Sri Lanka: Emergency rules on essential food access highlight the foreign exchange and economic crisis

Event

At the end of August, the government decided to impose emergency regulations  for the provision of essential food items such as rice and sugar at concessionary rates. The aim is to prevent shortage and high prices of basic food products, which could fuel social instability.

Impact

Sri Lanka is struggling against a broad economic crisis amid a severe Delta variant wave of coronavirus. As highlighted last July, the country is facing challenging external debt repayments as foreign exchange reserves continue their downward trend. According to the Central Bank, they were just at USD 4 billion in June, allowing an import cover of less than two months, and fell by a further USD 1 billion after a sovereign bond repayment. This fragile liquidity situation explains Sri Lanka’s short-term political risk classification in category 6/7. In those circumstances, the authorities have continued to court financial partners and multilateral institutions (the World Bank and ADB) for support. In August, Sri Lanka’s foreign exchange reserves were increased by a disbursement of USD 787 million as a recipient country of the historic SDR allocation implemented by the IMF and of USD 150 million under the currency swap arrangement with Bangladesh. This will bring relief to liquidity pressures, but could be short-lived as the economy continues to feel the depressing impact of the pandemic. Tourism remains in deep crisis whereas domestic activity is suffering further from a nationwide lockdown that has been prolonged until mid-September and will weigh on this year’s recovery. That explains why the government introduced emergency rules on basic food access, as it does not intend to lift the import restrictions on non-essential goods that were imposed last year to stimulate local production and save foreign exchange reserves.

As investors are defiant about the authorities’ capacity to repair external imbalances, the rupee has weakened by 8% against the US dollar in one year and remains under pressure. This has made imports more expensive and, combined with import bans, contributed to accelerating inflationary pressures to 6% last month. Hence, on 18 August, the Central Bank was the first among its Asian peers to raise interest rates since the beginning of the pandemic. Besides the economic, financial and social crisis, times are also difficult for the Rajapakse family who holds the reins of power and is facing growing criticism for its crisis management. The government’s priorities for the coming months will be to increase vaccination rates, manage the social crisis and honour its debt service commitments. In the absence of substantial economic progress, it will keep facing a rocky road ahead.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com