Macroeconomic Factors behind SriLanka’s economic downturn

"Anger, discontent, curfews, 12-hour power cuts and extreme scarcity of basic amenities" are
a few words that summarise the current Sri Lankan economic crisis.

The situation goes back to the early 2000s when the government of Srilanka started
borrowing money from other countries such as Japan, China and other sovereign bonds to
improve infrastructure. The US calls it the "Debt-Trap Diplomacy".

The country, already with 16 loans from the IMF, encountered significant economic shocks
in 2019. The serial bombing of churches and luxury hotels, killing more than 200 tourists,
affected the Tourism Industry. One of the significant GDP contributor industry showed an
80% decline. Later economic shocks occurred when the newly elected President promised to
revert the economic crisis by reducing VAT and new agriculture policies. Little did he know
that the condition would only worsen.

Vat and corporate tax were reduced from 15% to 8% and 28% to 24%, respectively, aiming
to promote more spending. Other indirect taxes such as nation-building taxes, pay-as-you-
earn taxes, and service charges were demolished. The reduction did not fulfil its intended
purpose and led to increased saving rather than spending resulting in reduction in multiplier
effect. This also led to a reduction of 2% of the overall GDP. However, the pandemic
worsened the situation and led to more money deficits.

National Policies implemented by the government destroyed the agriculture sector. In

November 2021, Sri Lanka was declared a 100% organic farming nation. This policy led to a
drastic fall in agricultural production, and more imports became necessary. The government
in March floated the Sri Lankan rupee. For a country that relies on imports for most basic
amenities, the situation worsened.

These events made the Sri Lankan government fall short of its money reserve. Hence, the
prices of the essential products rose, disturbing the supply and demand cycle. The current
inflation rate stands at 17.5%.
The current situation of Sri Lanka and its people is frightening. As a short term solution the
country refuses to approach IMF, it will be compelled to do so. Given the situation,
implementation of a balanced budget can act as a boon. Limiting the governmental spending
such that it does not spend more that what it earns is the safest bet in the medium term.
Leveraging the gap between governmental expenditure multiplier and tax multiplier, Sri
Lankan government can limit the damage caused. Afterwards, they can start to build by
triggering public spending and move towards a debt free goal.