ECONOMICS OF GROWTH

AND DEVELOPMENT
TOPIC: SRI LANKA AND INFLATION

PRESENTED BY: HARNEET (5123)

JYOTIKA (5134)
  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. Inflation is at
an all-time high of 17.5%, with prices of food items such as a
kilogram of rice soaring to 500 Sri Lankan rupees when it would 
normally cost around 80 rupees. Amid shortages, one 400g
packet of milk powder is reported to cost over 250 rupees, when
INTRODUCTION: it usually costs around 60 rupees.
 On April 1, President Gotabaya Rajpaksha declared a state of
emergency. In less than a week, he withdrew it following 
massive protests by angry citizens over the government’s
handling of the crisis.
 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.
 WHY IS SRI LANKA SUFFERING FROM CRISIS?
 Background: When Sri Lanka emerged from a 26-year long civil war in 2009, its post-war GDP growth was reasonably high at
8-9% per annum till 2012.
 However, its average GDP growth rate almost halved after 2013 as global commodity prices fell, exports slowed down
and imports rose.
 Sri Lanka’s budget deficits were high during the war and the global financial crisis of 2008 drained its forex reserves
which led to the country borrowing a loan of $2.6 billion loan from the IMF in 2009.
 It again approached the IMF in 2016 for another US$1.5 billion loan, however the conditionalities of the IMF further
deteriorated Sri Lanka’s economic health.
 Recent Economic Shocks: The Easter bomb blasts of April 2019 in churches in Colombo resulting in 253 casualties,
consequently, dropped the number of tourists sharply leading to a decline in foreign exchange reserves.
 The newly led government by Gotabaya Rajapaksa in 2019 promised lower tax rates and wide-ranging SoPs for
farmers during their campaign.
 The quick implementation of these ill-advised promises further exacerbated the problem.
 The Covid-19 pandemic in 2020 made the bad situation worse -
 Exports of tea, rubber, spices and garments suffered.
 Tourism arrivals and revenues fell further
 Due to a rise in government expenditures, the fiscal deficit exceeded 10% in 2020-21, and the debt to GDP ratio
 rose from 94% in 2019 to 119% in 2021.
 The lack of foreign currency, coupled with the disastrous overnight ban on chemical fertilisers and pesticides, has sent food
prices soaring. Inflation is currently over 15% and is forecast to average 17.5%, pushing millions of poorer Sri Lankans to the
brink.
REASONS FOR INFLATION:
1. SHORTAGE OF FOREIGN RESERVES:
The alleged economic mismanagement of successive governments has depleted 70
percent of Sri Lanka’s foreign reserves with only $2.31 billion left with debt repayment
of over $4 billion. Sri Lanka’s high dependency on imports for essential items like
sugar, pulses, and cereals adds fuel to the economic meltdown as the island nation
lacks foreign reserves to pay for its import bills. Rajapaksa recently said that Sri Lanka
could face a trade deficit of $10 billion this year.
2. THE PANDEMIC EFFECT:
The island nation's huge dependence on tourism and foreign remittances was sapped by
the COVID-19 pandemic that set the pretext for the current crisis. Tourism, which
accounts for over 10 percent of the Sri Lankan GDP, was hurt after it lost visitors from
three key countries: India, Russia and the UK.
3. RUSSIA-UKRAINE WAR-INDUCED INFLATION:
The ongoing Russia-Ukraine war resulted in steep price inflation of crude oil, sunflower
oil and wheat. Crude oil prices hit a record high in 14 years with prices soaring over
$125/barrel at the height of the crisis. India had to step in by supplying 40,000 MT of
diesel under a promised $500 million line of credit. India has so far supplied over
2,00,000 MT of fuel in the last 50 days.
4. AGRI SECTOR CRISIS:
The Rajapaksa government's decision to ban all chemical fertilizers last year to make agriculture 100
percent organic severely hit the country's farm production, especially in rice and sugar production forcing
the reversal of this decision.

5. SHARP FALL IN FDI:

The FDI in the country has drastically decreased under the rule of the incumbent President Gotabaya
Rajapaksa. According to government data, FDI stood at $548 million in 2020 compared to $793 million and
$1.6 billion in 2019 and 2018, respectively.

According to the statement from the Department of Census and Statistics, the high inflation level has hit
prices of most essential food items such as rice, sugar, milk and bread. Sri Lanka's economic crisis is
caused in part by a lack of foreign currency, which has meant that the country cannot afford to pay for
imports of staple foods and fuel, leading to acute shortages and very high prices.
Why are some people blaming China?

Many believe Sri Lanka’s economic relations with China are a main driver behind the
crisis. The United States has called this phenomenon “debt-trap diplomacy”. This is
where a creditor country or institution extends debt to a borrowing nation to increase
the lender’s political leverage – if the borrower extends itself and cannot pay the money
back, they are at the creditor’s mercy.
However, loans from China accounted for only about 10% of Sri Lanka’s total foreign
debt in 2020. The largest portion – about 30% – can be attributed to international
sovereign bonds. Japan actually accounts for a higher proportion of their foreign debt,
at 11%.
Defaults over China’s infrastructure-related loans to Sri Lanka, especially the financing
of the Hambantota port, are being cited as factors contributing to the crisis.
But these facts don’t add up. The construction of the Hambantota port was financed by
the Chinese Exim Bank. The port was running losses, so Sri Lanka leased out the port for
99 years to the Chinese Merchant’s Group, which paid Sri Lanka US$1.12 billion.
So the Hambantota port fiasco did not lead to a balance of payments crisis (where more
money or exports are going out than coming in), it actually bolstered Sri Lanka’s foreign
exchange reserves by US$1.12 billion.
 REAL REASONS FOR THE CRISIS:
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 (money
sent into Sri Lanka from abroad, perhaps by family members). Any decline in exports would
come as an economic shock and put foreign exchange reserves under strain. For this reason,
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 (so exports would become more
viable).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.
HOW INDIA IS HELPING:

 With inflation rates crossing the 18 per cent-mark and the continuous shrink in the
island nation's foreign exchange reserves, India has stepped in to help Sri Lanka
recover from its worst economic crisis. New Delhi has decided to help Colombo
with a USD 1 billion credit line to help it procure food, medicines, and other
essential items.
 India has extended nearly $3 billion to cash-strapped Sri Lanka since January 2022,
by way of currency swaps, credit lines for essentials, and loan deferments to help
Sri Lanka amidst one of its worst economic crises in history. 
 In February this year, India had extended another USD 500 million credit line to Sri
Lanka to fund its fuel purchases. The Line of Credit (LOC) Agreement was signed
between the Export Import Bank (EXIM) of India and the Government of Sri Lanka
(GOSL).
 India has also agreed to develop three wind farms in Sri Lanka's Jaffna at a budget
of USD 12 billion. Similarly, the Indian Oil Corporation (IOC) has also sent 40,000
MT of diesel to help Sri Lanka deal with the energy crisis.
 A $400-million currency swap with the Reserve Bank of India, extended early this
year, was on April 18 extended by another three months. A billion-dollar credit line
for essential imports is operational and around 16,000 MT of rice has been supplied
under it so far. India has helped Sri Lanka defer repayment of loans totalling $1
billion under the Asian Clearing Union.
 Crucially, any disillusionment in Sri Lanka with China eases
India’s effort to keep the Lankan archipelago out of 
China’s ‘string of pearls’ game in the Indo-Pacific.
 It is in India’s interest to contain Chinese presence and influence
in this region.
 To the extent India can extend low-cost help to alleviate the
hardships of Sri Lankans, it should, however it must be done
with due care keeping in mind that the optics of its
aid matters too. WHY HELPING SRI
 India’s Assistance: It would be completely unwise for India to
let the Chinese take over expanding chunks of Sri Lankan
LANKA IS IN INDIA’S
territory. India must offer Sri Lanka financial help, policy
advice and investment from Indian entrepreneurs.
INTERESTS?
 Indian businesses must build supply chains that intertwine the
Indian and Sri Lankan economies in goods and services ranging
from the export of tea to information technology services.
 India, rather than any other nation, should help steer Sri Lanka
towards realising its potential, to reap the rewards of a stable,
friendly neighbourhood.
FOUR-PRONGED APPROACH:

 Lines of credit: Lines of credit for food, medicines and fuel purchases granted by India.

 Lines of credit is a credit facility extended by a bank or any other financial institution to a government,
business or an individual customer, that enables the customer to draw the maximum loan amount.
 Currency Swap: A currency swap agreement to deal with Sri Lanka's balance of payment
 issues.

 The word swap means exchange. A currency swap between the two countries is an agreement or
contract to exchange currencies with predetermined terms and conditions.
 Modernisation Project: An early modernisation project of the Trinco oil farms that India has
been pursuing for several years.

 The Trincomalee Harbour, one of the deepest natural harbours in the world, was developed by
the British during World War II.
 In particular, the projects to develop oil infrastructure in Trincomalee have been hanging fire since
2017.
 Indian Investments: A Sri Lankan commitment to facilitate Indian investments in various
sectors.