Teji Mandi Explains: How will Sri Lanka's economic crisis impact Indian investors?

Teji MandiUpdated:Thursday, January 20, 2022, 04:15 PM IST
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Sri Lanka’s economy is in big trouble. The county has only a few weeks of foreign exchange reserves to seamlessly import even essential items such as fuel. Although it can be blamed upon the COVID-19 crisis and the loss of tourism that put the country in such a situation, there’s more to it! Let’s deep dive and see how the country got there in the first place.

How Did the Country Get There?

First things first. The Sri Lankan economy is heavily dependent on a few sectors. They make the most of their money from tourism, tea, and some other agricultural products. The tourism sector alone contributes around 10% to the country’s GDP. So it’s obvious that when the pandemic arrived, not many people visited their country, and this sector suffered badly. The economy shrank by 3.6% in 2020.

The financial crisis is exacerbated by high government expenditure and tax cuts, which are eroding state revenues, as well as massive debt obligations to China and foreign exchange reserves that are at their historic lows.

Sri Lanka's massive foreign debt burden, particularly to China, is one of the country's most critical matters. It owes China about $5 billion in debt and received a $1 billion loan from Beijing last year to cope with its severe financial crisis, which is being paid back in instalments.

Some Twist in the Policies

In an attempt to lower import bills due to fertiliser purchases, the government decided to go cent-per-cent organic, thus banning fertilisers. This further hit the tea plantations hard as tea exports accounted for a major chunk of the country’s dollar earnings. As per reports, tea is Sri Lanka’s single biggest export, which constitutes 10% of the country’s total export income. By the time the restrictions were relaxed, the damage was done.

The Current Scenario

The country is fast running out of forex reserves and is in a state of economic emergency. To worsen the troubles, the country has $1.5 billion worth of foreign bond repayments due in January and July 2022. The country’s debt to GDP ratio stands at 80%. The fertiliser policy also led to a further shortage of food production in the country, and inflation increased sharply.

The Rescue Mission

Sri Lanka being a geographically important island nation is of immense importance to India and China on the security and trade front. China’s debt offer to weak economies acts as bait when these economies are not able to service the debt. As a result, China starts imposing control over the borrowing nation’s resources.

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

How Will It Affect Investors?

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

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