Sri Lanka is in a terrible spot. Economically, it is stuck between a rock and a hard place, and falling fast, all at the same time. Market concerns were wholly realized when in April of 2022, the island nation announced that it could no longer service its burgeoning external debt amounting to 120% of GDP.
With severely dented growth prospects, the government was subsequently unable to make good on interest payments to its international bondholders on June 3, June 28 and July 18 earlier this year.
Additionally, the country must make payments of $28 billion to foreign debt holders by 2027, making the situation very precarious.
To make matters worse, the economy is forecast to shrink to the tune of 8% this year, offering no fiscal leeway to policymakers ahead of today’s budget.
Although the story of how Sri Lanka reached this unfortunate position is a long and complicated one, rife with civil unrest, dotted with declarations of national emergency, prolonged spells of political instability, knee-jerk taxation regimes and agricultural policies gone awry, dwindling international competitiveness and ineffective governance mechanisms, there is little doubt that a key trigger for the current predicament of the public at large was the onset of the global pandemic in 2020.
Tourism, which accounted for 12.6% of GDP in 2020, was ravaged, as global lockdowns and unending restrictions on international movement took effect.
Source: ORF; Thushanga and Piyada (2021)
Productivity in the all-important agricultural sector also collapsed thanks to the hasty implementation of poorly designed plans, that banned chemical fertilizers and saw rice yields collapse by 30% throughout the country, forcing the need for higher imports.
With the economy stumbling, government revenues suffering amid failed taxation reforms, foreign exchange reserves began to dwindle as monetary authorities desperately tried to preserve the stated peg to the dollar to continue to pay for rising import costs of essentials such as food, fuel and medicine amid global shortages.
To this end, the central bank tried desperately to liquidate foreign reserve assets, with reserves finally having crashed from USD 8,864 million in June 2020 to USD 2,361 million in January 2022.
The chaos spilt further into the streets as employment opportunities evaporated, fuel was rationed and the currency was decimated amid sky-high inflation.
As of July 2022, Sri Lankan inflation registered 60.8% in July 2022, the highest inflation in Asia, exacerbated by historic levels of money printing, and a surge in capital outflows.
Skyrocketing food prices are a catalyst for social tensions in low-income countries, where nutritional poverty is low and purchasing power is eroded by inflaiton.
Finally, public anger boiled over and protestors besieged the presidential residence, and ousted Gotabaya Rajapaksa on 15 July 2022.
Following this, Ranil Wickremesinghe, a six-time PM has taken over the reins of government as both President and Finance Minister.
Sri Lanka budget expectations
Struggling to maintain even day-to-day operations, the emphasis of the budget will likely be on bringing certain key ratios in line with global expectations while authorities attempt to negotiate an emergency loan of around $3 billion from the IMF.
Expenditure will be slashed by a “few hundred billion”, which could prove politically destabilizing necessitating a very cautious approach.These funds will then be used to support struggling communities and to make additional interest payments.According to Lakshini Fernando of Asia Securities, the government will likely set a target of 9.9% as the deficit target to ensure they avoid double-digit territory.In positive news, there is an expectation that the IMF and government of Sri Lanka’s talks are reaching a “successful level.“To create medium to long-term growth generation opportunities, the budget is expected to focus on rejuvenating the beleaguered agricultural sector, skilling the workforce, and closely tracking much-needed IMF expectations with a view to receiving international funding.
However, the reality is that given the difficulty faced by the authorities today, taking more external debt will have few options but to rely on international funds in the near to medium term.
Despite Rajapaksha fleeing from office, his party still controls the majority of seats in parliament which will likely act as an additional hurdle to the new government’s economic reform plans.
In November, the government is also expected to present a full-year budget that will hopefully shed more light on the country’s future economic roadmap.
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