August 10, 2023
Volatility of Sri Lanka Rupee signals the economic crisis is not over for recently bankrupt country
Sri Lankan 50 Rupee Bank Note
In July, the Sri Lankan Rupee (LKR) lost 6% of its value against the American Dollar (USD), and was the worst-performing currency in South-East Asia. The decline of LKR suggests that the economic crisis in the country that went bankrupt in 2022, is far from over.
Until the first days of March, 2022, one USD was worth roughly 200 LKR. Soon before the country defaulted on its debt in May 2022, the currency collapsed – the USD skyrocketed to around 360 LKR before the government enforced limits on currency exchange in efforts to arrest the economy’s transition to stable foreign currency.
As people died queuing for essentials, inflation jumped to over 70% in September 2022 and stayed in double-digits until July 2023. In 2022, the island nation’s GDP contracted by 8.7% and the International Monetary Fund (IMF) expects the recession to continue this year.
After months of talks with the government in Colombo, in March this year, the IMF approved a $3 billion support programme to assist Sri Lanka’s economic policies and reforms.
This allowed the LKR exchange rate to be partially freed and somewhat recover, but at the end of the second quarter of the year, the exchange rate still stood at 308.8 Rupees per USD, well above the pre-crisis level.
The Lankan currency remains highly volatile, depicting the nation’s precarious economic situation. After a surprising cut to interest rates in June, in July the LKR was the worst-performing currency in the region, losing 6% of its value and resulting in the price of the Dollar reaching 330 Rupees.
The recent depreciation of the Rupees is understood to be a result of speculations regarding the markets’ reaction to the shape of the swap of defaulted Dollar debt for newly issued Lankan bonds as well as their trust in the economic policies of the government.
The authorities, however, claim that the situation is under control. “In the second half of this year, we will see lots of inflows under the International Monetary Fund program,” the governor of the Central Bank of Sri Lanka, Dr. P. Nandalal Weerasinghe, said at a briefing in Colombo on August 3. “There is no justifiable reasons to expect large fluctuations going forward, beyond your fundamentals.”
Stabilising the currency exchange prices is only one of the challenges the island economy faces, as Colombo has also to weather the impact of the global economic crisis resulting from the COVID-19 pandemic and Russia’s invasion of Ukraine.
Inflation remains the number one challenge, with economists expecting price hikes to remain high in the upcoming years. Although the data states that Sri Lanka’s key inflation rate has eased – dropping from over 67.4% in September 2022 to 6.3% in July 2023. Further analysis from Trading Economics expects the CPI in Sri Lanka to reach 8% by the end of this quarter, and rise further, to reach 9% in 2025.
Persistent inflation, hectic currency exchange rates and rampant poverty do not help the government in Colombo in fulfilling the promises to balance the budget through limiting public spending, increasing tax revenues and privatising public companies.
The dire situation of Sri Lanka’s economy results from the fact that while otherwise strong economies had to endure the consequences of the COVID-19 pandemic and the subsequent impact of the Russian-Ukrainian war on energy prices, in Sri Lanka the economic crash was long in the making.
The consequences of years of economic mismanagement were exposed when COVID-19 led to the loss of tourism revenue.
In April 2021, when Sri Lanka’s foreign currency shortages became a prominent issue and the country proved unable to pay for essential imports, the administration of president Gotabaya Rajapaksa – who later fled the country and resigned – banned imports of chemical fertilisers, one of the country’s main imports.
Farmers were forced to use organic fertilisers, subsequently lowering the productivity of the agricultural sector. As textiles account for 52% of Sri Lanka’s exports, the trade policies had a detrimental effect on the country’s economy, only further exacerbated by the energy crisis resulting from Russia’s invasion of Ukraine.