So far in the story of Sri lanka crisis: Last Monday, the government of Sri Lanka declared an economic emergency due to soaring food costs, a weakening currency, and rapidly depleted foreign exchange reserves. President Gotabaya Rajapaksa has enlisted the army to help manage the issue by rationing basic supplies.
What is the state of Sri Lanka’s crisis?
The current economic crisis in Sri Lanka is the result of a multitude of reasons.
The tourism industry, which accounts for about 10% of the country’s GDP and generates foreign cash, has been heavily damaged by the coronavirus pandemic. As a result, foreign exchange reserves have fallen from over $7.5 billion in 2019 to roughly $2.8 billion in July of this year. The amount of money that Sri Lankans have had to spend to purchase the foreign exchange needed to import products has increased as the supply of foreign exchange has dried up.
So far this year, the Sri Lankan rupee has lost almost 8% of its value. It should be highlighted that the country’s food supply is mainly reliant on imports. As a result, food prices have grown in lockstep with the rupee’s depreciation.
The government’s restriction on artificial fertilizers in agriculture has exacerbated the problem by reducing agricultural output. Mr. Rajapaksa announced earlier this year that Sri Lanka would be the first country in the world to have a 100 percent organic agriculture sector. Many people, including Sri Lankan tea specialist Herman Gunaratne, fear that forcing organic cultivation could halve tea and other crop productivity, resulting in an even bigger food crisis than the current one.
What has the government done to address the crisis?
The government of Sri Lanka has accused speculators of the spike in food prices by stockpiling crucial supplies and has declared an economic emergency under the Public Security Ordinance. The army’s mission is to seize food supplies from traders and distribute them to customers at reasonable prices. It has also been granted the authority to guarantee that foreign reserves are utilized to buy necessities.
The government has refused to back down from its strong campaign for 100% organic farming, maintaining that the short-term costs will be offset by the long-term benefits. It has also offered to provide organic fertilizers to farmers as an alternative. Furthermore, Sri Lanka’s central bank banned dealers from exchanging more than 200 Sri Lankan rupees for an American dollar and from entering into forwarding currency contracts earlier this year.
Will the government’s reaction be beneficial to the economy?
Mr. Rajapaksa’s push to make Sri Lankan agriculture completely organic is expected to result in a major reduction in local food output and a further increase in costs. Furthermore, the government’s numerous responses to the crisis may exacerbate the problem. Food price caps, for example, might result in severe shortages if demand exceeds supply at the government-set price. Due to mounting shortages, many have already had to line to buy necessities.
The army’s strong-arm tactics sometimes have unexpected consequences. When traders’ stocks are taken, they have less motivation to bring in new supply to the market. It could result in even more shortages and higher pricing for necessities. It’s also worth noting that speculative traders contribute to price stability by sensibly allocating scarce supplies over time. As a result, to the degree that the army’s activities discourage speculation, food prices may become more volatile.
Furthermore, the Sri Lankan central bank’s decision to prohibit forward contracts and spot trading of rupees at more than 200 rupees to the US dollar may have an impact on crucial supplies. A rice dealer, for example, who wishes to spend more than 200 rupees for an American dollar to import rice may no longer be able to do so. In fact, since the central bank’s decree, currency trading in the spot market has ceased. Furthermore, without forwarding contracts, which allow dealers to shift currency volatility risk to professional speculators, many traders may be hesitant to acquire critical supplies.