Thread by @anshgupta64

Sri Lanka is facing an economic crisis and is on the verge of default.

What led to this situation?

A thread 🧵

1) Huge amount of tax breaks - In 2019 elections, the government had promised a large amount of tax breaks. They announced a number of tax cuts like no capital gains, VAT cut from 15% to 8%, half tax for construction companies etc.

While the government did deliver on its election promises, state revenues took a big hit.

2) Large government spending - Even before the pandemic, the spending by the government was on the rise. As a % of GDP, government spending which was 18.8% rose to 21.9%.

Not to mention, government revenues were already sub-par due to the pandemic and tax cuts. This worsened Sri Lanka’s finances.

3) Forex reserves - Due to lack of tourism which is one of the largest forex generators for country, forex reserves took a hit. They were just $1.6 billion dollars in November. Sri Lanka has to repay over $7 billion in the next 12 months in loans alone.

Forex(in mil USD) 👇

Even imports of food and raw materials were stopped to preserve forex. The situation is bad enough that Sri Lanka hopes to repay Iran’s past dues ($252M) by sending $5 million of tea crops each month to preserve forex.

Forex Reserves over past decade (in mil USD) 👇

4) Debt - Sri Lanka owes over $80 billion to various lenders. It owes $5 billion dollars to China alone and took an additional loan of 1 billion last year from China to help with the financial crisis. Sri Lanka is struggling to repay these debts.

Pre-pandemic, the foreign debt to GDP of Sri Lanka was ~43%. After the onset of the pandemic, it has gone up to 101% of GDP.

5) Inflation : Due to money printing, Inflation has risen to above 14%. People are finding it difficult to afford even basic necessities like food, water, rent, electricity, etc. It's using credit lines to buy necessities like food, medicines and fuel from neighbouring allies.

According to an estimate by the World Bank, over half a million people have fallen back into poverty. It took half a decade for Sri Lanka to uplift these many people from poverty before the crisis.

6) Agricultural Crisis - Due to the low forex reserves, the government banned the import of fertilisers and announced organic farming. The farmers were reliant on these fertilisers and found it difficult to produce healthy crops. Many didn’t plant at all fearing a bad produce.

And when the government repealed the ban, people couldn’t afford the fertilisers. People who were previously well off are finding it difficult to provide 3 square meals a day.

What is the road ahead?

India has conducted a currency swap of $400 million to help with forex. It has also freezed its own debt of $515 from Sri Lanka to help with the bleeding of reserves. It has also announced a billion dollar credit facility for assistance to Sri Lanka.

Sri Lanka can also approach the IMF for a loan but it already borrowed 717 million dollars last year and it comes with a lot of strings attached. The finance minister hopes to talk to China to restructure the outstanding debt and ease repayments.

However, the long term solution is clear. It needs to adopt a proper taxation system and stop populist measures like freebies and tax cuts. It also needs to become a more export oriented economy with less reliance on imports.

Trivia - Tomorrow it will be 1 year, 2 months, 3 weeks, and 4 days since the crisis came to limelight.