What is the issue in Sri Lanka?
Sri Lanka has declared a state of emergency over food shortages as private banks run out of foreign exchange to finance imports.
With the country suffering a hard-hitting economic crisis, President Gotabaya Rajapaksa has ordered emergency regulations to counter the hoarding of sugar, rice, and other essential foods.
The regulations give wide powers to officials to seize food stocks held by traders, arrest people who hoard essential food, and for the government to fix controlled prices. The government has appointed a former army general as commissioner of essential services, who will have the power to seize food stocks held by traders and retailers and regulate their prices.
Why has the Foreign Exchange Reserve(FOREX) depleted?
The country’s foreign exchange reserves have dwindled to barely enough to pay for three months of imports at a time when big repayments of its foreign debts are falling due, straining its financial system. The foreign reserves fell to $2.8 billion at the end of July 2021, from $7.5 billion in November 2019 when the government took office.
Sri Lanka needs to make foreign debt payments totaling $3.7 billion this year, having paid $1.3 billion so far. That’s in addition to local debt. Its currency has been gradually weakening against other major currencies, making such repayments more costly in local terms.
Fitch Ratings has downgraded Sri Lanka to its CCC category, indicating a real possibility of default.
|Fitch ratings is a credit rating agency that rates the viability of investments relative to the likelihood of default.|
Fitch is one of the top three credit rating agencies internationally, along with Moody’s and Standard & Poor’s.
Fitch uses a letter system; for example, a company rated AAA is very high quality with reliable cash flows, while a company rated D has already defaulted.
A Fitch rating of CCC means there is a real possibility of default of a nation
One of the reasons for the dwindling forex reserve is the huge trade deficit of Srilanka with other countries. As a result of the outgo of the dollar from the reserve, the domestic currency has depreciated to a great extent. As a result of which the country last year banned or licensed hundreds of foreign-made goods, including toothbrush handles. Between 2005 and 2015, Colombo borrowed billions from China, accumulating a mountain of debt. It was forced to hand over a port to a Chinese company after failing to keep up with payments. But Beijing is making more loans.
Sri Lanka has been printing money to repay the debt. This has adversely affected the FOREX position and created high inflation in the economy.
|Srilanka has basically printed money and exchanged it with the dollar to repay the debt. This has lead to |
-The outgo of the dollar from the foreign exchange reserve.
-Depreciation of local currency.
– High inflation due to increase in money supply
It is also facing the possible loss of preferential trade status for its garment exports to Europe, due to criticism over a terrorism law that critics say violates human rights.