Researched by: Sara Varghese and Surabhi Shukla 

The root cause: a foreign exchange shortage

Putting aside all the complicated numbers, Sri Lanka’s big problem is fairly straightforward.

One: It is an island nation heavily reliant on imports to meet its basic needs. The country imports everything from sugar to wheat, dairy products, milk powder and medical supplies. So it needs foreign exchange to pay for essentials.

Two: However, its foreign exchange reserves are dangerously low. As of now, the government has only enough dollars to cover less than two months of imports. According to financial experts, “For investors it’s a question of when, not if, they run out of FX reserves.” And the Sri Lankan rupee is down 7.3% this year—which makes purchasing imports more costly. Foreign reserves fell to $2.8 billion at the end of July, from $7.5 billion in November 2019. It has since blipped up to $3.55 billion, but that’s only because it drew money from the International Monetary Fund.  

Three: To make matters worse, Sri Lanka is in severe international debt—and many of those loans come due soon. For starters, there’s the $1.5 billion of foreign bond payments due in January and July, 2022—which is part of a total of $3.6 billion in foreign debt which matures next year. Point to note: the country’s debt burden has grown from 39% of Gross National Income (GNI) in 2010 to 69% in 2019. And 80% of the government revenues go toward interest payment.

The Covid effect: One of the key underlying causes for this forex crisis is a tourism industry devastated by the pandemic—which came on the heels of the Easter attacks. Tourism accounts for 5% of the Sri Lankan economy—which shrank by 3.6% last year due to Covid restrictions. The pandemic has struck a lethal blow to all major sources of foreign exchange earnings—including exports and worker remittances.

The knock-on effect: A massive food crisis 

The prices of basic commodities like rice and vegetables have risen sharply. And there are long queues outside stores due to shortages in milk powder, kerosene and cooking gas. Here’s how bad it is:

“Prices of essential commodities—including rice, dhal, bread, sugar, vegetables, fish— have risen several times during the pandemic, and more rapidly in recent weeks. Local varieties of rice—a staple item—currently cost about LKR 120 (Rs 44) a kg, while common vegetables such as onion and potato are priced over LKR 200 (Rs 73) per kg. A kilo of fish costs nearly LKR 700 (Rs 255).”

The government’s response: Making everything worse

The Sri Lankan government headed by strongman Gotabaya Rajapaksa has taken a series of measures—which have only helped make matters worse, and not just in terms of food shortages.

Bizarre import bans: Last year, the government suspended imports of vehicles and essential items such as edible oils, turmeric and even toothbrushes. Then it suddenly banned the import of all chemical fertilisers, pesticides and herbicides—insisting on an overnight shift to organic-only farming, making it the first nation in the world to do so. This is a catastrophe for the farmers—90% of whom use chemicals. At least, 85% expect the size of their harvests to plummet. 

As an example, let’s look at tea—which is Sri Lanka’s single biggest export, bringing in over $1.25 billion/year, which is nearly 10% of its export income. The ban will cut the average annual tea production of 300 million kg to half. And the market for organic tea—which is 10x more expensive—is much, much smaller. Never mind that Sri Lanka does not have reserves of organic fertilizers or compost to sustain organic-only farming.

Bad monetary policy: The Central Bank of Sri Lanka started printing money—over SLR 1000 billion ($5.02 billion)—over the last 18 months to inject cash into the economy. But in the midst of supply shortages, it hiked up demand—which in turn led to a sharp spike in prices. The inflation in turn “devalued the currency, made imports costlier, added to the debt and put the forex reserves under more pressure.”

A big power grab: Last not least, on August 30, the Rajapaksa government used the food crisis to declare an emergency. According to its ministers, stories about food shortages are a big fat lie: “There is absolutely no shortage of food in Sri Lanka and organised dissemination of fake news locally and internationally of a food shortage is highly mischievous.” The real problem is hoarding: “Certain unscrupulous traders have created an artificial shortage so that they can fleece consumers and profit.” Hence, the government had to declare an emergency—in order to fix reasonable prices for essential commodities and seize illegally hoarded stocks and distribute them to the public. 

Point to note: No one—not the opposition or independent experts—thinks imposing an emergency is going to mitigate the crisis. One reason:

“Sri Lanka does not have a universal public distribution system or ration cards that can ensure essential goods reach all consumers. The current regulations do not address our fundamental economic problem, and instead pose the risk of creating black markets.”

The other reason:

“The government’s decision, under the emergency, to fix prices of all essential items has further hit imports, as traders are reluctant to buy at high prices internationally without a promise of returns from sales in the markets at home.”

Also, it is very bad for democracy:

“The emergency law enables authorities to detain people without warrants, seize property, enter and search any premises, suspend laws and issue orders that cannot be questioned in court. Officials who issue such orders are also immune from lawsuits.”

The bottomline: Democracies keep electing strongmen who they believe are best suited to deal with a crisis. For some odd reason, they always prove to be the most incompetent leaders.

Reading list

Indian Express, BBC News and especially The Hindu offer the best overviews. Bloomberg News has more on Sri Lanka’s foreign exchange crisis. ORF Online looks at Sri Lanka’s options to extricate itself from this tailspin. The Print looks at the overnight switch to organic farming—while Al Jazeera reports on its effect on the tea industry. A related op-ed: Takshashila director Nitin Pai argues that organic farming should remain a luxury.