Sri Lanka’s reserve position. Given that China cannot be allowed to be seen as the saviour of countries like Sri Lanka, and that the immediate cause is the disruption caused in part by the harsh Western response to the Russian invasion, the US and India must together examine what it can do to prop up Sri Lanka.

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