More suffering in Sri Lanka before the crisis is resolved

Sri Lanka, once a prosperous country, is in turmoil as it runs out of petrol, medicine and foreign reserves. And the measures needed to pull its economy out of the unprecedented crisis could be even more painful.

This week’s assessment of the island’s economic woes by new Prime Minister Ronil Wickremesinghe was a necessary first step, economists say. His proposed solutions to restore some stability include selling the airlines at a loss, printing more money and possibly raising taxes, as well as fuel and utility prices.

Vikramasinghe said the “unpleasant and frightening” data facing the country included a revenue deficit that was 13% of gross domestic product (GDP), virtually no foreign reserves and a shortage of petrol, gas, furnace oil and cancer and anti-rabies drugs.

The country has suspended sovereign debt repayments and rating agencies are expected to set it as default.

Also, the prolonged foreign exchange deficit has led to massive inflation, bringing thousands of anti-government protesters to the streets of the Indian Ocean country, which China and India are pushing for influence.

Petrol was not available at most service stations in the commercial capital Colombo on Wednesday. The long line of autorickshaws, the most popular mode of transportation in the city, was parked in front, awaiting delivery.

Sri Lanka has no dollars to pay for petrol shipments, Power and Energy Minister Kanchana Wijesekera told parliament, appealing to the people to stop queuing for the next two days.

Economists say most of the PM’s proposals are understandable.

However, the decision to print money was worrisome and would lead to financial and external imbalances, said Patrick Quran, a senior economist at London-based Telemar.

“The announced policies are a necessary first step in resolving Sri Lanka’s economic crisis, but will face significant short-term pains due to high inflation and currency devaluation and will require further rate hikes from CBSL (Central Bank of Sri Lanka) to control the pressure,” he said.

S&P says money printing will have a “significant inflationary effect”.

The central bank held a rate meeting on Thursday and could raise rates for the fourth time in a row this year, according to a Reuters poll. It raised its core debt rate by a historic 7 percentage points in April to 14.5% and is likely to decide to raise it further to 2 percentage points this week, most analysts say.

Subsidies, fertilizers prohibited

Sri Lanka’s economic crisis, unparalleled since independence in 1948, stems from the confluence of the Kovid-19 epidemic, a combination of the tourism-dependent economy, rising oil prices and massive tax cuts by President Gotabhaya Rajapaksa and his brother Mahinda’s government. Who resigned as prime minister last week.

Other reasons include the high price of subsidized fuels and the decision to ban the import of chemical fertilizers, which has devastated the agricultural sector.

According to World Bank figures, Sri Lanka was a model of emerging market economy and grew at an average rate of 6.2% between 2010 and 2016. Over the next three years, the number dropped to 3.1%.

The World Bank predicts that the economy will grow 2.4% this year from 3.5% in 2021, but says the outlook is highly uncertain.

Charles Robertson, global chief economist at London’s Renaissance Capital, said the removal of electricity and fuel price subsidies was essential.

These and other reforms would set the starting point for negotiations with the International Monetary Fund for a significant bail-out, other economists say.

“We also need to see a massive tax increase, probably doubling the VAT from 8% to at least 15% as we saw in 2019,” Robertson said. “It’s a reduction in the VAT rate that contributed to the crisis.”

In the current environment, selling SriLankan Airlines is unlikely to make much money, experts say. “It’s not a bad thing to sell, but it’s a drop in the bucket compared to their demand for USD financing,” said Nathalie Marshik, head of sophisticated market sovereign research at Steffel Financial Corporation.

The concern is that rising fuel and utility prices will increase public anger against the government at a time when the administration is in deep turmoil. The new prime minister must convince the people that steps are needed to restore stability, economists say.

Inflation reached 29.8% in April, while food prices rose 46.6% year on year.

“Overall, it looks like corporates and individuals are preparing for a more tax system,” said Trisha Paris, head of economic research at Frontier Research in Colombo. “Also, electricity prices are expected to rise.

“In a sense, he was preparing the minds of the people for the coming economic crisis,” Paris said of Vikramasinghe.

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