Inflation and debt burden exacerbated the economic crisis

For Zahara Zain, the current time in Sri Lanka is reminiscent of the early 1970s, as the country is fighting to survive amid an increasingly severe food shortage.

“It feels like we’re reliving the 1970s when everything was classified,” said Zain, a small food business owner from the capital Colombo. She said daily life has become a struggle for most Sri Lankans as prices of many basic food items have skyrocketed due to limited supplies.

Sri Lanka is facing a twinge of rising prices and mounting debt, and its people are bearing the brunt of it as the situation in the country worsens.

“Milk has been dispensed with other foods, like rice and sugar,” said the mother of two. Previously, she could buy 1kg electric milk, but now, stores are only allowed to sell 400g.

“How can that be enough? I have kids who need milk,” Zain told CNBC. In addition, the price of milk has increased by nearly $1 per kilogram, she said.

The shortage of US dollars in the country has resulted in an impact on the prices of most food items and raw materials needed for her food business, Zain said. “The situation is really bad and people are suffering.”

Economic pain complicates Sri Lanka The foreign debt crisis is getting more and more difficultanalysts said.

Shahana Murkherjee, economist at Moody’s Analytics, said policymakers were grappling with the “dual challenge of managing overseas repayments while meeting domestic demand”.

Sri Lankan President Gotabaya Rajapaksa declared a economic emergency in September. It allows the government to control the supply of basic food items and to set prices to control rising inflation, which spiked to 14.2% in January.

The South Asian nation’s tourism dollar is depleted due to the pandemic. But even before that, Sri Lanka’s debt spiral was on an unsustainable path, economists said.

Dushni Weerakoon, executive director at the Sri Lanka Institute for Policy Studies, said that since 2007, successive governments have issued government bonds without giving much thought to how we will repay the loans. how.

“Reserves are accumulated by borrowing foreign currency funds, rather than through higher income from exports of goods and services. This exposes Sri Lanka to many external shocks,” she said.

Furthermore, the government has spent foreign currency to repay the debt, and the central bank has reduced its foreign reserves to support the Sri Lankan rupeeAlex Holmes, Asia economist at Capital Economics, said.

As a result, “there’s not a lot of foreign currency left in the economy to do things like import food, which is one of the reasons why we’re seeing double-digit inflation,” added Holmes. .

The tax cut In 2019, the situation worsened, leading to a significant drop in tax revenue and further weakening the government’s hand in supporting the economy during the Covid crisis, analysts say. analysis said.

““The pandemic has severed the usual channels of capital flows as already weak financial and debt indicators have worsened,” Ms. Weerakoon said.

In January, Rajapaksa meets Chinese foreign minister Wang Yi to ask China to restructure debt payments. Last year, the country’s central bank and the People’s Bank of China participated in bilateral currency swap agreement for a swap facility of up to $1.5 billion – This move is intended to reduce the risk of exchange rate fluctuations in the event of financial fluctuations.

From Sri Lanka public debt is expected to grow from 94% in 2019 to 119% of GDP in 2021.

“For the government, it is a matter of balancing the positives and negatives of default,” said Holmes. “Surely the default cost can be lower than the cost to [keep] going to Sri Lanka,” he said, adding that it was better for policymakers to “bite the bullet”.

Analysts say the country needs to restructure its debts or look to the International Monetary Fund for a bailout.

“We think the Sri Lankan government will eventually have to resort to the IMF, although we cannot rule out default before any deal with the IMF is finalized,” Citi analysts said. know.

The government’s message about pursuing the IMF option has been mixed. Finance Minister Basil Rajapaksa is quoted in Financial Times like saying all options are being explored, including an IMF bailout.

But the central bank Governor Ajith Cabraal told CNBC that Sri Lanka does not need IMF help because it already has an alternative strategy. In an interview at the end of January, he claimed Sri Lanka was able to finance its outstanding debt, especially international sovereign bonds, “without causing any pain to the our creditors.”

In February, the central bank said Sri Lanka was committed to honoring all upcoming debt obligations. It was also rejected Media reports declared that the country was on the verge of a sovereign default, and said that “such claims are completely baseless. “

It is possible that policymakers could prioritize stabilizing domestic conditions in the very near term by diverting a substantial portion of additional foreign aid to meet domestic demand, Moody’s Mukherjee said. of the country and avert a deeper economic crisis”.

For the people of Sri Lanka, the country’s ongoing debt crisis has become a source of growing anxiety and frustration.

“People are worried and there is a lot of anger directed at the government,” said Zain, a small business owner from Colombo.. “The country has sunk in a hole, hopefully they don’t dig a bigger hole – and will just solve the debt problem.”

– Saheli Roy Choudhury contributed to this report.