Sri Lanka is facing its severest financial crisis since independence. It has defaulted on its international loan service agreements and if nations, like entities, could declare bankruptcy then the country would be a fit case for foreclosure. The government declared it to be a ‘pre-emptive default’, meaning that debt restructuring was required prior to any immediate payments from a now depleted treasury.
But then, how did it come to this pass? Economic and financial analysts first sounded the early warnings of an overburdened and collapsing economy in 2015. The populist proposals of the Rajapaksas to garner election success in 2019 and their continued dismantling of the financial structure coupled with a slew of deficit enhancing measures proved to be the tipping point. Sri Lanka currently has a debt of over $51 billion owed to countries, multilateral financing institutions and private international capital market through sovereign bond issues. The latter comprise about 50% of the total debt, China and Japan have extended loan facilities of 10% each while financial institutions such as the Asian Development Bank and the World Bank have contributed 22% to the loan portfolio. The country’s foreign debt obligations this year are over $7 billion and it has about $1.6 billion in its coffers to pay for essential imports of oil, food and medicines.
There is a food, energy and health security situation. Inflation is currently at an unprecedented 30%, shortages of cooking gas and fuel together with power cuts ranging from 10-15 hours have brought businesses to a standstill and hospitals do not have adequate stock of either medicines or equipment. Sri Lanka is slipping into a comatose position to become the ‘very sick man of Asia’. While it is relevant to cite the global economic crisis, COVID-19 and the Ukrainian war as critical contributors to Sri Lanka’s economic woes, much of the financial issues were exacerbated by poor governance, mismanagement, untenable financial policies and a blind eye to the consequences of a debt trap for political aggrandizement.
The last 3 years have witnessed the introduction of ill-conceived and arbitrary policies and measures. The income tax and VAT rate cuts proposed by the Rajapaksa government did not spur the economy, instead it deprived the exchequer of much needed revenue to run the government thereby increasing the deficit. To make up for the shortfall the government resorted to printing money at an unprecedented scale thereby compounding an already precarious deficit situation. High interest loans from China were used to build unviable infrastructure projects such as the Hambantota port and the Hambantota airport which is referred to as the least used airport in the world. The servicing of these loans without a robust and realistic revenue generation mechanism has added to the debt default.
Deliberate and ill-advised decisions in the agriculture sector to shift to organic farming by banning inorganic and agrochemical-based fertilizers led to lower agricultural productivity by 20% in the rice sector resulting in the import of the commodity where once the island was self-sufficient. The tea sector was also adversely impacted with lower export volumes. Worker remittances have been a key source of foreign exchange for Sri Lanka and have bridged the trade deficit gap. Another policy misstep of forcibly pegging the LKR at 200 to the dollar led to a severe fall in remittances (61%) as unofficial channels were adopted to transfer money since the market value ranged from LKR 250 to LKR 350. The global downturn in the tourism industry following the outbreak of the Covid-19 pandemic diminished all hopes of any sizable earnings from the sector. From a high of $4.38 billion in 2018 tourism earnings in 2021 were a meagre $261 million thus depriving the country of valuable foreign exchange and impacting livelihoods.
Sri Lanka requires a clean administrator to pull it out of the quagmire of debt that has been built up. The Rajapaksa clan has held a vise-like grip on Sri Lankan politics by controlling all major posts and appointments ranging from the President, Prime Minister, ministries of internal security, irrigation, home affairs, disaster management, sports, finance, and a few others. Corruption allegations, human rights violations, gagging of the press and white elephant projects have all combined to make the once popular Rajapaksa family a reviled clan. As Sri Lanka slipped into its debt trap and everyday existence became difficult the people’s chant for the Rajapaksas to resign became more strident. Eventually the Prime Minister Mahinda, the scion of the family, resigned along with his cabinet but not before his supporters launched a violent attack on demonstrators. The enraged mob then torched the family home of the Rajapaksas and also burned down homes of their supporters. Mahinda Rajapaksa had to be whisked away to be holed at a naval base in the northeast to escape the wrath of the people. And yet, Gotabaya Rajapaksa (Mahinda’s younger brother), continues to serve as President defying all calls by the people and the opposition parties to resign.
The IMF, World Bank, China and India have all offered to provide financial assistance but with different agendas and each with its own terms and conditions. The IMF has suggested a restructuring of the total debt, which is unacceptable to China as it may have to agree to similar restructuring exercises in other countries. India seeks to strategically reduce Chinese influence amid security concerns and the Belt and Road Initiative. China has offered more debt funding to pay off the existing debt but is reluctant to change the terms and high interest rates. The new government will walk a tight rope to satisfy its lenders. It is apparent that Sri Lanka’s debt burden which is already 119% of its GDP will increase further as return to normalcy for the tourism sector, increased exports of tea, and a floating currency to attract remittances will take time.
The on-going economic crisis has pushed the most marginalized and vulnerable population into abject poverty and with shortages of food, fuel and foreign exchange for imports creating a day-to-day struggle for existence. Corruption is on the increase and it is the 102 least corrupt nation out of 180 countries, according to the 2021 Corruption Perceptions Index reported by Transparency International. This is alarming when compared to a record low of 52 in 2002.
There are several lessons to be learnt from the Sri Lankan crisis:
- The Central Bank has to be independent of the executive so that it can employ fiscal and macroeconomic policies to control the debt, deficit and foreign exchange situation. The Central Bank should have the capacity to sound early warnings of an impending financial crisis and not play second fiddle to a government prone to populist measures or financially unviable decisions and policies.
- The reduction of taxes to the detriment of government revenues is never a good idea. Freebies and populist measures are short lived but have long term economic ramifications. They have a domino effect on the economy and withdrawal of the concessions are always frowned upon.
- The structuring of debt is critical. Over 50% of Sri Lanka’s debt is in the form of International Sovereign Bonds that have high interest rates, shorter tenures and increased risks. Commercial borrowings have sucked Sri Lanka into the vortex of debt from which it may not emerge unscathed as its credit rating has dropped and it will not be able to raise capital at competitive rates or attract foreign investments.
- The country needs to become more self-reliant and sustainable so that it does not rely heavily on remittances or tourism for its foreign exchange requirements. Future investments should be to make the country food secure, encourage SMEs, develop niche exports and explore digital technology investment options. Lastly, it will require a political will to set up a clean administration that is committed to economic reform, people and country.
The challenges are immense given the current global scenario of war, strife, food security, health, recessionary trends and increased political instability. For the Emerald Island to regain its paradisiacal place in the sun it will need to make sacrifices and numbing changes to its body politic.