Sri Lanka’s dilemma: Repay the debt or pay for the milk, medicine and petrol | Business and Economics News


Colombia, Sri Lanka-A lone ox-cart carrying a barrel of kerosene, a symbol of life in Sri Lanka in the 1970s, is once again a common sight on the streets of Sri Lanka’s commercial capital as dwindling foreign currency reserves have hampered imports of basic necessities, including cooking gas. .

Sri Lanka’s huge debt is the root of the problem. The Gotabaya Rajapaksa-led government must repay $7.3 billion in foreign debt this year or default on its debt, an option that could damage its reputation, making it harder to borrow money from international markets to the future at affordable rates – a possibility that could, in turn, precipitate a severe economic crash.

In December, the country’s foreign exchange reserves hit an all-time low of $1.6 billion as income from foreign tourists, the main source of foreign currency, declined during the pandemic. But it received a boost late in the year when the central bank pulled a 10 billion yuan ($1.5 billion) currency swap it had agreed with China.

This one-off swap won’t do much to boost the country’s reserves and for Colombo, Sri Lanka’s largest city and trading capital, it comes down to a choice between servicing its debt or paying for imports of daily needs. So far, it seems the government is committed to the former, even if that means sacrificing the needs of its citizens who are struggling for all sorts of essentials, including cooking gas, powdered milk, fuel and medicine. .

Earlier this month, leaders of the Ceylon Chamber of Commerce, a leading industry body, called on the government to defer servicing bond payments and instead use scarce foreign currency to purchase items essentials like food and medicine for Sri Lankan citizens.

Vish Govindasamy, chairman of the industry body, in a statement to local media, urged the government to “allow the use of foreign exchange inflows to alleviate the difficulties of the general public in obtaining essential commodities”. And since the majority of the country’s foreign currency comes from tourism, “we cannot afford to send messages to the world of food shortages in the country, it will only be counterproductive,” he warned.

Former President JD Bandaranayake added that the government should focus on “alleviating hardship” and said “the government should reschedule the debt payment.”

So far, those pleas have fallen on deaf ears as ministers and the central bank have instead scrambled to find short-term fixes, mostly currency swaps like the one she did in December. But analysts say these swaps cannot be easily converted into US dollars and are virtually useless when it comes to paying down debt.

The central bank undoubtedly knows this and last week it liquidated half of its gold reserves to help meet the $500 million international sovereign bond payments it settled yesterday.

At the end of December, the government also ordered licensed commercial banks to sell 25% of all foreign exchange earnings to the central bank every week. Opposition MP Dr Harsha de Silva warned that this would further reduce the ability of commercial banks to meet the needs of importers.

Since commercial banks are unable to forecast their own inflows of foreign currency, they are unable or unwilling to open letters of credit to importers. As a result, importers who relied on other arrangements, such as purchasing goods with deferred payments, are running out of options.

Companies in a hurry

Laugfs Gas, one of the country’s two cooking gas suppliers, warned earlier in January that it was unable to import the required quantities of LPG due to dollar shortages.

Shortages of essentials, from fuel to medicine to powdered milk, are rife across the country [File: Dinuka Liyanawatte/Reuters]

A senior executive at a major food maker who preferred not to be named for fear of government reprisals, said the company’s production had halved because it can no longer import all the raw materials it needs. requires. “We have switched to other foreign suppliers who accept alternative terms, but this has increased our costs by 35%,” the official told Al Jazeera. “Shortage of fertilizer has impacted harvests, so local suppliers are also unable to meet our full demand.”

Small businesses are also significantly affected as they do not have much breathing space outside the formal banking system to finance their imports.

Amjad Nazeer is a co-owner of a store in Colombo selling premium quality nuts, seeds and healthy foods. He started the business with his family during the pandemic but struggles to plan his supplies with all the restrictions.

“We have stopped direct imports of products because we cannot open letters of credit or transfer money to our overseas suppliers. We are now relying on large-scale importers who can handle the situation better than us, but we are still struggling to get some equipment and raw materials from China due to these issues,” he told Al Jazeera.

All of this drove up costs by 20-30%, squeezing the company’s profit margins and forcing it to raise prices. This, however, resulted in lower order quantities and average order value, he said.

Other seemingly innocuous restrictions, such as a cap on overseas credit card transactions, also compounded Nazeer’s woes. “Credit card payments to online and social media advertising companies like Meta and Google are rejected if they exceed $100,” says Nazeer. He now has the extra work of setting up multiple payments, each capped at $100, he says.

Exports, a source of foreign income, are also affected as foreign exchange shortages, coupled with strict import restrictions on raw materials, machinery and equipment, are crippling production and hitting production.

Both small and large exporters face difficulties and delays in sourcing the raw materials needed to meet customer orders. Many had to find alternative suppliers or materials, which drove up their production costs, hurting their competitiveness in the international market. Other expenses, such as shipping and freight, have also increased, adding to the cost of doing business.

Strong Tactics

The central bank has resorted to a variety of heavy-handed tactics in an attempt to maintain its artificially low peg to the dollar while accumulating the foreign currency needed to service the country’s debts.

Sri Lankan President Gotabaya Rajapaksa sings the national anthem during the country's 73rd Independence Day celebrations in ColomboSri Lankan President Gotabaya Rajapaksa (pictured) has ruled out an IMF-style bailout [File: Dinuka Liyanawatte/Reuters]

Some of these tactics consist of forcing banks to compulsorily convert money received from abroad and income from exporters into rupees.

These strategies, however, exacerbate the shortage. Foreign currency inflows such as workers’ remittances have moved away from formal channels to informal channels where the dollar is selling for 25% above the official rate. Remittances through formal channels fell to $271 million in November 2021 – the lowest since 2010, tweeted economist and migration specialist Dr Bilesha Weeraratne. This, in turn, led to raids on money changers, which the government accused of “black market” transactions because they offered a higher exchange rate against the dollar.

The central bank’s directive to convert income from overseas has also upset the self-employed community that provides services outside Sri Lanka. “They freeze all my incoming income until I convert 90% of it into rupees or until I prove that I am not receiving these funds in a business transaction,” Y Senarath said, a designer and illustrator who accepts orders from international clients. “It’s unfair because the official rate doesn’t even reflect reality, the prices are exorbitant and I’m making a loss at this rate. It’s better if I find another way to keep my dollar earnings rather than sending them here.

Devalue the rupee?

As the country scrambles for foreign exchange, there are calls from different segments of the economy to allow the rupee to devalue to more realistic levels to bring inflows back into formal channels to ease the shortage.

This alone will not be enough to address the shortage, warns Nishan De Mel, an economist and executive director of Verité Research, a Colombo-based think tank.

“The fundamental objective should be to reduce the shortage of dollars through preventive debt restructuring,” he says. “As long as there is a fear that a shortage of dollars persists, there will be more demand than supply for dollars. Whatever the official price, the unofficial price will always be higher.

His solution: a credible and transparent debt restructuring process by the government to stem the shortage as well as fears of a future shortage.

Despite the urgency, the Sri Lankan government has ruled out an IMF-style bailout and instead pursued a series of other stopgap solutions, including a tea-for-debt swap with Iran last month. Colombo is also in talks with several bilateral allies, including Oman, Qatar and Japan, for loans to meet some of its import needs. India, which has already extended a $400 million swap facility, agreed to partially defer a $500 million loan and also pledged a $1.5 million essential goods line of credit. billion dollars.

Last week, President Gotabaya approached Beijing to restructure debt repayments in addition to a concessional credit facility to import goods. In return, Sri Lanka promised to ease COVID-related travel restrictions for Chinese tourists, the second major source of tourists for the island state. Part of their income will no doubt help fuel the struggling economy when that happens.


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