Decoding the aggravation of the Sri Lankan economic crisis

The Sri Lankan economy exhibits a speculative and grim economic outlook of late. Widening governmental indebtedness, curtailed household expenditure, aggressive price rationing, and devalued currency are consequent outcomes of numerous external and political factors abounding the country.

The prevailing economic downturn and political turmoil put upward pressure on commodity prices, eroding the real value of incomes and reducing affordability. The concurrence of demand-pull and cost-push inflation has negative repercussions on domestic production rates, while also disincentivizing new businesses to start operations, further shrinking productive growth potential.

Primarily, huge fiscal deficits and depleting foreign reserves reduced the purchasing power of imported goods. With the depreciating Sri Lankan Rupee, imports became more expensive. The prolonged persistence of this economic downturn is fueled by the Russia-Ukraine war and the consequent imposition of sanctions. This has led to an acute shortfall of imported fuel and food. The widespread scarcity of these necessities has deteriorated living conditions and quality of life. Oil shortages resulted in extended power cuts, local inconveniences, and nationwide protests. People in Sri Lanka are queuing up to obtain essential items, highlighting a wasteful utilization of human capital. Individuals and societies are altering their consumption patterns to procure basic items, hitting the producers of non-essential commodities and superior goods. This may lead to demand deficient (cyclical) unemployment in these sectors.

While the country was twirling towards the downside of the business cycle, coupled with a reduction in VAT rates, the unanticipated shock of the pandemic led to vulnerability in household financial incomings and fragile market trends. This led to a spike in poverty rates, increasing the dependence on the government. As a result, the government sought additional international aid packages to cease immediate uncertainty and provide relief, leading to an irreversible debt trap, especially over the short run. Moreover, lockdowns and curfews, imposed in consideration of the Covid situation, reduced economic activity and revenue generation in the tourism industry, exacerbating conditions in the downward spiraling economy

Public sector mismanagement, external business environment, and ill-timed governmental decisions caused the economy to collapse. Untimely tax cuts (November 2019) reduced financial inflows from a direct revenue stream for the government, leaving it with no choice but to borrow money to inject welfare during the pandemic phase.

The vitality to spur economic activity is accentuated in such unprecedented scenarios. Through a boost in productive activity and revival in customer confidence in the state of the economy, the velocity of circulation of money will recuperate to restore a lower exchange rate over the long run. This will make debt repayments easier and reduce reliance on other countries and international bodies for financial aid.