International Finance
Economy Magazine

Sri Lanka an island in peril

The country defaults on foreign debt; struggles with food, fuel & medicine shortages, hyperinflation, and civil discord.

A little over a decade ago, Sri Lanka crawled out of one of the worst civil wars in the world. Years of violence between the Sinhalese and the Tamils ravaged the island nation. And when the Liberation Tigers of Tamil Elam (LTTE) surrendered after the death of its leader Prabhakaran on May 18, 2009, though bloodied and battered, many hoped for peace and economic growth.

However, the recent month will go down as one of the worst months in Sri Lankan history. The police opened fire on protestors before Mahinda Rajapaksa’s residence, killing eight and injuring 200. The country has defaulted on its loans. A severe lack of foreign currency crippled the government’s capacity to pay for essential imports like fuel. Powercuts last half a day, medicines are hard to find, businesses have went bust, and food shortages have riled up the population.

Shortly after, Mahinda Rajapaksa resigned, and Ranil Wickremesinghe became the new Prime Minister. Yet the protests raged on, demanding the resignation of Mahinda Rajapaksa’s younger brother, President Gotabaya Rajapaksa. The president declared martial law in response to the violence before the Prime Minister’s residence, and the situation has spiraled out of control.

Where did it all begin?
Sri Lanka has never had it easy. It was a European colony for over 400 years. British held the territory for most of this period since 1815 and used it as a forward base against the Japanese in World War 2.

It was also an economic hub connecting Europe and East Asia. The British plantation owners realized the island was conducive to growing tea and turned large areas of rainforest land into plantations. Since tea growing was a very labor-intensive work, the colonists brought a huge population of cheap labor from the Madras Presidency- mostly Tamils.

The racial disharmony between the native Sinhalese and the migrant Tamils is the root of most Lankan strife. Sinhalese refused to accept the Tamil population as Lankan, denying them human rights and sparking a bloody civil war, which lasted till 2009.

Mahinda Rajapaksa took credit for crushing the LTTE, one of the most feared terrorist organizations in history, known for their suicide operations, including the assassination of the late Indian Prime Minister Rajiv Gandhi. Though, there were widespread allegations of war crimes against the Rajapaksas and the Sri Lankan army; he was hailed as a national hero.

How did it get to this?
The next 13-years were marked by economic mismanagement by successive governments, which weakened the country’s public finances through excess government spending and reduced national productivity.

The Rajapaksa’s regained power following the 2019 Easter bombings. The nepotistic family had three members in the cabinet apart from Gotbaya and Mahinda and held a monopoly over decision-making. The Rajapaksa govt cut taxes steeply after assuming office in 2019, exacerbating their economic woes.

Before the festering economic crisis could be fixed, Covid-19 struck, wiping out most of the national revenue. Tourism -a major source of revenue- was hit hard during the global lockdowns and travel restrictions. Remittance from the Sri Lankan diaspora also fell because of inflexible foreign exchange rates.

Rating agencies, apprehensive of government finances and repayment capabilities, downgraded the nation’s credit rating in 2020 and soon restricted them from the international financial markets.

The country reached into its coffers and spent 70% of its foreign exchange reserves within two years- a move that debilitated the economy by creating a dollar shortage.

The Rajapaksa government’s steep tax cuts reduced government revenue during a great crisis. They had hoped to tempt foreign investments and stimulate the economy, but the racial tensions, terrorism, corruption, and a global pandemic scared away investors.

One of the most horrible decisions made by the Sri Lankan govt is its plunge into organic farming. They began experimenting with natural fertilizers and pesticides. Also, when the government ran out of foreign currency for imports, it encouraged domestic fertilizer and pesticide manufacturers, who delivered substandard products to the nation’s farmers. Consequentially, the yield of agricultural products plummeted. The tea industry was nearly wiped out reporting the lowest exports in 23 years. Food shortage ensued with poor local farm yields and food imports blocked because of an impoverished exchequer.

Despite the many facets of the crisis glaring at them, the Rajapaksas were reluctant to negotiate with the IMF in the belief that tourism would bounce back soon.

They did seek help from India and China, the two regional superpowers who have constantly vyed to pull Sri Lanka into their sphere of influence. New Delhi claimed that it provided support worth $3.5 billion this year.

Earlier this year, President Rajapaksa beseeched China to restructure the $3.5bn debt owed to Beijing. Many have accused China of trapping the island in its debt trap as a plan to realize the trillion-dollar Belt and Road initiative. The Chinese cooperated with the Sri Lankans by providing a 1.5bn yuan-denominated swap in late 2021. There are even reports of Chinese embassy officials sending money and food to high-ranking officers in Sri Lanka.

Eventually, Sri Lanka did open talks with the IMF in May. Even with all the assistance, Sri Lankans have no power, no fuel in their tanks, no food, and very few medicines.

After the Prime Minister’s resignation, the member of parliament, Harsh De Silva, said that they needed a stable government soon to restore the country to some sense of normalcy. He added that if not, then the mobs would go berserk, and law enforcement officers would be helpless; Harsh De Silva would prove himself to be right.

Businesses were also looking for political leadership to restore law and order and economic stability. The Joint Apparel Association Forum, which represents the nation’s vital apparel industry, said the need for a new government was “critical.”

Where is it heading?
Amidst growing public resentment, President Rajapaksa installed former rival Ranil Wickremesinghe as the new Prime Minister. The leader began by accepting and disclosing the current scenario to the public through a string of tweets.

The new Prime Minister tweeted, “The next couple of months will be the most difficult ones of our lives. I have no desire to hide the truth and lie to the public. Although these facts are unpleasant and terrifying, this is the true situation.”

He went on to explain the situation further. He said the foreign reserves were at $7.5 bn in November 2019, but the government couldn’t find even one million in 2022. The budget deficit was around SLR 2.4 trillion (13% of GDP).

On May 16, Wickremesinghe tweeted that the island had only enough fuel for a day, though he hopes of acquiring diesel shipments through the Indian credit line. He forecasted great adversities for the future but hoped that Sri Lanka’s foreign allies would come to its aid.

Sri Lanka is now in a precarious situation. Being economically broke, they are not in a position to negotiate with foreign powers. The island is a geopolitical chokepoint for any nation which wants to control the Indian Ocean. China and India were already trying to get the country on their side through loans, infrastructure development, and financial aid. Its negotiations with the IMF would alarm its Chinese debtors, who already fear the United States would want to establish a military base in Sri Lanka.

The pandemic has been harder on the poor than on the rich. Whether the poor in question be individuals or nations, has made no difference. Many developing economies didn’t have the resources to withstand a strict lockdown. Lebanon slipped into a recession quickly. Others like Pakistan and Nepal aren’t doing well either. India is experiencing high inflation, and some African and South American countries are seeing contracting economies.

Another point to note is the huge income inequality in Sri Lanka. Many are starving, but the middle class still lives in neighborhoods with no power cuts and eats out at expensive restaurants. Schools for the rich are still open, and many private vehicles still ply the road. A curious case in a country that hardly has a day’s stock of petrol. If not addressed, there will be law and order problems in the nation.

The situation in Sri Lanka might signal hard times for developing economies. The inflation in the US and Europe is also alarming, but they have generations of wealth saved up for a rainy day. All eyes are on the US, expecting a recovery and fearing a global recession.

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