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Explainer | Sri Lanka and Pakistan crisis: What can India do?

Much of the South Asian region is facing a crisis, making India’s role in the region even more prominent

May 30, 2022 / 01:26 PM IST
File photo of Sri Lankan soldiers dressed in traditional costumes carry nation al flags during the Independence Day celebration in Colombo, Sri Lanka. (AP Photo/Eranga Jayawardena)

File photo of Sri Lankan soldiers dressed in traditional costumes carry nation al flags during the Independence Day celebration in Colombo, Sri Lanka. (AP Photo/Eranga Jayawardena)

Renowned economist Rudiger Dornbusch once famously said: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.” That quote is apt for Sri Lanka and Pakistan, where economic crises brewed for nearly a decade, before finally striking in 2022, unravelling quickly, and surprising everybody.

The International Monetary Fund (IMF) recently concluded its meetings with the authorities of both the countries. This explainer helps in understanding the crises in the two countries, the IMF’s assessment, and implications for India.

What Led To The Crisis In Sri Lanka

Sri Lanka may have gained independence in 1948, but its economy did not recover from the colonial hangover. Sri Lanka’s economic structure has broadly remained unchanged as it manages its economic affairs mainly via trading with other countries. The economy’s major exports are tea and tourism, and its major imports are food and oil. The economy is also heavily reliant on remittances from Sri Lankans working abroad.

Sri Lanka also faced a deadly civil war for nearly 30 years, from 1983-2009, undoing any development done earlier, and creating conditions for little development later. From 2009 onwards, Sri Lanka has mostly been governed by one political family, the Rajapaksas, who paid little attention to economic conditions, and an impending crisis. The government also cut income taxes over the years, which led to an even higher government deficit, and introduced organic farming overnight in May 2021, creating an agricultural crisis out of thin air.

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Sri Lanka’s economic structure meant that all it needed was a small global shock to suffer a major crisis. The COVID-19 pandemic followed by the Russia-Ukraine war, acted were these global shocks. The global trade and tourism markets declined, pushing Sri Lanka into a corner. The country needed food and oil to survive, but there were no export earnings or foreign exchange reserves to pay the bills. The crisis has led to slowing of growth, high inflation, and widening deficits on both the government and external account.

viju Graph1

The country’s citizens have come out on the streets protesting against the government (read Rajapaksas) leading to the resignation of both the Prime Minister and the central bank Governor. The country has a new Prime Minister and a central bank Governor, but it will take a long time for the situation to normalise.

What Led To The Crisis In Pakistan

Pakistan has been perennially in a political and economic crisis. Its political situation has been highly volatile with constant friction between the army and the political establishment. The frictions have led to multiple changes, and to six Prime Ministers in the last 10 years. In the 2010-19 period, Pakistan’s growth rates averaged 4 percent, and inflation averaged at nearly double at 7.3 percent. The government’s deficits averaged 6 percent, while the current account deficit was more manageable at 2.1 percent.

viju Graph2

The twin global shocks worsened Pakistan’s economic situation. Inflation crossed 10 percent, and the current account deficit jumped to 6-7 percent. Despite alarming economic conditions, the only recent change in Pakistan is that it has a new Prime Minister. The government also did not renew the contract of the central bank Governor (Reza Baqir) and currently the central bank is helmed by an interim Governor (Murtaza Syed).

How Does IMF Come Into The Picture

The objective of the IMF is to provide financial help to member countries in case of a crisis in the external account. It is the lender of last resort in such cases. The IMF lends money based on certain conditions, and typically economies availing these loans have to undergo macroeconomic reforms such as lower inflation, reduce public debt levels, and so on.

Both Pakistan and Sri Lanka became members of the IMF in 1950. While Pakistan has availed IMF help 23 times, Sri Lanka has reached out 16 times. In the 2010-20 period, Pakistan accessed the IMF window three times (2013, 2019 and 2020), whereas Sri Lanka accessed it once (2016). The IMF provides financial support based on membership quota. Pakistan’s loans from the IMF are already 216 percent of its quota, whereas Sri Lanka’s loans equal 154 percent of its quota. Pakistan has also taken an emergency loan which is 50 percent of that quota.

Despite Sri Lanka and Pakistan exceeding their loan limit, they have again reached out to the IMF as there is no other alternative. The IMF’s statement on Pakistan noted that monetary policy was on track to lower inflation, but there have been deviations in its fiscal policy. In its statement on Sri Lanka, the IMF has assessed the country’s debt as unsustainable, and has said that while the IMF will support the country, it needs “adequate assurances that debt sustainability will be restored”. In both statements, the IMF has expressed concern about the impact of the ongoing crisis on poor and vulnerable people.

The China Link

Apart from the IMF, Sri Lanka and Pakistan have also found an active suitor in China, which has granted loans in a quid pro quo mechanism. These countries have given strategic locations to China, which has allowed the latter to position its power in the Indian Ocean. While Pakistan has given Gwadar port to China, Sri Lanka has obliged it with the Hambantota port. Chinese money also allowed Pakistan and Sri Lanka to avoid an imminent crisis in the 2010-19 period. However, the Chinese did not provide much aid during the two global shocks, which accelerated the crisis in both economies.

What does all this mean for India?

China’s retreat from Sri Lanka and Pakistan, and the inability of developed countries to help due to ongoing war, has catapulted India into the centre of action. India has helped Sri Lanka extensively in the crisis, providing financial support, petrol and diesel supplies, and food.

Pakistan has not reached out to India for obvious reasons. As one writes this, much of the South Asian region is facing a crisis, making India’s role even more prominent in the region. However, India should not look at its ties with these countries in an opportunistic manner but rather with compassion and empathy.
Amol Agrawal is faculty at Ahmedabad University.
first published: May 30, 2022 01:05 pm
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