The economic turmoil that Sri Lanka is witnessing today is due to a shortage of foreign currency or a balance of payments (BOP) crisis.
In simple words, BOP is the difference between all the money that has entered the country during a particular period of time and all the money that has left the country during that same period.
In his address to the nation last week, Prime Minister Mahinda Rajapaksa had said that the country will have a trade deficit of $10 billion. That means Sri Lanka has imported more than it has exported.
Therefore, the outflow of money is more than the inflow, which, over the years, has led to the foreign exchange crunch.
One reason for this is the collapse of the tourism industry in the country, which contributes to around 10 percent of the country’s Gross Domestic Product (GDP).
Tourism was anyway going down after the serial bomb blasts in Colombo in 2019. The COVID-19 pandemic made it worse.
Even its major export destinations like China, and countries of the European Union, due to COVID-19, had issues with trade, thereby reducing Sri Lanka’s foreign exchange earnings.
Another factor concerns the Foreign Direct Investment (FDI). According to government data, the FDI into Sri Lanka has decreased to $548 million in 2020, compared to $793 million in 2019 and $1.6 billion in 2018.
If the FDI into a country plummets, so does the foreign currency in its reserves.
Additionally, Sri Lanka refuses to take a loan from the International Monetary Fund (IMF).
The governor of the central bank, Ajith Nivard Cabraal, told reporters in January that the “IMF is not a magic wand.”
“At this point, the other alternatives are better than going to the IMF,” he had added.
By other alternatives, he meant China. “They would assist us in making the repayments… the new loan coming from China is in order to cushion our debt repayments to China itself,” as quoted by Reuters.
Therefore, in summary, Sri Lanka is facing a forex crunch, which is severely damaging its ability to import essential items.
The roots of that forex crunch lie in the recent failure of the tourism industry, the failure to procure enough FDI, and the refusal to take a loan from the IMF.