Sri Lanka’s Economic Crisis

What’s in today’s article?

• Why in News? 
• What is the Paris Club? 
• Brief Background on Economic Crisis in Sri Lanka
• Implications of the Economic Crisis in Sri Lanka
• IMF Bailout for Sri Lanka
• What is IMF? 

 

Why in News?  

• The Paris Club, an informal group of creditor nations, will provide financial assurances to the International Monetary Fund on Sri Lanka’s debt.

 

What is the Paris Club?

• The Paris Club is a group of mostly western creditor countries that grew from a 1956 meeting in which Argentina agreed to meet its public creditors in Paris.
• Objective – To find sustainable debt-relief solutions for countries that are unable to repay their bilateral loans.
• It is a forum where official creditors meet to solve payment difficulties faced by debtor countries.
• Member Countries – Australia, Australia, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Japan, Netherlands, Norway, Russia, South Korea, Spain, Sweden, Switzerland, the United Kingdom and the United States.
  • All 22 are members of the group are also part of the Organisation for Economic Co-operation and Development (OECD).
• OECD is a group of 37 member countries that discuss and develop economic and social policy.

 

Brief Background on Economic Crisis in Sri Lanka

 

Image Caption: Sri Lanka’s Economic Crisis

• Sri Lanka is currently in an economic and political crisis of mass proportions, recently culminating in a default on its debt payments. 
• There are several reasons for this crisis and the economic turmoil has sparked mass protests and violence across the country. Following is a brief timeline of events which eventually led to the crisis – 
  • 2009 – 
    • In 2009, a decades-long civil war in the country ended and the government’s focus turned inward towards domestic production. 
    • However, a stress on local production and sales, instead of exports, increased the reliance on foreign goods.
  • 2019 – 
    • Unprompted cuts were introduced on income tax in 2019, leading to significant losses in government revenue, draining an already cash-strapped country.
  • 2021 – 
    • The Sri Lankan government introduced a ban on foreign-made chemical fertilizers. The ban was meant to counter the depletion of the country’s foreign currency reserves.
    • However, with only local, organic fertilizers available to farmers, a massive crop failure occurred and Sri Lankans were subsequently forced to rely even more heavily on imports, further depleting reserves.

 

Implications of the Economic Crisis in Sri Lanka

• Sri Lanka is home to more than 22 million people who are rapidly losing the ability to purchase everyday goods. 
• The government owes $51 billion and is unable to make interest payments on its loans, let alone repay the amount borrowed.
• And its currency had collapsed by 80%, making imports more expensive and worsening inflation that is already out of control, with food costs rising 57% by May, 2022.
• Due to power outages meant to save energy and fuel, schools were shut down.

 

IMF Bailout for Sri Lanka

• In September 2022, International Monetary Fund (IMF) and the Sri Lankan authorities reached a staff-level agreement to support Sri Lanka's economic policies with a 48-month arrangement under the Extended Fund Facility (EFF) of about US$2.9 billion.
• The objectives of Sri Lanka’s new Fund-supported program are – 
  • To restore macroeconomic stability and debt sustainability, 
• Stepping up structural reforms to address corruption vulnerabilities and unlock Sri Lanka’s growth potential.

 

What is IMF? 

• The IMF was originally created in 1945 as part of the Bretton Woods Agreement, which attempted to encourage international financial cooperation by introducing a system of convertible currencies at fixed exchange rates. 
  • The dollar was redeemable for gold at $35 per ounce at the time.
• The planners wanted to avoid the trade barriers and high-interest rates that helped cause the Great Depression (1929).
• Mission: 
  • Furthering international monetary cooperation, 
  • Encouraging the expansion of trade and economic growth, and 
  • Discouraging policies that would harm prosperity.
• To fulfil these missions, IMF member countries work collaboratively with each other and with other international bodies.

 

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Q1) What is meant by Bretton Woods Agreement?

The Bretton Woods Agreement established a system through which a fixed currency exchange rate could be created using gold as the universal standard. The agreement involved representatives from 44 nations and brought about the creation of the International Monetary Fund (IMF) and the World Bank.

 

Q2) What is a Bailout?

A bailout is the injection of money into a business or organization that would otherwise face imminent collapse. Bailouts can be in the form of loans, bonds, stocks, or cash. Some loans require reimbursement—either with or without interest payments.

 

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Source:  Paris Club likely to provide financial assurances to IMF on Sri Lanka debt   |  Reuters