The South Asian island nation is facing the worst economic downturn in memory since its independence in 1948. At one time, Sri Lanka was the best in the region in terms of social indices. It was ahead of everyone in education. The garment sector was the first to enter South Asia in Sri Lanka. Sri Lanka was also a favorite destination of tourists.
But the civil war did not allow the country to move forward. Due to a lack of security, the garment industry moved to Bangladesh in the 80s. The number of tourists also decreased in the meantime.
The country is heading towards hyper-inflation. Foreign exchange reserves have declined alarmingly. Daylong blackouts across the country and the empty fuel stations are the perfect epitome of the country's dwindling economy. Acute food and energy shortages sparked widespread outrage among the mass public, which turned into anti-government protests too.
Sri Lanka is in this position today because of the factionalism of the royal family, whimsical decisions, wrong policies, wrong project selection, and massive corruption.
After the end of the Civil War in 2006, Sri Lanka's gross domestic product (GDP) continued to grow until 2012. At that time, the per capita income increased from $1,436 to 3,619, which was the highest in South Asia. The country also became an upper middle income country in 2019.
But it could not hold any of its achievements. As its growth slowed, the World Bank dropped them to low-middle-income countries the following year. After that, due to the decline in exports, there was a huge imbalance in the current income.
Sri Lanka has three main export products: Ready-made garments, tea, and rubber. Revenue from all three products has been declining, but the biggest downturn has been in the last two years, during the pandemic. After all, they are in an even greater crisis because of the Russia-Ukraine war.
The two events of 2019 are particularly significant for today's fall of Sri Lanka. A bomb explosion near the northern city of Colombo has killed at least 253 people and injured dozens more. Then the tourism industry, which contributes to 10% of the GDP, collapsed abruptly, posing serious pressure on foreign exchange reserves.
The second incident happened because of President Gotabaya Rajapaksa himself. As a popular measure, the VAT rate was reduced from 15 to 8% all of a sudden. At the same time, he abolished the system of Nation Building Tax and “pay as you earn.” These measures had a negative impact on revenue. Within just one year, the country's VAT collection was reduced by 50%.
Since the spread of Covid-19 started, in the last two years, expatriate income, tourism, exports -- everything has gone downhill. During this time, the governments of all the countries of the world have increased costs; they have had to give incentives to the economy. Likewise, Sri Lanka has also had to increase its budget expenditure -- but their income was low. As a result, the budget deficit increased to 10%. Usually, there is need for caution if it is more than 5%.
Inflationary pressures mounted when the central bank started printing money. Inflation in Sri Lanka is now 16.7% as per the government, and 30.1% in food products. However, as of a private sector measure, inflation is more than 55%. In this situation, the country's trade deficit now stands at more than $1 billion.
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A debt trap
Sri Lanka's debt is now 119% of GDP. In other words, the country owes more than the goods and services it produces in one year. 36.4% of Sri Lanka's debt is in international sovereign bonds. According to the International Monetary Fund (IMF), a total of $500 million will be repaid to Sri Lanka this year as debt repayment. But now, Sri Lanka has only $231m worth of foreign exchange reserves. So it is a far cry to repay the loan, as they have to take new loans to run their economy.
It is said that Sri Lanka is in the debt trap of China. Although there are pros and cons, a large number of infrastructure projects have been implemented with loans from China. For example, for the construction of the deep-sea port of Hambantota, they borrowed $307m from China on a 15-year commercial basis at an interest rate of 7.3%.
But the income from this seaport was meager, and that was not enough to repay the loan. As a result, another $656m was taken from China for management. Alas! That didn't work either. The port was later leased to China for 99 years.
Another “White Elephant” project, borrowed from China, is Mattala Rajapaksa International Airport. The cost of this airport is more than the income. Fewer passengers, fewer aircraft takeoffs. Hence, this airport is now called the most empty international airport in the world.
In the current crisis, Sri Lanka has asked for a new loan of $2.5bn from China. India is also lending $1bn. However, it is unlikely that any other country or entity will give new loans to Sri Lanka. The country's debt has fallen because it has not been able to repay its previous debts. Last year, Bangladesh lent $200m from foreign exchange reserves. They could not pay the money on time.
In January, Sri Lanka's Central Bank governor Ajit Nevard Cabral said he did not want to go to the IMF at all. He also commented that the company does not have any magic wand to solve the problem. But in the end, they had to go to the IMF. The crisis is so deep that they have officially asked for a loan from the IMF.
The Bangladeshi perspective
The situation in Sri Lanka doesn’t seem too relevant to Bangladesh. But the recent trend of adopting very expensive and glamorous projects in the country has led to fears that Bangladesh, like Sri Lanka, may fall into the “debt trap” in the future. At a recent international conference in Munich, Indian Foreign Minister Jayashankar called on Bangladesh to rethink such unnecessary projects.
However, there are also questions about the profitability of many large projects in our country. Inflationary pressures are rising, and expatriate income is declining. On the one hand, as the import expenditure is setting new records, so is the current account deficit. Experts are advising Bangladesh to be careful in this situation.
We also need to take steps to reduce unnecessary expenditure, taking lessons from Sri Lanka's crisis. In Bangladesh, there are a number of government-run projects with foreign loans. There are questions about the need for all of this.
By the fiscal year 2020-21, the total debt of the Government of Bangladesh was 42.5% of the GDP, but of this, 16.5% of GDP was foreign debt of $72.43bn. In the budget of 2021-22 financial year, with the government's tax-to-GDP ratio falling below 9%, huge allocation for debt repayment is a red signal.
At the same time, it should be noted that the economy of Bangladesh is highly dependent on garment exports and remittances. If these two sectors collapse, our economy will also be in crisis.
Inadequacy of physical infrastructure is a major obstacle to the economic development of Bangladesh, so the construction of infrastructure must be accelerated. But it would not be too late for Bangladesh to fall into the trap of indebtedness like Sri Lanka if, instead of taking on the necessary projects, the fascination of glamorous and unnecessary projects are given priority.
Ahmad Bhuiyan is a student of Economics, University of Dhaka, who can be reached at [email protected].
