Sad to see how Sri Lanka’s current situation has evolved. The governments that once held power made numerous errors in economic mismanagement over the years, which led to the current economic crisis that grew and intensified into this catastrophe. While there are many lessons that the Indian government can learn from the developing economic crisis in Sri Lanka, as investors, we too can use these lessons to ensure that our own personal finances are not mismanaged in a similar manner.
Can Srilanka’s fall teach you some lessons on personal finance?
Here are some tips related to the Lanakan crisis that could help investors manage their personal finances more effectively moving forward.
Tax revenue in 2020 was merely 8.09% of GDP1 –The World Bank claims that tax revenues above 15% of a country’s GDP are essential for both economic growth and the fight against poverty. Due to poor management by its political leaders, Sri Lanka’s tax revenue was below average and kept declining. Failure to increase this deficit was one of the reasons for its economic downfall.
The same can be attributed to our personal savings versus lifestyle expenses. How much of our income is set aside towards savings? According to the 50-30-20 budget rule, 20% of one’s income should be set aside for savings. This is the least expected. The more invested, the better the returns, the faster the financial goals are achieved.
Economic mismanagement by successive governments
One of the root causes of Sri Lanka’s crisis has been its political instability over the years. In a bid to win over competition and hold governance, political leaders have tried to woo voters by incorporating unreasonable demands. These bad decisions led to deep tax cuts that resulted in a reduction of one million tax payers from the tax net. This unfortunate decision was enacted merely months before COVID struck, causing the dip in tax revenue that the country was dependent on. The loss of tax revenue, coupled with the loss of tourism revenue due to the pandemic, was a mighty blow to the country’s economy.
In a similar vein, we often see investors tend to mismanage their finances without worrying about the repercussions. An investor once discovered a fantastic deal on a residential apartment that he was certain to sell for a profit, but he lacked the available funds to make the initial down payment. So he decided to break his SIPs that he had been investing in for the last 15 years towards his now 15 year old son’s further education. He had intended to use this corpus to invest in his son’s medical school fees when he turned 18 years old. While the transaction was successful, he was unable to flip or resell the property. After three years, he was left with an unmarketable, illiquid asset and no corpus to pay for his son’s continued education as planned. In order to meet his immediate needs until he could sell the property, he had to obtain a student loan. The loan’s interest payments ate into the corpus that had been amassed over the previous 15 years.
Investors often make the mistake of investing in luxury items or assets that depreciate over time using their emergency savings or other funds set aside for other goals. This is yet another error that can result in serious financial pitfalls.
Loans from China as a debt trap
Even though Sri Lanka’s debt to China may not be a major contributing factor, it did increase their deficit to GDP ratio from 76% in 2016 to 117% in 2018. People are being enticed to purchase goods that are out of their price range because credit is so easily accessible through multiple credit cards, BNPL offers, EMIs, and other means. While there are many ways to leverage these debt avenues to the advantage of investors, overusing and abusing them frequently results in investors falling into debt traps.
Sri Lanka’s failure to effectively handle a crisis hastened their downfall. Effective economic decision-making was hampered by a fragmented crisis management strategy that included the creation of two overlapping committees to address the debt crisis, one composed of important ministers and the other of business leaders. Ineffective ministers and leaders were in charge of a task that really required economists.
An analogy to this situation is how investors frequently decide to buy assets based on recommendations from friends and family. In a similar vein, when a crisis arises (such as market volatility), people frequently become overly anxious and let their emotions rule them, leading to knee-jerk reactions that cause them to convert hypothetical losses into actual ones.
Have you been following Sri Lanka’s economic crisis? Nobody could have predicted that such mismanagement and misery could befall a young, promising nation like Sri Lanka. But then we never see the domino effect in all its glory until the first domino is struck, right? Governments all over the world can learn from this crisis, but that is not all. You’ll be surprised by the lessons in personal finance that Sri Lanka’s fall can impart too.
Read on to find out.