Sri Lanka on brink of severe economic crisis, claims BowerGroupAsia

BowerGroupAsia (BGA), a strategic advisory firm that specialises in Foreign Direct Investment throughout the Indo-Pacific, has cautioned its clients, claiming that Sri Lanka is on the brink of severe economic crisis. 

BGA cited a host of recent developments to substantiate its warning.

In a confidential commentary to its clients, BGA claims Sri Lanka’s external finances are perilously low, foreign debt repayments are large, and weak public finances severely limit the capacity of the government to take adequate measures to alleviate escalating poverty by providing income support to prevent starvation or stimulate economic growth. 

“If Sri Lanka’s Government and Central Bank continue to hold onto the current short-term policy measures, without immediately addressing the worsening crisis in the country’s external account, the Sri Lankan rupee is likely to plummet even beyond the current exchange rates prevailing in the black market,” opines BGA.

“There is an urgent need for the country to seek the support of the International Monetary Fund (IMF) to resolve the current crisis in the country’s external account, which has led to shortages in US dollars in the country’s banking sector,” it added.

BGA advised businesses operating in Sri Lanka should be prepared for a tumultuous business environment at least through the end of 2021. 

It said the Government’s ballooning current account deficit, plummeting foreign exchange reserves and drastically reduced revenue increase the risk of rapid depreciation in the Sri Lankan Rupee. Sri Lanka’s strained relationship with Western economies due to human rights and political concerns also threatens key export markets for cornerstone industries of the economy, exemplified most saliently by the risk of the island losing preferential access to the European Union for its readymade garments. Investors should be particularly observant about whether international creditors make good on threats to ‘blacklist; the Sri Lankan Government, which would complicate access to global capital markets on the island.  

BGA helps clients interpret the world's most complex and dynamic markets, providing on-the-ground, hands-on support and actionable insights and analysis to implement strategies, mitigate risk, expand business and do great things in Asia.

In its commentary to clients, BGA has highlighted the impact from unsuitable economic policies in the weak state of economy.

It said the fragile financial conditions are compounded by inappropriate policies, and ineffective management has depressed incomes, increased prices of essential consumer items, decreased food availability and accessibility and aggravated poverty. The sudden banning of chemical fertiliser will reduce agricultural output, increase import expenditures, reduce export earnings and decrease the incomes of farmers and agricultural workers. Food prices are likely to increase, and Sri Lanka risks a hunger crisis if there are not adequate food imports. 

By the end of May, Sri Lanka’s gross foreign exchange reserves fell to $ 4 billion, while the external debt servicing for the next 12-month period stood at close to $ 7 billion (including private sector external debt servicing commitments).  

A Government overdraft with Sri Lanka’s State banks had soared to Rs. 620 billion ($ 3.1 billion), or 3.7% of gross domestic product (GDP), by April 2021 up from Rs. 304.4 billion ($ 1.5 billion) as spending grew and revenues were under pressure because of tax cuts and the pandemic. 

BGA said the overdraft is now also bigger than total Government revenues in the first four months of 2021, which were at Rs. 481.7 billion ($ 2.4 billion), or about 2.9% of GDP, and is also bigger than the budget deficit of Rs. 520 billion ($ 2.6 billion), or 3.2% of GDP. Revenues in the first four months were down 19% from Rs. 598 billion ($ 3 billion) in 2019. 

The reduction in agricultural export earnings at a time when manufactured exports are under the threat of a withdrawal of the Generalised System of Preferences (GSP) Plus concession by the European Union is a serious concern. 

The Government is confident that the withdrawal of GSP Plus would not matter, but export manufacturers consider it to be a grave threat. 

It said the Apparel Exporters Association has said that a withdrawal of GSP Plus will affect the country’s exports severely. In addition, if other countries that are main markets for manufactured exports also withdraw concessions, the country’s exports would be seriously jeopardised. 

BGA is of the opinion that the country may be compelled to brace itself for an impending financial storm that may strike sooner than later, which could seriously damage the country’s economy. 

Domestically and internationally, the Sri Lankan currency has come under siege with little relief in sight. The Government took the extreme step of printing an unprecedented Rs. 208 billion ($ 1 billion) on June 28 after having already printed Rs. 23 billion ($ 115.6 million) the previous week. The Governor of the Central Bank of Sri Lanka issued a statement on the state of US dollar reserves and appealed for calm and restraint on 29 June. 

With this input of fresh liquidity, the Central Bank holdings of Government securities or the printed money stock reached a record Rs. 1.1 trillion ($ 5.5 billion) from Rs. 919.2 billion ($ 4.6 billion) on 25 June 2021. 

BGA noted internationally, a crippling debt burden has reduced foreign reserves to only $ 4 billion, which may not be enough to service the annual interest to international lenders, let alone enable Sri Lanka to meet other commitments. 

The risk of a worldwide blacklisting is a reality should the Government fail to make good on loan repayments when due, warned BGA.

It said despite the pending crisis, the Government has dismissed seeking help from the IMF. Minister of Money, Capital Markets and Public Enterprise Reforms Ajith Nivard Cabraal has ruled out any arrangement with the IMF for restructuring its debt servicing criterion but asserted that there were alternatives, though he did not provide any details on a strategy. 

The Minister has insisted that the economy was not on the brink of a severe crisis, despite contrasting remarks by Opposition legislators, and accused the Opposition of wishing to capitalise on a bankrupt economy to catapult it into power. Interestingly, on 26 April, he made the remarkable observation there was no relationship between printing money by the Central Bank of Sri Lanka and the depreciation of the local currency in the foreign currency market. 

BGA commentary also referred to nine restrictions on outward remittances. It said effective for six months from July, the Central Bank issued an order under the Foreign Exchange Act, suspending and restricting outward remittances.

It said on 10 June, the European Parliament adopted a resolution calling for the withdrawal of the GSP concession to Sri Lanka in the absence of Government efforts to strengthen the fundamental rights of its citizens, a mandatory condition of the EU’s GSP. The focal point of the EU resolution was the controversial Prevention of Terrorism Act (PTA).

In the face of the European Union (EU) threat to withdraw the GSP concession to local exporters, if Sri Lanka does not clean up its human rights record, the Government has decided to end the standoff by changing its position. It agreed to improve and address its tainted human rights record and amend the PTA by studying existing legislation, past practices and international best practices. 

The GSP scheme is limited by its declared object: to provide duty concessions on exports to approved applicants as an incentive to protect and enhance the human rights of the applicant nation’s citizens. The EU itself has no power to stray beyond this limited ambit, BGA said.