By Jevan Soyer. Sri Lanka, formally Ceylon also called the Teardrop of India, is a tropical island nation just a few miles southeast of India is most known for its international cricket team and scenic tourist destinations. Recently, it has been making news for all the wrong reasons. Economists around the world are using the current situation in Sri Lanka as a guide to see if a global food crisis is coming.
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Prices continue to rise in Sri Lanka
What situation? Currently, more than three million Sri Lankan students in its largest provinces have had their end of year exams cancelled, Grades 9, 10 and 11 specifically. The reason is the Sri Lankan Ministry of Education could no longer afford ink or even paper on which to print it. The announcement was made on March 19th, 2022.
Unfortunately, this is the least of Sri Lanka’s problems. Entire cities have ground to a complete stop due to public protests. These protests are because the prices of everything from rice and fuel to medicine have doubled, then tripled, and continue to rise.
Added to this is power outages lasting up to 15 hours a day. Hindus, Muslims, and Buddhist monks who just 10 years ago fought each other in a Civil War, all joined forces to demonstrate their dissatisfaction of government policies that have made food prices out of reach for the poor, knowing fully well this is just the beginning.
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What are Sri Lanka’s mistakes?
In May 2022, the United Nations called the situation a “perfect storm” brewing in the developing world, one that is expected to leave, quote “deep and long-lasting scars”. Sri Lanka may very well be the preverbial, “canary in the coalmine”.
Firstly, we need to understand how Sri Lanka got here, so as to not make the same mistake, or as the saying goes “when your neighbour’s house is on fire, wet yours”. As we enter a global food crisis, we must not suffer the fate of being dependent on food imports and inputs to produce food.
If a country imports more “things” than it exports, it is said to have a “trade deficit”, and if it exports more than it imports, it has a “trade surplus”. The ideal situation is to have balanced trade between countries and the best situation is to have a surplus in trade.
The reason is most international transactions happen in US dollars. Even if you are trading with China, Japan or India, the currency of choice would be US dollars and not Sri Lankan rupees. If a country imports more than it exports, it will run out of US dollars since it would be spending more than it is saving. Running out of US dollars is problematic because that is what you need to buy imports.
A lot of countries run deficits in their trade balance. By itself, there is nothing bad about having a trade deficit. Most countries simply make up the balance by taking international loans. Management of the repayment of these loans is what makes the difference.
In the case of Sri Lanka, mismanagement best describes its repayment of loans. Economists have always said that Sri Lanka was destined for a crisis of some kind and that it was only a matter of when.
Here is an example of one of Sri Lanka’s major missteps. In 2021, in a bid to become the world’s first “all-organic” nation, the government banned the import of all chemical fertilisers. To the surprise of no one but the president, crop yields were immediately cut in half and affected its agricultural exports and ability to earn foreign exchange.
This is an example of how decisions made by governments with the best of intentions could contribute to a global food crisis.
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Sri Lanka before 2020
Things were not always this bad, as a matter of fact, Sri Lanka had US$7.9 billion of foreign reserves in 2019, but by the end of 2021, it had been depleted to US$1.6 billion. We all know what happened in 2020, this affected tourism which accounted for 22% of its total GDP.
Foreign tourists were bringing in the valuable foreign exchange. Another source of foreign exchange was remittances, workers would go overseas, earn foreign currency, and send it to their families back home.
Sri Lanka’s decline started before the 2020 pandemic, In the Spring of 2019, terrorists bombed a string of churches and hotels across the capital, Colombo. This resulted in the death of 269 people. Forty-five of which were foreign nationals. This caused 70% drop in tourists’ arrivals. As concerns about public safety and government’s lack luster security policies, it did not inspire local or international confidence.
For political reasons, it is customary for some Central Banks to either under or over value their currency. This is done in most cases to keep staple goods affordable, governments in developing countries to maintain both economic and political stability. It was also done because the country depends so heavily on imports.
An example of this in practice is say Sri Lanka imports an item from India at the cost of US$1 and US$1 is currently worth 200 Sri Lankan Rupees. If the Sri Lankan Central Bank declares the exchange rate to US$1 to 150 Sri Lankan Rupees, that item is 25% cheaper. Maintaining an artificial exchange rate involves buying and selling or borrowing foreign currency, which Sri Lanka is low on currently.
Sri Lanka is running out of US dollars
The reason why most countries do not do this, is because of what is going on in Sri Lanka right now. There was in effect two exchange rates in Sri Lanka, the official rate 1 to 150 and the Black market rate which was 1 to 200.
Go to your neighbourhood corner store, hand the proprietor US$1 and you would get 200 Rupees, but go to the bank and you would get 150. Migrant workers quickly learned not to send their remittances home through official channels, because of this, the central bank has even less foreign currency, making it even harder to maintain its inflated exchange rate.
This is when things started spiralling out of control. Sri Lanka is running out of US dollars, it can’t buy enough imports, there is not enough food, fuel or medicine to go around. People’s personal savings are suddenly worth far less today than they were yesterday. Entire life savings and pensions are gone overnight.
Worst of all the Sri Lankan Rupee is rapidly depreciating in value. Last week, I could have afforded a basket of groceries, but today I can only afford half. As a result, every rational household starts stocking up on essential goods, leading to chaos, confusion, and chronic food, fuel and medical shortages. Lines at gas stations were so long that two men collapsed and died waiting to full up their gas tank.
Trifecta of shocks for coming global food crisis
The salt in the wound with this situation that can already be called a crisis is the war in Ukraine. The conflict and the subsequent sanctions are currently causing the largest commodity price shock seen in 50 years.
Russia produced 28% and Ukraine 15% of the global supply of wheat and maize. Totaling 43%, that is almost half of the world’s production in what could be considered the two most important grains, in terms of food for both humans and animals. Some countries get nearly all their wheat from one or both.
Russia also supplies 15% of the world’s fertiliser, and, just as importantly, LNG the fuel used to make fertiliser. Fuel prices for transportation has already risen to record highs. Many countries have or will react by banning food exports, further exacerbating the situation for net importers like Sri Lanka and other third world countries.
Countries being unable to pay back their loans is not all that uncommon. There’s a system for this sort of thing the equivalent of “bankruptcy” for nations. Normally, organisations like the IMF and World Bank step in.
However, Sri Lanka last received a bail-out from the IMF for $1.6 billion in 2016.The difference this time is bail-outs are conditional, one of which would be having a functional government and implementing economic policies which would be politically unpopular. The IMF doesn’t just write cheques on a whim, it would need to know that the country will not end up in the same situation six months later.
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Connecting the dots of a global food crisis
These are conditions Sri Lanka simply can’t meet. Citizens are very justifiably angry at their government. The reality is that political turmoil and social unrest will likely only discourage foreign assistance.
Protestors are right that the country’s economic woes didn’t come from nowhere. The groundwork for the current crisis can be traced back decades. When Sri Lanka began paying off old loans with new ones, in what the World Bank has compared to a pyramid scheme.
While it’s easy to connect the dots between an unprecedented global pandemic and a sudden economic collapse, so too is it easy to blame Chinese loans, but neither theory captures the whole truth. Only about 10% of Sri Lanka’s debt is owned by China, and its leaders have been pursuing policies for years that end in disaster, long before any of the recent events. In 2019, it cut taxes precisely when it needed public revenue the most.
What is surprising is not Sri Lanka’s poor leadership, but how quickly it all unravelled. In a matter of weeks, millions of Sri Lankans went from living a fairly middle-class lifestyle of cars, college education, and leisure, to wondering whether they can eat dinner. This is how countries spiral out of control.
The decision to be made at this point is, choosing between servicing debt or spending what little foreign exchange remaining to save lives at home.
Coming global food crisis, a ‘perfect storm’
Pakistan is the next domino expected to fall. Pakistan’s currency is currently in rapid decline. The war in Ukraine is expected to decrease global GDP growth by 1% in 2022.
A global pandemic, a change in interest rates, and the largest armed conflict in Europe since the Cold War, would each, by themselves, be hugely significant. But all three at the same time? That’s why the UN calls this a “perfect storm”.
The hope is that governments from other countries take notice to what is happening in Sri Lanka and take preemptive measures to avoid suffering the same fate.
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