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A long drawn-out war in West Asia and the continuation of the Russian-Ukrainian conflict would un-dermine the Sri Lankan economy that is striving to recover. An economic recession together with a steep rise in oil prices will cause a severe economic crisis for the country.

Expansion of war

The Israel-Palestinian war of nearly a month shows no signs of cessation. There are reports of a ground invasion in retaliation for the Hamas attack that killed around 1,400 people and saw 230 people taken hostage.

The Lebanese militant group Hezbollah and Iran might wade into the fight against Israel and drag the US into the war. The war is expanding and may engulf other countries in the region. The consequent economic consequences for the Sri Lankan economy are extensive.

Global economy

These expansions of the war could drag the global economy into a recession and a financial crisis.

Impact on Sri Lanka

Last Sunday’s column discussed the serious repercussions of the rise in prices of fuel, fertiliser and food and how a global recession and an increase in import prices would affect the Sri Lankan economy.

It would increase import expenditure sharply, reduce exports, widen the trade deficit, strain the bal-ance of payments and deplete foreign reserves.

Remittances

It is not only import prices that would impact the economy. The worker remittances inflows and tour-ism earnings could also be impeded if the conflict expands.

Impact on Oil prices

Initially, the expected rise in oil prices did not take place. They remained at around US$ 85 per barrel. On Wednesday, the price was US$ 82.5 per barrel.

Explanation

Analysts explain this as being due to the recessionary conditions in the US and some increases in output. However, this is not expected to remain at these levels.

Price escalation

The continuation and expansion of the war in West Asia is expected to increase prices to US$ 100-120 a barrel. This would make the import costs unbearable.

Government finances

The estimates of government revenue and expenditure for 2024 presented to parliament and the Budget proposals to be presented on November 13 would be difficult to realise owing to the severe external shocks the economy is likely to face. The fiscal deficit targets for 2023 and 2024 are not likely to be realised.

Fiscal imbalance

In this global economic environment, the estimates of revenue and expenditure presented to parliament are unlikely to be realised due to the adverse impact of import prices. The escalation of import prices of essentials and the contraction of the economy would reduce government revenue.

In any event, most years have been characterised by shortfalls in revenue and overruns in govern-ment expenditure. This would be inevitable next year.

Budget

The budget to be presented on November 13 may prove irrelevant, if its expectations of revenue and expenditure cannot be achieved. Although expenditure overruns and revenue shortfalls are a regular feature of Sri Lankan budgets, the reasons for next year’s widening fiscal deficit will be due to the se-vere strains on expenditure caused by the global economic consequences of the war.

Reforms

The IMF’s reform agenda which was in doubt owing to political conditions in the country would now face more political protests though privatisation provides a means to enable fiscal consolidation.

Hardships

Apart from global conditions impacting the economy, making it difficult to comply with IMF conditions, the hardships caused by increased prices, increased unemployment and poverty would lead to de-mands for relief. If these are granted, government expenditure would surely increase above the esti-mates, while the economic contraction would decrease revenue.

Protests

Currently, there are protests against the income tax increases and there are demands for salary hikes. These are impossible to grant in the current and foreseeable economic conditions.

Politics

The political situation with elections due shortly makes compliance with IMF conditions more difficult. If the government is unable to comply with conditions, will the IMF understand the difficulties caused by the external shocks?

IMF conditions

The inability of the country to achieve the agreed fiscal targets and the tardy implementation of economic reforms have serious implications for the continuation of the agreement with the IMF. Will the agreement with the IMF be discontinued or is there a possibility for the IMF conditions to be modified due to the global conditions?

Reality

While the answer to this question remains to be seen, the stark reality that the discontinuance of the IMF’s Extended Fund Facility (EFF) would spell disaster for the country must be recognised.

Summary

The expansion of the war in West Asia and the continuation of the Russian-Ukrainian conflict would accentuate the current global recession and financial crisis. This would, in turn, impact heavily on the Sri Lankan economy.

The US economy is already slowing down as people’s savings dwindle and expenditure has to be cur-tailed.

The expansion of the Israeli-Palestinian conflict could ignite a global economic downturn and financial catastrophe that would worsen Sri Lanka’s economic problems.

The widening of the trade deficit owing to decreased exports and increased import expenditure, the deterioration of the balance of payments owing to the larger trade deficit, lower inward remittances and a downturn in tourism owing to insecure air travel could be much more in 2024 than during the next two months.

Conclusion

The adverse economic developments would make it extremely difficult to comply with the conditions of achieving a lower fiscal deficit and implementing reforms. Will the country default again and plunge the economy into a catastrophe?