How will the economic crisis in Sri Lanka impact Indian investors?

Sri Lanka’s economy is in serious trouble. The county only has a few weeks of foreign exchange reserves to seamlessly import even essential items such as fuel. Although this could be blamed on the COVID-19 crisis and the loss of tourism which has put the country in such a predicament, there is more to it! Let’s dive deep and see how the country got here in the first place.

How did the country get here?

First of all. The Sri Lankan economy is highly dependent on a few sectors. They make most of their money from tourism, tea and some other agricultural products. The tourism sector alone contributes about 10% of the country’s GDP. It is therefore obvious that when the pandemic arrived, few people traveled to their country, and this sector suffered a lot. The economy shrank 3.6% in 2020.

The financial crisis is exacerbated by high government spending and tax cuts, which erode state revenues, as well as massive debts to China and foreign exchange reserves that are at historic lows.

Sri Lanka’s huge external debt burden, especially to China, is one of the country’s most critical issues. It owes China about $5 billion in debt and received a $1 billion loan from Beijing last year to deal with its severe financial crisis, which is being repaid in installments.

Some twists in politics

In an attempt to reduce import bills due to fertilizer purchases, the government has decided to switch to one hundred percent organic, thereby banning fertilizers. This hit the tea estates even harder, as tea exports accounted for a significant portion of the country’s dollar earnings. According to reports, tea is Sri Lanka’s biggest export, accounting for 10% of the country’s total export income. By the time the restrictions were eased, the damage was done.

The current scenario

The country is rapidly depleting its foreign exchange reserves and is in a state of economic emergency. To compound the problems, the country has $1.5 billion in foreign bond repayments due in January and July 2022. The country’s debt-to-GDP ratio stands at 80%. The fertilizer policy also caused a new shortage of food production in the country and inflation rose sharply.

The rescue mission

Sri Lanka being a geographically significant island nation is of immense importance to India and China on the security and trade front. China’s supply of debt to weak economies acts as bait when those economies are unable to service the debt. As a result, China begins to impose control over the borrowing nation’s resources.

Observing all this, it becomes important for India to prevent Sri Lanka from falling into the hands of China. As a result, India’s $900 million relief package comes for a deal, where a major port in Sri Lanka will be leased to India.

How will this affect investors?

Although the event would not directly impact Indian investors, it could have indirect repercussions. These strategic ports could be used to store oil and fill ships. If China traps all of Sri Lanka’s ports, India could be in big trouble during events like a war, which could, in turn, lead to stock market instability.

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Posted: Thursday, January 20, 2022, 4:15 PM IST

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