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Sri Lankan Rupee exchange rate In early March 2022 the Sri Lankan Rupee began losing value quickly in the first half of 2022
Tax cuts and money creation The
Government of Sri Lanka under president
Gotabaya Rajapaksa made large
tax cuts that affected government revenue and
fiscal policies, causing budget deficits to soar. These cuts included increased tax-free thresholds that resulted in a 33.5% decline in registered taxpayers, reducing VAT to 8%, reducing corporate tax from 28% to 24%, the abolishment of the
Pay As You Earn (PAYE) tax and the 2% “nation-building tax” which financed infrastructure development. The massive loss of tax revenue resulted in rating agencies downgrading the sovereign credit rating making it harder to take more debt. In 2021
P. B. Jayasundera stated that President Rajapaksa was aware of the loss of revenue but considered it an "investment" and had no plans of increasing taxes for another 5 years. To cover government spending, the
Central Bank began
printing money in record amounts ignoring advice from the
International Monetary Fund (IMF) to stop printing money and instead hike interest rates and raise taxes while cutting spending. The tax cuts were also opposed by the former Finance Minister
Mangala Samaraweera who noted that as the Sri Lankan government already had far less tax revenue relative to most countries which combined with its high debt load tax cuts would be dangerous. Samaraweera predicted that "If these proposals are implemented like this not only will the entire country go bankrupt, but the entire country will become another Venezuela or another Greece." On 6 April 2022, the CBSL allegedly printed 119.08 billion rupees, making it the highest reported amount printed on a single day by the CBSL for the year 2022. The total money added to financial markets for the year 2022 increased to Rs. 432.76 billion. Sri Lanka's foreign debt increased substantially, going from US$11.3 billion in 2005 to $56.3 billion in 2020. While foreign debt was about 42% of the GDP in 2019, it rose to 119% of its GDP in 2021. In 2020, US economist
Joseph Eugene Stiglitz, published a report that blamed the quantitative easing policy made by US banks after 2008, for exporting debt bubbles to developing countries including Sri Lanka. In the same year,
Chatham House published a report that concluded that Sri Lanka's debt crisis was primarily "a result of domestic policy decisions and was facilitated by Western lending and monetary policy". Their research pointed that after 2008, western central banks had favored a monetary policy of quantitative easing, which created low global interest rates, and had largely facilitated Rajapaksa's borrowing-and-spending spree as he borrowed low interest ISBs heavily. However the winding-down of quantitative easing in the US after 2013, had later sharply increased Sri Lanka's borrowing costs, and the interest rates doubled, to approximately 10 percent for short-term loans, while long-term rates had jumped from 7 to 8 percent to 11–13 percent. Failure to defend their currency, further shrank Sri Lanka's foreign reserves to only $6 billion by 2016. In 2020,
S&P Global Ratings said Sri Lanka's existing funding sources did not appear sufficient to cover its
debt servicing needs, estimated at just over $4.0 billion in 2021. According to the agency Bellwether, "To solve Sri Lanka's 'budgetary problem' in repaying debt, Treasuries auctions have to succeed. When that is done, the 'transfer problem' of foreign exchange will be automatically solved... Instead, with failed Treasury bill auctions filled with printed money, the country is slipping deeper into debt." To resolve the debt crisis, Bellwether noted that Sri Lanka would need a credible fiscal plan and monetary policy, increasing taxes to repay debt, and interest rates and opening of imports would allow taxes to flow back to the Treasury. While it is possible to raise rates and generate dollars to repay the foreign debt by curtailing domestic credit, it is not practical to do so on an ongoing basis for many years. If investors see foreign reserves going up after debt repayments, confidence may come back but it is an arduous affair, which may or may not work given the current ideology. In September 2021, the government announced an economic emergency, as the situation was further aggravated by the falling national currency exchange rate, inflation rising as a result of high food prices, and pandemic restrictions in tourism which further decreased the country's income. This drove Sri Lanka to the brink of bankruptcy due to foreign reserves falling to $1.9 billion as of March 2022, this being insufficient to pay the foreign debt obligations of $4 billion and an International Sovereign Bond (ISB) payment of $1 billion for the year 2022. The government repaid $500 million International Sovereign Bonds which was due in January 2022 despite growing opposition coming from economic analysts and experts who all advised the government to postpone the ISB payment in order to preserve the foreign reserves. On 12 April 2022, Sri Lanka announced that it will be defaulting on its external debt of $51 billion.
Debt trap Numerous observers have described the loans made to Sri Lanka by the
Exim Bank of China to build the
Hambantota International Port and the
Mattala Rajapaksa International Airport, which turned out to be unprofitable
white elephants, as examples of
debt-trap diplomacy and
predatory lending. China is Sri Lanka's largest bilateral lender. In 2007, the state-owned Chinese firms
China Harbour Engineering Company and
Sinohydro Corporation were hired to build the port for $361 million. Exim funded 85 percent of the project at an annual interest rate of 6.3 percent. After the project began losing money its government decided to lease the project to state-owned
China Merchants Port on a 99-year lease for cash. The $1.12 billion lease to the Chinese company was used by Sri Lanka to address balance-of-payment issues. In regards to the Hambantota Port, he added, "The Hambantota Port is not a debt trap." She said that the
Canadian International Development Agency financed the Canadian engineering and construction firm
SNC-Lavalin's
feasibility study for the port, and its study concluded in 2003 that construction of a port at Hambantota was feasible. Strategic-trap diplomacy term was coined by Asanga Abeyagoonasekera and published initially on 16 September 2021, assessing the Chinese Debt-trap diplomacy in
Sri Lanka at an interview with
Voice of America.
Chatham House published a research paper in 2020 concluding that Sri Lanka's debt distress was unconnected to Chinese lending, but resulted more from "domestic policy decisions" facilitated by Western lending and monetary policy than from Chinese government policies. However while external debt owed to China was officially 10% of the total debt by April 2021, some officials said that China's total lending was much higher after taking into account loans to state-owned enterprises and the central bank. Indian observers have noted that the
Colombo Port project with China has accelerated the country's debt crisis. According to Chinese state media, it is the largest project by China in Sri Lanka and has a total value of $1.4 billion. The damage to the once-prosperous tourism industry from the
COVID-19 pandemic has also been blamed for failing to generate enough revenue to pay the country's debts. The Australian
Lowy Institute said that Sri Lanka was "not engulfed in a Chinese
debt trap", as 47% of Sri Lanka's external debt is owed to international capital markets, while 22% is held by multilateral development banks, followed by Japan having 10%. Supporters of the debt-trap theory noted that "calculating the volume of loans provided by other foreign nations and sovereign bonds/private commercial loans vis-a-vis that from China is an oft quoted argument to dismiss the theory of debt-trap diplomacy". In January 2022, President
Gotabhaya Rajapaksa's office stated that it would appeal to China to reschedule its debt burden during talks with the Chinese foreign minister
Wang Yi. As of March 2022, there has been no official response from China.
Fall of foreign remittances The Central Bank of Sri Lanka under Cabraal attempted to maintain the
Sri Lankan rupee pegged while continuing heavy money printing and strict exchange controls thus pushing down the market value of the rupee. Thus, by February 2022 while the government attempted to keep the currency pegged at Rs. 200/- to the United States dollar, the unofficial market value of the rupee exceeded 248 to the dollar. As a consequence, Sri Lanka's credibility among lenders has been undermined, further exacerbating the challenge of accessing international financial markets for borrowing purposes. This led to foreign workers remitting money through unofficial channels causing Sri Lankan banks to run out of foreign currency and foreign remittances to crash with a 61% reduction in official remittances in January 2022. In turn Cabraal threatened to freeze bank accounts of those that use unofficial money transmission methods. Then Cabraal began targeting merchandise and services exporters with exporter dollar surrender requirements forcing the residual after the utilization of export proceeds to be converted into rupees and forcefully converting dollars in forex accounts of resident Sri Lankans who earn dollar salaries ignoring concerns of this creating a similar situation to remittances. As Banks struggled, Cabraal issued warning letters to CEOs of banks demanding strict adherence to the fixed conversion rate. Former Deputy Governor of CBSL W.A Wijeywardana criticized the policies calling it "Cabraalnomics 2.0" noting that the dollars are disappearing from official markets while a superior dynamic black market has caused exporters and immigrants to shun the formal banking system resulting in dismantling the power of the Central Bank as the forex regulator.
Tourism The country's tourism sector represented over one-tenth of the GDP of Sri Lanka. The sector was negatively affected by the
2019 Easter bombings, and the COVID-19 pandemic prevented recovery. Tourism earned Sri Lanka $4.4 billion and contributed 5.6% to GDP in 2018, but this dropped to just 0.8% in 2020. In a failed prediction in April 2021 the World Bank stated, “Despite the heavy toll of the COVID-19 pandemic on Sri Lanka's economy and the lives of its people, the economy will recover in 2021, though challenges remain."
Agricultural crisis Sri Lanka had been self-sufficient in rice production with imports limited to specialty rice such as Basmati. In April 2021, President
Gotabaya Rajapaksa announced that Sri Lanka would only allow
organic farming, banning inorganic
agrochemical fertilizers. The policy led to a 20% drop in rice production within the first six months, reversing previously achieved self-sufficiency and requiring $450 million of rice imports. In lower tea production alone, the nation suffered losses of $425 million. The tea industry was decimated by the organic farming requirement, with farmers complaining of ten times the expenses with half the yields. The program was welcomed by its advisor
Vandana Shiva, but it ignored warnings from the scientific and farming communities about the possible collapse of farming, including a financial crisis due to the loss of foreign exchange earnings from tea exports. Both Dr Anurudha Padeniya, President of the
GMOA, and
Gotabaya Rajapaksa have associated the use of
chemical fertilizer with
chronic kidney disease, but scientific research has blamed the high mineral content of local water, including fluoride and magnesium, combined with the hot climate. The World Health Organization also doubted that chemical fertilizer use was a major cause of kidney disease. The banning of chemical fertilizers and
pesticides produced a severe economic crisis, with severe privation of income and food. In November 2021, following weeks of protests over rising food prices, Sri Lanka abandoned its plan to become the world's first organic farming nation. The government cancelled some measures, including importation of 44,000 tons of urea under the rescue line of credit. The government has proposed
peacetime rationing of essential goods.
Russo-Ukrainian War The
repercussions of the 2022 Russian invasion of Ukraine further battered the staggering Sri Lankan economy, as Russia was the second largest market for Sri Lanka in
tea exports, and Sri Lanka's
tourism sector relied heavily on Russian and
Ukrainian guests. The war halted Sri Lanka's economic recovery, with both tea and tourism sectors hard hit. On 13 July, Ukrainian President
Volodymyr Zelensky stated that Russia is accountable for the economic crisis in Sri Lanka, accusing Russia of creating a global food crisis and fueling inflation.
Corruption and impunity A
UN report in September 2022 highlighted that impunity of Sri Lankan officials for human rights violations and economic crimes are causes of the economic crisis. == Impact ==