5 charts which explain the Sri Lanka economic crisis

High inflation and a sharp depreciation of the Sri Lankan currency appears to be the immediate cause of chaos.
Sri Lanka police officers stand guard on a road leading to the parliament building, after the government of President Gotabaya Rajapaksa lost its majority, amid the country's economic crisis, in Colombo, Sri Lanka.(REUTERS) PREMIUM
Sri Lanka police officers stand guard on a road leading to the parliament building, after the government of President Gotabaya Rajapaksa lost its majority, amid the country's economic crisis, in Colombo, Sri Lanka.(REUTERS)
Updated on Apr 06, 2022 06:27 PM IST
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By, Hindustan Times, New Delhi

Sri Lanka is facing its worst ever economic crisis, as the island nation reels from severe shortages of food, fuel and essential commodities. Protests have erupted across the nation, prompting President Gotabaya Rajapaksa to declare a state of emergency on April 1. How did the country get here? What led to the buildup of the crisis? What role did the pandemic play? Here are five charts on economic indicators that explains this.

What’s the immediate trigger for this crisis?

High inflation and a sharp depreciation of the Sri Lankan currency appears to be the immediate cause of chaos. Data from the Central Bank of Sri Lanka show that retail inflation, as measured by National Consumer Price Index (NCPI), started surging from October 2021. Annual growth in inflation was 6.2% in September 2021 but soared to 17.5% by February. The NCPI core index, which excludes volatile food, energy and transport prices, increased from 4.8% to 14.1% during this period. The value of the Sri Lankan rupee plummeted. The US Dollar-Sri Lanka Rupee exchange rate was 294.37 per dollar in the week ended April 1. This value was 199.55 a year ago. Given the fact that Sri Lanka imports a lot of essential commodities, depreciating currency and rising inflation have triggered a vicious cycle.

Even institutions such as IMF did not see this coming

The International Monetary Fund finished its 2021 Article IV consultation with Sri Lanka on February 25. Under Article IV, the fund holds bilateral discussions with members, usually every year. A team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. The report of the deliberations, released on March 2, paints a grim picture, compared with the numbers given in the October 2021 edition of IMF’s World Economic Outlook.

Between October 2021 and March 2022, the projected GDP growth for 2022 has been brought down from 3.3% to 2.6%, inflation forecast has been increased significantly from 6.25% to 10.5%, and the external balance for Sri Lankan economy was expected to be much worse at 3.8%. But despite the deterioration, the fund did not see the crisis coming.

Sri Lanka’s GDP growth was falling even before the pandemic’s impact

While the current crisis has escalated quickly, and the commodity price spike due to the war in Ukraine has added to Sri Lanka’s problems, economic growth started losing momentum much before the pandemic forced a contraction. This can be seen clearly from a long-term comparison of compound annual growth rate (CAGR) of Sri Lanka’s GDP. After a temporary boom in the 10 years ending 2015, when GDP growth rate was above 6%, the Sri Lankan economy grew at just above 3% between 2015 and 2019. The current crisis is expected to generate additional headwinds.

Bad policy has played a major role in the Sri Lankan crisis...

While the agricultural sector performed well across countries during the pandemic, Sri Lanka’s farm production dipped to below pre-pandemic levels. Gross Value Added in agriculture in Sri Lanka fell to 0.23% between 2019 and 2021. This contributed to both food scarcity as well as a drop in export earnings. One of the main reasons for fall in production was the government’s decision to ban the import of chemical fertilisers in April 2021 (in an ill-advised organic push). By the time the decision was reversed in November, the damage was done. “During the main rice cultivation season in 2019, Sri Lanka produced 3.5 billion kg of the grain. Agriculture experts predicted paddy output could fall as much as 43% this year due to the import ban,” a November 2021 Reuters report said. The March 2022 IMF report includes “worse-than-expected agricultural production” as a downside risk to the economy.

A bad tax policy added to the ill-effects of a bad agriculture policy. A recent tax reform gave a severe blow to the tax revenues. In December 2019, President Rajapaksa introduced a series of tax tweaks such as reduction of the value-added tax (VAT) from 15% to 8%, and an increase in income threshold to exempt more people from personal income tax. This led to the share of government revenues in GDP falling from 12.65% in 2019 to 9.17% in 2020.

...but some of it was bad luck as well

The Easter bombings of April 2019, along with the rise of the Covid-19 pandemic, led to a fall in tourism revenues. In absolute terms, tourism earnings fell from $4.4 billion in 2018 to just $682.4 million in 2020 and $506.9 million in 2021. Tourism revenues contributed 4.98% to GDP in 2018, but below 1% now.

 

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