SRI LANKA – Slipping into a Never-Ending Crisis

It wasn’t the typical joke made on April 1 in many parts of the world( I mean “April Fool’s Day”). In fact, on April 1, 2022, Sri Lankans rudely woke up to the news that their government had declared a state of emergency in the country.

It was apparent something as drastic as this was waiting to happen. For weeks before the announcement, signs of crisis in the island nation were aplenty — dwindling economy, food and fuel shortages, medicine and energy shortages that led to unprecedented political turmoil and economic instability. With no immediate solutions, impacted Sri Lankans began protesting on the roads and forming long queues for their daily necessities. Officials posted barricades with the idea of keeping protestors at arm’s length.

After months of escalating frustrations and public protests came the resignation of Sri Lanka’s Prime Minister Mahinda Rajapaksa and his brother President Gotabaya Rajapaksa. Both decided to leave the country after failing to handle the crisis.

Today, the island nation’s economy is in its worst state. Sri Lanka has defaulted on international loans and is facing an acute shortage of foreign currency needed to buy fuel and food supplies. The sudden departure of the top leadership like President Gotabaya leaves the state in total disarray.

Let’s understand how the country got into this murky situation. And what does this political and economic crisis mean for the nation?

Shaky foundations since 2009

In the aftermath of the Sri Lankan Civil War, President Mahendra Rajapaksa decided to go in for substantial foreign loans to pay war expenses. Rajapaksa initiated big infrastructure projects to attract tourism to the picturesque island nation and reward the trusted cronies without having many foreign reserves in the kitty.

Indeed, a better way would have been to focus on the planned economic reforms to shore up the FOREX reserves. Analysts believe the second blunder was even more prominent when Rajapaksa implemented several tax cuts to shore up populist political support.

Such a move is a favourite ploy used by politicians today without knowing much about economics and its long-term consequences. And that was the beginning of the island’s never-ending economic and political crisis.

Situations worsened in the last few years.

The double whammy — Easter bombings 2019 and the COVID-19 pandemic — hit Sri Lanka. The bombings destroyed the tourism business in Sri Lanka that was once a leading source of foreign exchange earnings, while lockdowns virtually paralyzed what was left over.

Adding salt to injury, Mr Gotabaya went ahead with his ill-timed “All Organic “plan to ban chemical fertilizers — a move that single-handedly destroyed the famous tea industry. Although the decision was reversed later, international grain shortages due to the Ukraine war made the country more food insecure. Rajapaksa’s experimental and ill-timed economic moves led to the collapse of once a vibrant South Asian nation.

Economic policies since independence haven’t been strong.

Successive governments since Sri Lanka’s independence in 1948 have failed to bring visionary economic policies integrating the country into the global supply chain. Instead, governments opted for populist and costly protectionist measures. This has led the nation to the “twin deficit” problem in which Sri Lanka faces a budget deficit and a current account deficit.

 

A victim of “Debt Trap Diplomacy”?

Being a middle-income segment country, Sri Lanka always lacked Foreign Direct Investments (FDI). It has never made viable plans to improve its export revenues. Instead, it preferred to rely on International Sovereign Bonds (ISB) and external borrowings (from other countries but at a much high-interest rate with short payback periods.

Official communication from Sri Lanka’s Finance Ministry says that today China accounts for about 10% of the country’s $51billion in external debt, and the country is defaulting on all external obligations, including loans from foreign governments. (Source: TOI April 13, 2022).

Sri Lanka’s effort to get into a balancing game between India and China and extract maximum cheques and benefits from them has not worked in their favour. It has caused more harm than good for all the concerned stakeholders.

How can Sri Lanka overcome its problems?

Ensure political stability and have sufficient liquidity to honour regional and international commitments. Positive negotiations with the International Monetary Fund (IMF) on a priority basis can pave the way for bilateral and multilateral financing opportunities. According to an estimate, the country may require approx. $6 billion this year to honour its commitments. This can only be possible if the IMF program materializes.

Challenges before the interim government 

In the current scenario, the new government headed by President Ranil Wickremesinghe and Prime Minister Dinesh Gunawardena must complete its negotiations with the IMF. An IMF bailout can at least soften the impact of the current economic crisis.

Restarting the economy will take time and resources and how the Sri Lankan people can hold on remains a million-dollar question. Already, there’s bickering and mudslinging in political circles. The new government lacks a favourable perception amongst the protestors. They accuse Wickremesinghe of protecting the Rajapaksa family and failing to prosecute them for alleged corruption and other crimes, the same old story. Only a free and fair direct election in the country and the new leadership directly elected by the people could be a better solution for the much-sought political stability.

India: The resilient neighbour and big brother

The new interim government has a delicate geopolitical dynamic to sail through. Throughout the current crisis, India has emerged as Sri Lanka’s trusted ally, presenting Sri Lanka’s case at the IMF and providing approx. $4 billion in financial assistance. India’s NDA government also created a task force to determine how it could further help the country during its crisis.

China: Uses a lopsided approach.

Although Sri Lanka has negotiated hard with China on debt restructuring, it failed to make China agree to Sri Lanka’s terms. On the contrary, China enjoyed a particular equation with the “Rajapaksa family” and benefited from numerous policy decisions under the regime. China has not provided any visible debt relief till now. Because China prefers refinancing loan options and fears, it might set a precedent for other countries facing similar debt crises today.

The current economic and political stalemate seems to be a long process before it gets resolved. Even if the new interim government can manage a good deal from the IMF, the fact remains that funds usually take a long time to get disbursed. On the contrary, the government of Sri Lanka will have a regular payment schedule to pay the external creditors and for essential goods.

Economic recovery: A long road ahead for Sri Lanka

Compounding the challenge, the protesters on the road are unlikely to see the current interim government as legitimate, making the authority handicapped in implementing much-required economic reforms. So, the provisional government and new government (to be elected in the next general election) would have their hands full working on viable economic reforms and policies to bail the nation out of this never-ending crisis.

Sri Lanka’s economic and political future remains uncertain. The current crisis sends a wake-up call to other countries like Pakistan, Egypt, Argentina, and many others. It highlights the perils of sovereign debt in the new era of geopolitical competition.

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