21 May, 2024

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Unraveling The Root Causes Of Sri Lanka’s Foreign Currency Crisis

By Gayantha Dehiwatte

Gayantha Dehiwatte

Pre-1978, Sri Lanka upheld economic independence through stringent controls on trade and capital, fostering a production-based economy and eschewing foreign indebtedness. However, the victory of the United National Party in 1978 marked a pivotal shift, embracing free market ideology and neoliberal policies. This shift has brought forth a multitude of economic challenges. Certain individuals often labeled as economic parasites have taken advantage of free market ideology to infiltrate critical sectors such as finance, health, education, energy, media, agriculture, and land. Their primary focus is personal gain, disregarding the nation’s overall welfare. Through regulatory manipulation, this elite class exploits both public and private wealth, masking their actions as societal advancement while prioritizing their own interests.

The liberalization of trade policies during this period sparked rapid deindustrialization, which was compounded by subsequent financial sector liberalization. This fueled a surge in consumerism and led to the accumulation of foreign debt. Consequently, the country’s debt burdens have intensified, exacerbating income inequality. Industries have dwindled, and agriculture has faced challenges, as there’s been a growing dependence on trading for immediate profits, further destabilizing the economy. During this period of economic upheaval, Sri Lanka has experienced a substantial trade deficit and witnessed the depreciation of the Sri Lankan rupee.

The sudden devaluation of the rupee by 100% in 2022 marked a pivotal moment, seen as a move towards seeking assistance from the International Monetary Fund (IMF). However, amidst this economic turmoil, the majority of Sri Lankans struggle to make ends meet, earning less than $1.35 a day, depriving them of basic necessities and worsening poverty. Economic elites have ensnared Sri Lanka in a cycle of debt servitude, exacerbating inequality and impoverishment. With over 60% of the population burdened by debt, the once vibrant middle class is disappearing. Recent data highlights a stark increase in poverty and income inequality, challenging earlier claims of progress.

The balance of payment crisis further exacerbated hardships in Sri Lanka, causing severe scarcity of essential goods, closures of small businesses, soaring unemployment rates, and increased malnourishment among children. The central bank’s decision to raise interest rates by over 30% worsened the burden on an already struggling populace, contradicting its goal of shielding the poor from inflation. Additionally, the flawed strategy of implementing moratoriums, followed by excessively high interest rates, worsened economic struggles. Private debt also played a significant role, diverting earnings towards debt servicing and limiting room for consumption or investment, exacerbating Sri Lanka’s economic challenges.

In this current economic crisis, private debt has surged much faster than private incomes. Efforts, especially by the central bank, are worsening the problem, prioritizing profits for bankers over the well-being of the public. While claiming to protect poor depositors, the central bank’s actions mainly benefit the super-rich, as poorer depositors hold very little money by comparison. Simple measures like deposit guarantees could easily protect smaller depositors. Government policies are deepening income and wealth gaps by favoring a wealthy few and leaving many struggling.

Moreover, Neo-liberal economic policies have entrenched Sri Lanka in a cycle of foreign debt dependency since 1978. The country relies heavily on foreign loans for infrastructure and imports, but this has led to massive debt without easing living costs for citizens. Instead, these loans have often been mismanaged and wasted on unsuccessful projects, putting the nation’s economic independence at risk. Foreign bondholders now have significant influence, forcing the government to impose austerity measures that cut spending on vital services like health and education. IMF-imposed austerity measures, including tax hikes and privatization, worsen the economic crisis and widen income gaps. Combined with the aftermath of the 2019 Easter attacks, these challenges promise more hardship for the population.

Recommendations for addressing Sri Lanka’s economic challenges:

1. Implementing a Wealth Tax: A tax reform to alleviate the burden on consumers and wage earners and shift it towards the wealthy. This involves reducing or eliminating indirect taxes, providing reasonable tax breaks for wage earners, and increasing taxes on the financial sector and monopolies. Introducing taxes for technological giants in the digital economy is also essential. Government spending should prioritize economic growth, regardless of tax revenue, using target rates like unemployment or growth rates. Sri Lanka’s sovereign currency allows for deficit spending without technical constraints, facilitating this approach.

2. Implementing automatic stabilizers: This can help moderate or eliminate the “fiscal trap” in Sri Lanka’s economy. Long-term fiscal solutions should include a rational combination of policy rules and automatic stabilizers to ensure that spending is increased when needed. This approach, supported by Keynesians like Minsky, would involve increasing the deficit when economic indicators like capacity utilization, employment growth, or economic growth are below par, and vice versa. Automatic stabilizers would provide countercyclical assistance for both the state and private sector, helping to stabilize the economy during downturns.

3. Implementing socialist policies: such as a Job Guarantee program can help address key issues in Sri Lanka’s economy. This includes increased spending on domestic infrastructure, industries, and welfare programs like free healthcare, education, and transfer payments to low-income earners. The focus would be on creating employment through public sector hiring, rather than relying on the neoclassical notion of the invisible hand or perfect markets. Embracing heterodox economic traditions offers hope for effective policies that avoid the fiscal trap and promote economic recovery.

4. Address the debt crisis reduce inequality:  proposing government spending on debt forgiveness, drawing inspiration from ancient practices. The premise is that debts that cannot be paid should be forgiven. Widespread foreclosures and evictions would exacerbate income and wealth inequality, hindering economic and social sustainability. Writing down debts to manageable levels would pave the way for genuine recovery, redirecting resources from debt service towards societal well-being.

5. Advocating for the implementation of protective tariffs: this would bolster local industries and foster an independent national economy through a nationalistic trade strategy. Drawing from economic history, countries like the USA, UK, China, Japan, and Germany have successfully developed their economies through protectionism. By reducing imports, protective tariffs can mitigate the country’s indebtedness and promote domestic industry growth, paving the way for economic self-reliance and sustainability.

6. Staunchly opposing relying on foreign loans for domestic spending:  advocating for using domestic sovereign currency to stimulate the economy through keyboard entries. This approach eliminates the need for foreign capital inflows, safeguarding Sri Lanka’s sovereignty from interest extraction by foreign creditors.

7. Advocating for the nationalization of money creation to centralize control and prioritize productive purposes: This would benefit the society, the economy, and the environment. This entails nationalizing the banking system or implementing window guidance by the central bank. Money, not being a commodity but a debt and a creation of the state, should be allocated solely for productive endeavors. Importing consumption goods and asset purchases should be strictly prohibited to ensure the optimal use of resources.

8. Prioritizing government spending on infrastructure development, skill enhancement, and healthcare improvement.  This strategic allocation of resources is aimed at reducing the cost of living by lowering the cost of production. By enabling domestic producers to capitalize on natural export opportunities, this approach enhances our competitiveness in global markets. Ultimately, it fosters sustainable economic growth and prosperity for the nation.

9. A significant increase in government spending on renewable energy, environmental protection schemes, and reforestation initiatives to foster a green economy in Sri Lanka. Additionally, incentivizing the private sector through tax breaks and other concessions will encourage their contribution to environmental sustainability efforts. These measures are crucial for mitigating the challenges posed by climate change and promoting a sustainable future for the nation

10. Advocate for providing risk-free financial assets, such as government bonds, treasury bills, and other savings instruments, accessible to EPF/ETF funds and pensioners. Introducing special savings vehicles with favorable returns for deserving categories would ensure secure and risk-free investments. This strategy aims to provide stability and financial security for investors while encouraging savings and investment in Sri Lanka’s financial markets.

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Latest comments

  • 2
    0

    Gayantha Dehiwatte, the points you give are imperative for the Motherland,.

    Yes, stabilizers should be implemented asap, and include reduction of existing mortgage rates on housing when salaries don’t keep up with inflation, although at the time the mortgage was taken out, people could afford it. Also, there should be mortgage reduction of rates on struggling SME’s. There should be debt forgiveness programs as you say.

    Imagine Ranil and his UNP following the “invisible hand or perfect markets.” They are Western concepts and constructs, and is not invisible at all. Their “invisibility” comes from previous global colonization, and the continuous wars to sustain that gained wealth. Ranil does not care for our Lankan people and is a silly fool. He is using this invisible hand to merge with India, so this invisible hand can satisfy Western capitalistic interests. This process, might give a temporary boost for about a year, but will fall flat yet again for it is a far huger area to contend with.

    • 3
      0

      Tariffs would be shouted down because they do not benefit the global economy. Yes, they should be protective tariffs. Trouble, Lankan who design the tariffs have no clue on how to implement intelligent ones. Much corruption is involved also is playing down tariffs, as the tariff designers get some pay-out from not implementing them

      Are they using foreign loans for domestic spending? Guess Rajapaksas did that when they build unnecessary infrastructure upon infrastructure. They should have used domestic sovereign currency for all of the country infrastructure. Now there’s no choice but to borrow from the goose to pay the gander (something like that). Ranil has borrowed from the IMF to pay off Chinese debts. People suffering as a result. IMF doesn’t mind, for it can balance out their monies that way, which involves China as well. Rest of the IMF is used for developing in tandem with India to produce new-age technology that will become old-age stuff in about a decade.

      • 3
        1

        Nationalizing of money creation is an impossibility with the current government (and previous ones), because of reduced or zero taxation upon the monied interests in our land. For example, much money goes out of the land, because moneyed interests send their children overseas to study in Western lands. Billions of rupees and more, goes out of the country this way. Hence the reliance on foreign debt and banking to balance out the discrepancy.

        Ultimately, only a party like the NPP can bring about all these changes.

      • 2
        0

        Hello Ramona,
        “Advocating for the implementation of protective tariffs”? It puzzled me as to why all the Sri Lankans that I knew in the Middle East were buying expensive Consumer Goods to send back home. I didn’t realise until I came here to live that there were high Import Duties and most of the equivalent products available here were sub-standard shoddy seconds. I could write a book about the serious state of manufactured goods, ranging from “not fit for purpose” plumbing materials to unsafe Electrical Appliances and Hardware.
        When we left to come back to Sri Lanka my wife even packed Sugar, Salt, Shampoos and Kitkats etc into our Shipping Box. I said she was crazy, now I know she wasn’t.
        Best regards

        • 5
          0

          Lanka Scot,

          Oil rich Middle East has the best of everything from around the world (most of which they don’t produce). That’s why people stuff their suitcases and boxes there. But GoSL, instead of building up the local industry, is recently opening up tariffs so we can can be like oil-rich M.E!

          Any industry they open up is to do with the global agenda like environment ones on a relative low polluted island. That, plus chopping down of our ancient forests and decimation of our farmlands for globalized business opportunity via India.

    • 1
      4

      Ramona,
      “Yes, stabilizers should be implemented asap, and include reduction of existing mortgage rates on housing when salaries don’t keep up with inflation, “
      Mortgage rates are linked to interest rates. Say the bank pays you 9% for your money in an FD. It loans out the same money at 15% as a mortgage. You can’t get 15% on your FD and expect a 9% mortgage at the same time.
      And what about pensioners, who demand higher rates? You can’t satisfy everybody.

      • 2
        4

        “Advocate for providing risk-free financial assets, such as government bonds, treasury bills, and other savings instruments, accessible to EPF/ETF funds and pensioners. “
        Very nice, but what happens when the country goes bankrupt and the currency loses half its value?
        “Implementing socialist policies: such as a Job Guarantee program can help address key issues in Sri Lanka’s economy. This includes increased spending on domestic infrastructure, industries, and welfare programs like free healthcare, education, and transfer payments to low-income earners. The focus would be on creating employment through public sector hiring, “
        Haven’t we heard such sunshine stories before? Yes, from the Viyathmaga crowd.
        Has the author learnt nothing in the last 3 years?

      • 3
        0

        That’s why it is called a stabilizer OC. Banks will have to be subsidized (bailed out) by the government. Government will get the money from higher income earners of Rs. 500,000 rs or more,…..ok, currency value has changed – 1,000,000 rs. or more…..plenty of them around exempt from the 24% tax.

        • 0
          3

          Ramona,
          Where are the facts to prove that there are that many “higher income earners”?
          Any of these higher income earners can invest in an Australian or UAE business visa, and move there. That’s why Chamath Palihapitiya, Nandana Lokuvithana, and Sena Yaddehige all have foreign residency.
          https://economynext.com/sri-lanka-only-has-137-persons-who-paid-income-taxes-of-rs5mn-or-more-legislator-100108/

          • 1
            0

            OC,
            Shocking that Sri Lanka does not have the global taxation scheme. NPP will certainly bring this in, together with all the other tax evaders.

            • 0
              3

              Ramona,
              Sri Lanka can’t tax citizens of other countries. Not even the NPP can do that.
              Now, let’s say the NPP got 2 million taxpayers, who can pay a million each annually. That amounts to only 2 billion rupees. How do you expect to subsidise banks with that.?
              Do your sums.

              • 1
                0

                OC,…..no, but they can tax the dual citizens who are minting money in Sri Lanka and investing the money of the hardworking-Lankan-masses on foreign enterprise. And they are not only the politicians (although they hold the greatest amount invested outside the land). There is an inordinate number of Lankan business enterprises earning well over a 347,222.2222 rs. a month i.e. over US$ 1157 a month (based on the million rupees a year of tax you mention). Actually, they earn well over a million rs. per month.

                Those who migrate will have to pay capital gains taxes when they sell their assets and take their money out.

                Not everyone will require a lower rate on their home loans. But the 2-billion you mention would be a good start, and it certainly won’t be from 2-million people…..just the elite set who spend vast amounts of USD (via Sri Lankan masses hard work), to e.g. send their children to Western lands to study, and/or own homes in places like Dubai.

                With all the aforesaid numbers based on normal internationally accepted norms, Sri Lanka can become a rich, healthy nation very soon.

                • 1
                  0

                  OC…and many are only Lankan citizens (not dual ones) who place their gotten wealth in foreign-property ownership in places like Dubai. US, Canada, Australia, Spain, Portugal are other places.
                  https://www.landzero.com/blogs/we-love-land/countries-that-allow-foreign-land-ownership

                • 0
                  3

                  Ramona,Ramona,
                  “OC,…..no, but they can tax the dual citizens who are minting money in Sri Lanka and investing the money of the hardworking-Lankan-masses “
                  Please, please, do your sums.
                  Even if all 29 million citizens pay a million each, that will be 29 billion RUPEES total.
                  The national debt is 52 Billion DOLLARS. At that rate, it will take about 600 years to settle it. The IMF way is better, don’t you think, since we are told we can do it by 2048?

                  • 0
                    0

                    OC,

                    Well if the 10,000 Lankans who have over 10-million USD each, pay 1,000,000, (10% tax), we’d have a billion USD. If they are taxed 50%, we’d have 5-billion USD. If they are prosecuted and have to return all of the over 10 bil. USD, we’d have 10-billion USD. But we ALL know that most of them have 50- million USD and more in all kinds of overseas luxury accounts and schemes. With the money thus collected from them, we can easily save the country with the 50-billion USD. Problem solved!

                    Oh boy no! I calculated wrong. I’ll start again. If the 10,000 Lankans who have over 10- mil. USD, pay 10% tax,we will have…let me see… 10,000,000,000 (10- bil.USD) already! But as they actually have $50- million and over, a 10% tax on them will easily collect the 50-billion USD. No prosecution necessary! Country is saved!

                    • 1
                      2

                      Ramona,
                      Where is your evidence that 10,000 Lankans earn over 10 million USD each?

                    • 0
                      0

                      OC,

                      Where is your evidence we can do it in 2048? Too pie-in-the sky, especially concerning the IMF. And too much suffering of the Masses along the way.

                      But as for mine, ok, ok, we’ll adjust the values from10-bil to 50-bil……(after all, it is healthy for all countries to have some debt….US is in trillions of dollars of debt).

                    • 0
                      0

                      And OC…..that, and tax those earning over 500,000 rs. a mth.( many such), and we’d really be out of the hole.

                    • 0
                      0

                      Indeed OC, 50-bil. can be gotten in one shot with just a one time tax of 50%.

                      9 bil. USD from Mahinda Rajapksa itself (net worth 18- bil USD.

                      https://www.topmost10.com/mahinda-rajapaksa-biography-age-family-and-net-worth/

                      From Dhammika Perera, we can get 3-bil. USD. (Net worth over 6-bil USD).

                      Two-bil. USD from Harry Jayawarden (net worth over 4-bil. USD).

                      2.5 billion from Ranjith Page, and so on

                      https://en.m.wikipedia.org/wiki/List_of_South_Asian_people_by_net_worth

                • 0
                  1

                  Ramona,
                  “There is an inordinate number of Lankan business enterprises earning well over a 347,222.2222 rs. a month i.e. over US$ 1157 a month (based on the million rupees a year of tax you mention). Actually, they earn well over a million rs. per month.”
                  Where is your evidence? Talk doesn’t make taxes.

        • 0
          0

          Hello Ramona,
          Was that 5 Lakh per Week or per Month as a Higher Income Earner?
          Best regards

  • 1
    4

    ramona therese fernando,
    You are as opinionated as I am.
    NPP is just the cloak. Anura is only the Face. The show will be different.

  • 2
    0

    1.one thing that has been missed here is the development of the financial sector. We should at least make it about one third of the economy and make banking the largest sector of the economy.

    2.we should make sri lanka one of the most competitive financial centers in the world.

    3.we should specialise in cross border- fund administration business. In case of those who are not aware of what fund administration is and which i am strongly into “Fund administration is the name given to the execution of middle-office activities including fund accounting, financial reporting, net asset value calculation, capital calls, distributions, investor communications and other functions carried out in support of an investment fund, which may take the form of a traditional mutual fund, a hedge fund, a private equity fund, a venture capital fund, a pension fund, a unit trust, or other pooled investment vehicle.Managers of funds(like me for example) often choose to outsource some or all of these activities to external specialist companies, such as the fund’s custodian bank or transfer agent. These companies are known as fund administrators.

    • 2
      0

      contd

      4. Our financial center should be an international one as are most in the world with small domestic markets.We can tap into the vast market of our neighbour india.

      5 we should have more than 100 banks at least with cross- border financial expertise.

      6. banking secrecy and multilingual staff are a must and easy access to other asian centers.Having first class communication facilities and political stability too.

      7.we have to root out the corruption n this country as nobody in their right mind will give us billions of dollars for safe keeping which is what it is all about and we get fees.

      8.we have to attract banks from india,japan,south korea and US with india having the largest component of banks here with thousands of holding companies.

      9.we must try to attrct large financial institutions such as ADB etc to locate here.

      10.we have to make this small country an attractive destination for tax avoidance.

      • 2
        0

        Hello Shankar,
        “Having first class communication facilities” – how can you have this with the current state of your Electrical Infrastructure? Yesterday our Electrical Supply was down for 5 hours. Today it has been down for 2 hours and still waiting. My UPS will shut down in 1 hour. My Nephew works for SLT and is constantly complaining about what problems the atrocious Electrical Supply causes to IT Equipment.
        Best regards

        • 2
          0

          LS,
          .
          The barbarians are preparing our criminals again.

          Lalkanta(senior candidate of JVP cadre) should be arrested for such statements. We must not tolerate brutal animators.
          .
          https://www.sundayobserver.lk/2024/05/12/news/23105/people-should-take-to-the-streets-with-weapons-k-d-lalkantha/
          .
          They are as bloodthirsty as my childhood friends from the 89-92 era. Friends were brutally murdered by them and their heads were hung on the gates of their houses.

        • 3
          1

          lanka scot

          you electricity problem will be solved by 2048. Be patient.Patience is a virtue.

          https://www.ft.lk/columns/The-Magic-2048-What-is-to-be-done-to-make-Ranilnomics-a-reality/4-747608

        • 3
          0

          Hello LankaScot,

          Have you considered purchasing a generator?

          • 0
            0

            Moving to Colombo is an option, and moving abroad is another.

            • 1
              0

              Hello SJ,
              If you are saying that Colombo is better treated than the rest of Sri Lanka, that’s a sad admission. The other option is tantamount to giving up the struggle. Let’s take the CEB into Public Ownership (what do you mean it already is?).
              Best regards

              • 0
                0

                LS
                I can tell you more.
                During the COVID-19 power cut months, certain parts of Colombo were even more selectively treated. Not by any position of influence or privilege, I live in an area that had not even an hour of power cut when houses only a few hundred meters away suffered 2 hour spells of darkness.

          • 1
            0

            Hello Lester,
            Every time i think of buying one people tell me “don’t worry it’s getting better”. So I put it off and then I remember the times when we had no Electricity and no fuel (No Paraffin, no Diesel and no Petrol). So I have decided to install a Solar System. My Niece will buy the parts in Qatar and send them for her next visit. The available systems here are garbage.
            Best regards

            • 1
              0

              lanka scot

              lester’s idea is the best for you.My friend in colombo has one and would have died of sweat if not because he can’t live without airconditioning at full blast.

        • 3
          3

          Shankar,
          “1.one thing that has been missed here is the development of the financial sector. “
          You are right. Here we have pensioners grumbling about FD rates being too low, and businessmen saying loan rates are too high. In most developed countries, Fixed deposits yield perhaps 2 to 4% on average. So, home mortgages can be had at 7% .Retirees don’t live on fixed deposits, but on Pension Funds which invest their savings in things like shares. We have such Funds, but their returns are lower than bank interest, because our stock market is so chaotic and unpredictable. In addition, we aren’t allowed to invest in foreign markets

    • 3
      3

      Shankar,
      “1.one thing that has been missed here is the development of the financial sector. “
      You are right. Here we have pensioners grumbling about FD rates being too low, and businessmen saying loan rates are too high. In most developed countries, Fixed deposits yield perhaps 2 to 4% on average. So, home mortgages can be had at 7% .Retirees don’t live on fixed deposits, but on Pension Funds which invest their savings in things like shares. We have such Funds, but their returns are lower than bank interest, because our stock market is so chaotic and unpredictable. In addition, we aren’t allowed to invest in foreign markets.

      • 0
        0

        old codger
        “we aren’t allowed to invest in foreign markets.”

        don’t these donkeys understand that we have a small domestic market and have to look outwardly,not inwardly to become prosperous. We have to be like ireland.

        • 0
          0

          Shankar,

          You are talking to someone who assumes insider trading is legal. Anyway, most people in Sri Lanka will not be able to afford overseas stocks, based on the exchange rate alone. The number one stock in the US market costs around 269295 SLR per share. My understanding is that the monthly salary in SL is 90,100 SLR. The US market is the only one worth trading, as the other markets (Asian) are rigged or lack volatility.

          • 0
            1

            Lester the liar,
            “My understanding is that the monthly salary in SL is 90,100 SLR”
            I personally know people who draw over a million a month. What difference does it make, when Shankar is talking about Mutual Funds, which deal in billions anyway?
            BTW, another hang-up to add to the collection: “Insider trading ” 😂😂

            • 0
              1

              “but on Pension Funds which invest their savings in things like shares.”

              Freudian slip? Government school slip?

  • 0
    0

    when we talk about Root causes , we should dig deep into the real Root .
    For that , one should get out of the box . Reading theories from books and
    going after number statistics that don’t disclose real situations won’t help
    solve anything . Traditionally who earned foreign currency ? What was
    done to them ? And even today who earns and where is it largely coming
    from ? Without correctly taking historical backgrounds into account , no
    analysis will do the justice to the current disaster .

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