Sri Lanka economy being crushed by war in Ukraine

Sri Lanka has seen long waits at petrol stations, fuel shortages and blackouts lasting as long as seven hours. PHOTO: AFP

COLOMBO (BLOOMBERG) - Russia's war in Ukraine, which has caused a humanitarian crisis and convulsed global financial markets, is now threatening to crush a US$81 billion (S$110 billion) economy more than 4,000 miles away in the Indian Ocean.

Hit by soaring oil import costs and a dip in tourism revenue, Sri Lanka is racing to avert a default amid dwindling foreign exchange holdings.

With inflation already at 15 per cent - the worst in Asia - the conflict is only making it harder for the tropical island located off the southern tip of India. Fuel shortages and blackouts lasting as long as seven hours have become daily routine, while the wait gets longer at gas stations where prices surged almost 50 per cent this month.

The authorities are struggling to contain the crisis. They have raised interest rates, devalued the local currency and placed curbs on non-essential imports.

But with a meagre US$2 billion in forex reserves and US$7 billion in debt payments due this year, the battle is turning uphill. The government this week finally abandoned its reluctance to seek help from the International Monetary Fund (IMF) and President Gotabaya Rajapaksa pledged to fulfill Sri Lanka's obligations.

The Russia-Ukraine conflict could not have come at a worse time for Sri Lanka, which is still recovering from a brutal 30-year ethnic strife that ended in 2009. The South Asian country has sought to revive growth since, spending millions on tourism infrastructure, until the pandemic dealt a blow to its plans.

The crisis also showed how Russia's war is putting some of the fragile developing economies at risk and imperilling decades of efforts to lift millions out of poverty.

In South Asia, other vulnerable countries include Bangladesh, Maldives, Nepal and Pakistan, said Bloomberg Economics economist Ankur Shukla. Though direct trade and financial linkages with Russia and Ukraine are limited, the "price and supply shocks are powerful", he wrote in a note on March 9.

With a population of about 22 million, Sri Lanka is a net importer of goods from medicine to fuel. In December last year, petroleum products accounted for about 20 per cent of inbound shipments and the cost jumped 88 per cent from a year earlier. The increase in oil prices this year is adding to the burden.

The country has also been paying off external debt it piled on to help rebuild an economy scarred by the bloody civil war between the majority Buddhist Sinhalese and a Tamil minority that is predominantly Hindu. That has been draining its forex reserves.

Sri Lankans protesting in Colombo against the economic crisis on March 15, 2022. PHOTO: REUTERS

Another pain point is tourism revenue. About 30 per cent of visitors this year were from Russia, Ukraine, Poland and Belarus, and the war is threatening to turn off that tap. Sri Lanka earned US$3.6 billion from tourism in 2019 before the pandemic slashed that to less than a fifth two years later, official data showed.

The central government's foreign-owned debt stood at US$32 billion as at last November. Optimism that the government will soon manage to reach a deal with the IMF has already spurred a rally in the country's dollar bonds.

An offshore bond due 2030 rallied to 49 cents to the dollar from a record low of 38.9 cents on March 9, while one-year default probability has dropped to 18.2 per cent from as much as 31.3 per cent in late December last year, according to data compiled by Bloomberg.

The nation's international bonds need to be restructured by July as Sri Lanka does not have the necessary resources to pay the US$1 billion due that month, Citigroup said in a February note.

Besides raising borrowing costs and devaluing the rupee, central bank governor Ajith Nivard Cabraal also urged restrictions on non-essential imports of around 300 items from electronic appliances to apples and increases in fuel prices and power tariffs.

"The government seems to be reacting positively and that would help steer the economy to calmer waters in this time of unprecedented global challenges," Mr Cabraal said by phone last week.

Yet for ordinary Sri Lankans, the pain is real. Civic groups have held vigils highlighting rising costs, while the main opposition party organised a mass rally in the capital city of Colombo on March 15, demanding the resignation of President Rajapaksa.

The protests pose no immediate threat to his government, which commands almost two-thirds majority in Parliament.

Mr Sugath Chaminda, 44, said he spent about 10 hours to refuel his auto rickshaw, after being turned away by numerous gas pumps that had run dry. He then spent more time hunting for a cylinder of cooking gas, which was also in short supply.

Some of the inflation surge is also self-inflicted. Last year, the government banned imports of chemical fertilisers in an ambitious plan to promote organic farming. That caused a shortage of nutrients, leading to crop failure and protests, prompting the government to reverse the decision in November.

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