Economic Insider

Sri Lanka to rescue economy with $3bn bailout

Sri Lanka
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The IMF has approved a $3 billion (£2.4 billion) bailout for Sri Lanka, which is experiencing its worst economic crisis since independence.

The deal has been in the works for about a year and will deliver billions of dollars in loans to the country.

Foreign Minister Ali Sabry stated that the administration intends to acquire funds by overhauling state-owned enterprises and privatizing the national airline.

Experts, conversely, caution that Sri Lanka faces a rough road ahead.

The epidemic, rising oil prices, populist tax cuts, and more than 50% inflation have seriously affected the country’s economy.

A lack of medications, fuel, and other needs also contributed to record-high living costs, causing widespread riots that resulted in the removal of the current administration in 2022.

As a result, the government defaulted on its debts to international lenders in May for the first time in its history.

Earlier this year, the country levied income taxes on professionals ranging from 12.5% to more than 36%.

It also raised taxes on necessities such as gasoline and groceries.

This starkly contrasts the massive tax cuts introduced in 2019 by former Sri Lankan President Gotabaya Rajapaksa, which cost the government more than $1.4 billion (£1.14 billion) every year.

“Sri Lanka still has a long path ahead of it in terms of consolidating its government balance sheet, consistent economic development, and external stability,” said Andrew Wood, an analyst with S&P Global Ratings.

Earlier this month, the IMF said that Sri Lanka has secured funding commitments from all of its important creditors, including China and India, opening the way for the bailout.

Mr. Sabry stated that it was “too early” to speculate on whether China, Sri Lanka’s largest bilateral lender, may consider writing off some of the country’s liabilities.

The Sri Lankan government had hoped to conclude a new payment arrangement with China and India by the end of 2022.

China owes Sri Lanka roughly $7 billion (£5.71 billion), whereas India owes approximately $1 billion (£820 million).

Can commerce help Sri Lanka re-establish itself?

Sri Lanka is “bankrupt,” according to the country’s president.

The Indian Ocean nation defaulted servicing its sovereign debt in May 2022, plunging it into economic and political upheaval.

The Colombo government secured a $2.9 billion (£2.4 billion) IMF bailout in principle the following September.

Nevertheless, the monies will only be sent to Sri Lanka if China and India agree to restructure billions of dollars in bilateral debt.

Although recent speculation that such an agreement was on the way, it has failed to materialize, and Sri Lanka’s economic woes and its people’s suffering continue.

Even if the bailout monies start flowing in the coming weeks or months, it will just be the start of Sri Lanka’s economic rehabilitation program because it is widely agreed that the country’s economic model requires a fundamental overhaul.

Sri Lanka received a sizable “peace dividend” in the years following the government’s 25-year battle with the separatist Tamil Tigers, which ended in 2009.

The administration was successful at the time in garnering significant foreign investment flows from foreign governments such as China and private international bondholders.

These financial flows encouraged domestic economic growth while increasing imbalances.

Throughout these years, the domestic economy grew less competitive worldwide. Yet, while exports climbed from $6.5 billion to $19.4 billion between 2000 and 2018, their share of the GDP declined from 39% to 23% during the same period.

Even before the outbreak wreaked havoc on the island’s valuable tourism industry in 2020, Sri Lanka’s trade deficit – the gap between imports and exports – was already more than 6% of GDP.

One of the reasons Sri Lanka was so hard struck by the default was that it suddenly found itself unable to generate the foreign currency needed to acquire essential supplies of food and fuel.

Ranil Wickremesinghe, who became the president after the discredited and despised Gotabaya Rajapaksa fled the country in July 2022, has stated unequivocally that correcting the imbalance at the root, notably raising exports, will be vital to Sri Lanka’s rehabilitation.

As a result, the big economic question for Sri Lanka is: can it be done? Can commerce help the country re-establish itself?

Sri Lanka’s principal exports have traditionally been agricultural, beginning with cinnamon in the 16th century, which brought European conquerors. Tea, however, remains the most important export item today.

Yet, the tea industry is still suffering as a result of the previous government’s disastrous 2021 fertilizer import ban, which slashed output by a fifth.

Governments should focus on increasing agricultural productivity.

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Yet, many tea companies claim to be “artisan” growers, with leaves plucked by hand as they were two centuries ago when the British Empire created plantations. Despite this, many estates continue to use obsolete processing equipment.

Additionally, Roshan Rajadurai, general manager of the Pedro estate in Nuwara Eliya, believes that his employees are hesitant to apply newer, more successful selection methods.