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Political Failure and Economic Crisis: Case Study of Sri Lanka

Sri Lanka is currently experiencing a severe economic and political crisis that recently resulted in a default on debt obligations. Additionally, the nation’s foreign exchange reserves are almost depleted, which limits its ability to buy imports and raises domestic costs for goods.

There are many reasons of sir Lankan economic crises and the economic turmoil has provoked the challenges. This ongoing crises in sir Lanka has come up after long economic mismanagement.

In 2019 Sri Lanka’s free-market economy had a nominal GDP of $84 billion and purchasing power parity GDP of $296.959 billion (PPP). From 2003 through 2012, the nation had grown by 6.4 percent each year, far more than its contemporaries in the area. The expansion of non-tradable industries, which the World Bank warned would be neither sustainable nor equitable, was the main driver of this growth. Since that time, growth has slowed. With a 2019 per capita income of 3,852 nominal US dollars or 13,620 PPP dollars Sri Lanka was previously categorized by the World Bank as an upper medium income country but has since been downgraded to lower middle income.

The current crisis is not the first set of problems for Sri Lanka. Naturally, the most of the critique has concentrated on the last two years, blaming the Rajapaksas for the nation’s economic downfall. The few assessments that have looked at the structural reasons for that collapse fall into one of two categories, which this article refers to as the orthodox or the heterodox. Both emphasize the structural roots of the crisis, but from opposing angles: the heterodox side concentrates on the nation’s failure to industrialize, while the orthodox camp emphasizes the government’s failure to liberalize the economy.

The island’s external debt, which totals more than USD 55 billion, is the cause of the issue. In 2019, the debt-to-GDP ratio was 87 percent; today, it is around 120 percent.  Six billion dollars in debt must be repaid by Sri Lanka in 2022 alone. The difference between what the nations owes and what it owns has all but immobilized the economy. With the balance of payments situation still unresolved.

Three kinds of income have historically been crucial to Sri Lanka’s economy: tourism, international remittances, and commodities exports. These have served as Sri Lanka’s mainstays in practice. The nation, which is marketed as a tropical paradise, has long fascinated tourists and explorers. Two million tourists were welcomed in 2019, bringing in more than $4 billion in foreign cash. 31 Remittances from expatriates, especially poor expats working in the Middle East, generated USD 7.26 billion that same year, while exports generated an additional USD 20 billion or so.

It should come as no surprise that the COVID outbreak hurt these industries. In 2020, there were only 540,000 tourists arriving, and in 2021, there were only 194,000. In 2022, the numbers started to increase. 1,682 tourists arrived in January 2021, but more than 82,000 arrived a year later36. Whereas it had spent USD 330 million on fuel in December 2019, rising costs now required it to spend more nearly USD 500 million each month.

 Frist Sri Lanka requires a more effective and progressive system of taxation that forces the wealthy to pay their fair share. The tax base needs to be expanded, and direct taxes need to be raised. The government must enact more transparency-focused rules to allay worries about capital flight. The expanding upper middle and middle classes need the government to protect their property rights and corporate interests.

Second Sri Lankans need to be informed about how their government functions and that politicians should cease utilizing their preferences as a means of gaining power. Given that Sri Lanka has a very low ratio of entrepreneurs, there argues needs to be a push to foster entrepreneurship among the populace.

Third Sri Lankan government spends far too much on appeasing those who are supposed to serve the people rather than enough on the people themselves. For the administration to achieve fiscal discipline, state-owned enterprises (SOEs) need to be restructured and overhauled. Many SOEs can be privatized, especially in industries where natural monopolies, coupled with market incentives and regulatory mechanisms, would produce far superior results.

The Fourth point is to make raw materials more affordable for businesses that rely on exports, Sri Lanka must lower its import tariffs. There is a need for free trade agreements with neighbors like Bangladesh, Thailand, and the Gulf States, among others. Sri Lanka needs to implement strong, comprehensive regulatory changes in order to increase investor and consumer confidence.

With the departure of 26 cabinet ministers on April 3, 2022, political unrest increased. Since the ministers submitted their resignations to the Prime Minister rather than the President, the resignations were declared void. Gotabaya Rajapaksa appointed four members to a provisional cabinet. After only one day in office, Ali Sabry Member of Parliament, appointed from the national list of the Sri Lanka Podujana Peramuna submitted his resignation as minister of finance on April 5.  41 MPs who were the SLPP (Sri Lanka Podujana Peramuna) government’s main allies started to turn against it. The Sri Lanka Podujana Peramuna’s (SLPP) nine MPs made the decision to leave the ruling party.

The opposition party SJB demonstrated within Parliament on April 6, 2022, calling for Gotabaya Rajapaksa to step down immediately. If the President and Prime Minister do not resign, the SJB party stated that it would attempt to introduce a no-confidence move in Parliament.

The private sector of Sri Lanka unanimously requested, in letter, on April 7, 2022, that political stability be restored in order to support the country’s economy. The parliament has been urged to fix the economic situation to avert catastrophe by over 38 organisations representing exporters, importers, manufacturers, the shipping and logistics industry, and the tourism industry. The Chamber of Young Lankan Entrepreneurs (COYLE) also urged the government to address the present political and economic issues on April 7, 2022.

Ali Sabry, the recently appointed finance minister, has called for political stability and insisted that Sri Lanka required an emergency bailout or a ban from multilateral organisations like the IMF, World Bank, and Asian Development Bank. Furthermore, he maintained that the only other course of action for dealing with the situation is to request aid from international organisations, and he specifically urged the government to restructure the US$1 billion ISB bond repayment, which is due around July 2022.

The biggest risk Sri Lanka will face is social unrest and turmoil, according to a warning from former World Bank official Shanta Devarajan on April 8, 2022. He emphasized that in order to prevent the economy from collapsing, a cash transfer Programme could be started with the goal of assisting the poor. Subsidies on food and fuel could also be reduced, he said.   Moody’s Investors Service had previously issued a warning that the wave of resignations among cabinet members would only increase the level of policy uncertainty and make it more difficult to obtain or borrow external financing.

 Moreover, for long-term sustainable growth, Sri Lanka needs extensive economic reforms. To maintain macroeconomic stability and public trust in the local currency, a steady monetary policy is essential. The Treasury may be compelled to take fiscal strengthening seriously by an independent central bank that has the power to refuse to generate money. State finances are severely drained by state-owned enterprises (SOEs). With one of the highest tariff rates in the area, Sri Lanka protects its own industries by encouraging import substitution.

Finding unique value adds in the supply chains of multinational corporations is a practical approach for Sri Lanka to improve its exports. The manufacturing industry in Sri Lanka must follow the current global trend and join global supply chains. Sri Lanka might plan to make use of its current FTAs (landscape analysis for trans) , particularly the one with India, to promote exports. According to the World Bank’s rankings of the ease of doing business, Sri Lanka is ranked 99th in the world. 82 percent of the land in Sri Lanka is owned by the government, significantly limiting private sector land use. In order to draw in investments, a suitable system of land assessment is also essential.

Other than that Ranil Wickramasinghe, the president of Sri Lanka, has taken moves to revive the island nation’s economy. He intends to implement changes that have been delayed for more than ten years. The top goal right now is to use an Extended Funding Facility Programme to get International Monetary Fund (IMF) funding for reforms. Although a Staff-level Agreement was created in August 2022, the Programme still has to receive IMF Executive Board approval. Sri Lanka has engaged foreign financial and legal advisers to conduct parallel negotiations with private creditors.

  This case study investigates the issue by examining the underlying factors that go back to Sri Lanka’s independence the lack of industrialization, the cost of the protracted civil conflict on the economy, and the majoritarian leanings of policy. The epidemic and terrorist strikes only made the situation worse. Travel restrictions were put in place on a worldwide scale, severely harming Sri Lanka’s tourism industry.

More significantly, the balance of Sri Lanka’s debt portfolio has significantly shifted in favor of expensive external debt. This crisis teaches developing nations valuable lessons about diversifying their debt, industrializing their economies, avoiding populist tax cuts that harm the government’s balance sheets, and reducing pointless public spending.

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