Sri Lanka is an island in the Indian Ocean and lies southeast of India. The country is known for its vast plains and impressive mountain tops, tea plantations, and beautiful temples. The island was formerly known as Ceylon, a name which is still used for the tea that comes from Sri Lanka.
Sri Lanka is in the grip of an unprecedented economic turmoil since its independence from Britain in 1948. The crisis is caused in part by a lack of foreign currency, which has meant that the country cannot afford to pay for imports of staple foods and fuel, leading to acute shortages and extremely soaring prices.
Months of lengthy blackouts and acute shortages of food, fuel and pharmaceuticals have triggered widespread protests calling for the government’s resignation.
According to the data published by the government’s Census and Statistics Office, the overall inflation hit 29.8 % in April from 18.7 % recorded in March.
The food inflation increased from 30.21% in March to 46.6 % in April. Most food items have recorded price increases.
The government’s decision to float the rupee in March after it ran out of dollars to defend a peg has depreciated the currency by over 60%. This has had a spiralling effect on all prices of essentials.
What is hyperinflation? And what are the effects of hyperinflation
Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.
Although hyperinflation is a rare event for developed economies, it has occurred many times throughout history in countries such as China, Germany, Russia, Hungary, and Argentina.
When hyperinflation is in effect, consumer behaviour adjusts. To keep from paying more for goods tomorrow, people begin hoarding today. That stockpiling creates shortages. Hoarding can start with durable goods, such as automobiles and washing machines. If hyperinflation continues, people hoard perishable goods, like bread and milk. These daily supplies become scarce, and more expensive, and the economy falls apart.
People lose their savings as cash loses its value. For that reason, the elderly are often the most vulnerable to hyperinflation. Soon, banks and lenders go bankrupt because their loans lose value. They run out of cash as people stop making deposits.
Hyperinflation sends the value of the currency plummeting in foreign exchange markets. The nation’s importers go out of business as the cost of foreign goods skyrockets. Unemployment rises as companies fold. Government tax revenues fall, and it has trouble providing basic services. The government prints more money to pay its bills, worsening the hyperinflation.
Inflation and the cost of living
If prices increase, so does the cost of living. If people spend more money to live, they have less money to satisfy their obligations (assuming their earnings have not increased). With rising prices and no increase in wages, the people experience a decrease in purchasing power. As a result, the people may need more time to pay off their previous debts allowing the lender to collect interest for a more extended period.
However, the situation could backfire if it results in higher default rates. Default is the failure to repay a debt, including interest or principal on a loan. When the cost of living rises, people may be forced to spend more of their wages on nondiscretionary spending, such as rent, mortgage, and utilities. This will leave less of their money for paying off debts, and borrowers may be more likely to default on their obligations.
How it started
Critics say the roots of the crisis, the worst in several decades, lie in economic mismanagement by successive governments that created and sustained a twin deficit – a budget shortfall alongside a current account deficit.
But the current crisis was accelerated by deep tax cuts promised by the government during a 2019 election campaign that were enacted months before the COVID-19 pandemic, which wiped out parts of Sri Lanka’s economy.
With the country’s lucrative tourism industry and foreign workers’ remittances sapped by the pandemic, credit ratings agencies moved to downgrade Sri Lanka and effectively locked it out of international capital markets. In turn, Sri Lanka’s debt management programme, which depended on accessing those markets, derailed and foreign exchange reserves plummeted by almost 70% in two years.
How it can be solved
If wages increase with inflation, and if the borrower already owed money before the inflation occurred, the inflation benefits the borrower. This is because the borrower still owes the same amount of money, but now they have more money in their pay check to pay off the debt. This results in less interest for the lender if the borrower uses the extra money to pay off their debt early.
When a business borrows money, the cash it receives now will be paid back with cash it earns later. A basic rule of inflation is that it causes the value of a currency to decline over time. In other words, cash now is worth more than cash in the future. Thus, inflation lets debtors pay lenders back with money worth less than it was when they originally borrowed it.
Upended by crisis, Sri Lanka must finally face its financial demons head-on. It will be a difficult fight. But a currency board—which strips the government and the central bank of the opportunity to mismanage the budget and the exchange rate, thereby restoring the credibility of our economic governance—vastly improves Sri Lanka’s chances of winning.