Lessons from the implosion of Sri Lanka’s tiny economy? 

News: Recently, Sri Lanka’s entire cabinet resigned over inability to handle the ongoing country’s worsening economic crisis. It is undergoing a state of emergency due to a deteriorating food and fuel crisis. 

What were the reasons behind Sri Lanka’s economic crisis? 

In 2019, the newly-elected government of Sri Lanka has been accused of announcing a series of populist measures like tax cuts, 50% reduction in value added tax, eliminating capital gains tax etc. 

Tourism, remittances and the apparel export are the top three foreign-exchange earners for Sri Lanka’s economy.

– Inward remittances dropped before the Pandemic.

– Tourism revenues fell down due to the pandemic.

– In addition, the apparel exports too have been hit during the pandemic.

– Its tea export which is a crucial forex earner was also hit due to decline in the production. It happened due to a ban on the use of chemical fertilizers. 

Sri Lanka depends upon the import of crude oil for transportation and energy. But, the prices of crude oil have been spiked by the Ukraine war.

In addition, there is an inflation of more than 19%.

Sri Lanka is facing both domestic and foreign debts. As a result, it has twin deficits – fiscal and the current account deficit. It is burdened by the Chinese debt. China has invested in Sri Lanka as part of its Belt and Road Initiative. 

What steps are being taken by Sri Lanka to overcome the crisis? 

Sri Lanka is trying to raise forex by floating sovereign dollar bonds. But it may turn ugly. If Sri Lank borrows someone else’s currency, it will not have the freedom to either repudiate or print its own currency out of a debt hole. 

India has provided emergency aid via food and fuel shipments.  

What lessons can be learnt by India? 

Sri Lanka’s crisis was in the making from much earlier than the pandemic or Ukraine war. Populist measures proved to be a major cause of it.

India is also witnessing a lot of populists welfarism at the state level and the Centre level.  

– The state of finances of certain states of India, such as Punjab, Bengal, Delhi, Telangana and Andhra Pradesh is going to face a lot of challenges. For example, they are providing a lot of freebies from their respective budgets like free electricity, free water, etc.

– In fact, the states of Chhattisgarh and Rajasthan may shift their pension regime. They may shift away from the National Pension Scheme of 2005. 

The fiscal burden of the central government is also likely to increase. The major causes behind this could be One Rank One Pension scheme, new extension to free rations scheme among others.  

Source: The post is based on an article “Lessons from the implosion of Sri Lanka’s tiny economy?“ published in the Live Mint on 5th Apr 22.