What is an Economic Crisis?
The term “economic crisis” refers to a range of situations in which financial institutions or assets lose a significant portion of their worth all of a sudden. Many economic crises were linked to banking panics in the 19th and early 20th centuries, and many recessions followed. Stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults are all examples of what is commonly referred to as financial crises.
Many economists have proposed theories to explain how economic crises arise and how they might be avoided. However, there is little agreement, and global economic crises continue to occur on a regular basis.
In the first decade of the twenty-first century, the globe was confronted with the terrifying spectacle of an economic catastrophe that has no precedence in history, according to some. The failure of the banking system, on which countries rely for economic activity, has resulted in a slew of issues, including joblessness, halting development, shutting down industrial and business enterprises, and decreasing people’s living standards, as well as a worldwide trade downturn.
In 2008, the housing market in the United States showed the first signs of the global economic crisis. It has since spread to practically every major and developing country on the planet. We had hoped that we would be immune to the depression’s impacts, but there are already indicators that we may be caught up in the vortex as well. – Economic Crisis
Causes And Consequences Of Economic Crisis:
Financial markets’ strategic complementarities It is commonly stated that effective investing necessitates each investor in a financial market guessing what the other investors will do. Self-fulfilling prophecies, it has been argued, can emerge when people or businesses have a strong incentive to do what they expect others to do.
If investors expect the value of the yen to rise, for example, the value of the yen may rise; if depositors expect a bank to collapse, the bank may fail. As a result, economic crises are sometimes portrayed as a vicious spiral in which investors avoid a certain institution or asset because they expect others to do the same.
Leverage: Leverage, or borrowing to fund investments, is widely blamed for financial meltdowns. When a financial institution (or an individual) invests only their own money, they may lose their own money in the worst-case scenario. When it borrows to invest more, however, it has the potential to gain more, but it also has the potential to lose more.
As a result, leverage boosts investment profits while simultaneously raising the chance of insolvency. Because bankruptcy is defined as a company failing to make all of its pledged payments to other companies, it has the potential to transmit financial problems from one company to the next.
Asset Liability Mismatch: Many developing market governments are unable to offer bonds denominated in their native currencies on a global scale, and must instead sell bonds denominated in US dollars. This causes a currency mismatch between their liabilities (bonds) and assets (local tax receipts), putting them at danger of sovereign default owing to exchange rate swings.
Uncertain Behavior: Investors’ lack of awareness with contemporary technical and financial advancements may explain why asset values are frequently drastically overstated.
Furthermore, if the first investors in a new asset class (for example, stock in “dot com” companies) profit from rising asset values as other investors learn about the innovation (in our example, as others learn about the potential of the Internet), then even more others may follow their lead, driving the price even higher as they rush to buy in the hopes of making similar profits. A crash may become unavoidable if such “herd mentality” causes prices to rise far beyond their true value. – Economic Crisis
Case Study Of Sri Lanka-:
Due to the depletion of foreign reserves, Sri Lanka is experiencing an extreme economic crisis. Foreign reserves have been declining since August 2020, but they reached a dangerous low point in November 2021. (see Figure 1). It was only enough to cover the import for one month. After a month, there was a modest uptick, but it was still insufficient for two months’ import.
According to reports, overall foreign reserves fell by further 24% to US$ 2.3 billion in January 2022. The government of Sri Lanka’s ability to account for imports of necessary products and debt servicing has been hampered by the depletion of foreign reserves.
Authorities in Sri Lanka have admitted that settling import invoices is becoming increasingly problematic. Dollar shortages, especially when it comes to fuel imports for daily use. However, the government and the Central Bank of Sri Lanka (CBSL) are optimistic that, despite the current economic crisis, Sri Lanka will not default on debt payments.
With a continuous supply of forex, the Governor of the CBSL anticipates that economic pressures would relax soon. Despite the fact that the circumstances on the ground, as well as studies of the government’s policy initiatives and global geopolitical-economic developments, such as the aftermath from the Russia–Ukraine war, indicate that the Sri Lankan economy is in a state of uncertainty. – Economic Crisis
Forex Reserve Crisis:
Sri Lanka’s economy has always had a trade deficit, as its import cost has always been higher than its export revenue. For years, a large portion of the foreign currency gained has been used to pay for imports. The government’s debt-service obligations have increased the burden on foreign reserves in recent years.
Foreign exchange inflows into the country, on the other hand, have decreased, first as a result of the Easter Sunday attack on the tourism sector in 2019, and then as a result of the global pandemic, which has severely impacted all of Sri Lanka’s major foreign currency earning sectors, namely tourism, remittances, and exports.
The CBSL has continued to provide liquidity from the foreign reserves since April 8, 2020, because the government has been unable to raise adequate cash due to extraordinary poor market conditions. The Central Bank used its foreign reserves to settle government debt worth US$ 1,007 million between April 8 and June 22, 2020.
For the period July 2021–July 2022, the debt commitment is estimated to be between $5 billion and $7 billion. The current foreign crisis has been exacerbated in recent years by a reduction in foreign reserve inflows at a time when outflows are high. – Economic Crisis
HOW Did Sri Lanka Get Here?
Sri Lanka’s economy is export-driven, with exports accounting for over 23% of GDP (GDP). Unlike other export-oriented developing economies, however, the country has been unable to diversify its exports, and its export portfolio has remained limited to agricultural commodities and clothing. Sri Lanka continues to be heavily reliant on imports.
The country’s current account deficit has been rising since 2012. For the current situation, this was the first red signal. In the meantime, Sri Lanka’s economic growth rate has slowed over time, falling from 7% in 2015 to 2% in 2019. For nearly two decades, taxes have been dropping as a source of government revenue.
At the moment, taxes are as low as 9.2 percent of GDP. This was the present crisis’s second red flag. Government subsidies and tax breaks have been a continuous policy element for all Sri Lankan governments. As a result, the country has had a fiscal deficit for many years. The deficit reached a high of 10.51 percent of GDP in 2021. Increased government borrowing has been used to make up for the revenue gap.
Sri Lanka’s debt-to-GDP ratio has been steadily increasing over time. People were promised a brighter economy following the 2019 elections that elected Gotabaya to power. Shortsighted tax exemptions, poor internal policies, and the pandemic, on the other hand, had a negative impact on the situation. During the pandemic, Sri Lanka’s economy suffered greatly, with the country losing more than US$3 billion (S$4.12 billion) in tourism earnings in the first eight months of 2021. – Economic Crisis
Due to a fall in tourism earnings, the country lost more than US$3 billion (S$4.12 billion) in the first eight months of 2021. Sri Lanka had a debt of US$34.4 billion (S$47.29 billion) when Gotabaya took over as president in November 2019. By lowering the value-added tax to 8%, removing seven other taxes, and giving relief packages, he made the fiscal deficit even worse.
Though he planned for the new tax regime to encourage economic growth, it began to eat into needed revenue. As a result, the government’s borrowing from the CBSL increased in a predictable fashion. – Economic Crisis
Sri Lanka currently needs US$20 billion (S$27.29 billion) in order to import necessary things such as gasoline, food, and intermediate materials in order to begin exporting. As a result, on April 12, 2022, the government announced that it will seek an IMF bailout and repay all of its pending debt of US$25 billion (S$34.37 billion) after completing a restructuring program with the IMF.
The IMF has stated that any agreement must take into account Sri Lanka’s “debt sustainability.” At the same time, Sabri’s recent words suggest that Sri Lanka is more concerned with avoiding a harsh default than with finding a long-term solution to its debt problems. To re-establish supply networks, the government is seeking a $3 billion (S$4.12 billion) loan from the IMF. To Know more information about 10 things of Sri Lanka Worst Economic Crisis, Click Here.
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