How Did Sri Lanka Become Near To A Default State?

Sri Lanka Economy Default 2022- An Analysis

 Today in the age of globalization, every economy has been facing challenges and disasters due to natural climate changes and human corruption.

After the Covid-19 pandemic, developing countries have been facing these challenges more sharply. Unfortunately, some economies have not been able to handle the Covid-19 shock well. Sri Lanka is the recent unfortunate example of a failed economy after the Covid-19 shock.

 
Now Economists are doing case studies behind the reasons that would help them to understand how the Sri Lankan economy has come into a default state?

Have a macro overview of the economy of Sri Lanka:

Sri Lanka's economy is an import-based economy where most consumer goods are purchased related to agricultural products and food, Minerals-fuels, Machinery, and Pharmaceuticals from foreign countries. It does not have large enterprises in the sector of self-manufacturing but has a good quality tourism industry. The revenue sources come from apparel, tires, and investment in property. 

So what was the reason that country went into the economic crisis? (apart from political crisis)

We know the Covid-19 pandemic has hit many economies bad. It also hit the Sri Lanka economy. 

Sri Lanka's economy, as I mentioned, is based on imports, tourism, and real estate. After Covid-19, it affected all these sector growths over the past two years. Simultaneously, their export industry also got disturbed as it now imports $3bn more than it exports every year, and that is why it has run out of foreign currency. With no improvement in export and growth, in order to stimulate tourism and the other sectors of the economy, the institution spent the expenditures disproportionately to balance these deteriorated sectors, resulting in an increased government public debt. This pressure kept building up on the current account. The worst scenario was the behaviour of policy-making institutions where the Sri Lankan government and other institutions have not realized the consequences of their policy-making decisions and considered the same policy to stimulate the economy in the usual ways. Even the Central Bank of Sri Lanka did not change its monetary policy, and its discount policy (interest rate) remained low. According to the Central Bank of Sri Lanka Monetary Survey Report-Annual (1995-latest), the interest rate has risen up to 14.5% in 2022, a total increase of 700 points basis, and their overall fiscal budget was in deficit by 12.2% of GDP in 2021. Even they did not change their exchange rate policy. It was around 170 and 200 Rupees per Dollar from 2019 to 2021. (Source Central Bank of Sri Lanka). 

All these reasons further caused a decline in the current account, which comes to a US$ -3.3 billion deficit. They are now striving to control it.

They were throwing dollars in the market, as we do through imports. Hence, the foreign exchange reserves reached an end of $3.1 billion at the end of 2021, causing a Forex crunch as payments increased more than the inflow of foreign currency amid the pandemic. To control the effects, they had to increase the discount policy and exchange rate overnight. That was the other unfortunate shock due to improper policy-making decisions, which led them to a bad state. 

Pakistan has a near similar scenario, yet fortunately, we are not in the same situation because, after Covid-19, Pakistan is among the best-performing country in tackling the circumstances of the pandemic well. It was an awful shock, yet Pakistan handled these circumstances with wiseness and braveness on both the health and economic side.

In other countries, when the public debt was increasing in enormous amounts, in the provision of better health facilities, vaccination, and saving for a falling economy- the State Bank of Pakistan intervention supported and stimulated the economy. That did not make the fiscal institution compelled to expand its budget disproportionately. So our economy has not had to face as much increase in public debt as in other countries. 

The government gave only targeted stimulation through the reallocation of expenditures without spending new expenditures. Besides that, the government supported the layman through the social welfare program of Ehsaas and Benazir Income Support. In 2019, Pakistan's GDP faced an annual decline of -3.36% which is an annual change of 1% against a 5% to 15% fall in other developed and developing countries. 

Pakistan needs to avoid all the mistakes that Sri Lanka had made due to political influence and policy-making to avoid the same consequences. Ban on Imports and the decision by the State Bank of Pakistan to increase the interest rate policy are due to these circumstances, and by observing the mishap to Sri Lanka's economy, the decision is sound as it is increasing all over the world as well.

Source: Central Bank Of Sri Lanka

Sri Lanka Economy 2019-2021 Table Overview.
 

Sri Lanka Economy Graphical Overview 2019-21.