September 2024 marked a key moment in Sri Lanka’s political history. The country, which had been struggling with economic challenges since 2022, elected Anura Kumara Dissanayake, a leftist anti-poverty advocate, as its new President.
The 55-year-old, immediately after taking over the country’s reign, dissolved the 225-member Parliament in which his left-leaning National People’s Power (NPP) alliance had just three seats. The snap election will take place on 14 November, almost a year ahead of schedule. The president also selected his ally Harini Amarasuriya as Prime Minister, choosing a woman for the third time in the country’s history.
Anura Kumara Dissanayake, who has drawn increasing support in recent years for his anti-corruption and anti-poverty policies, won just 3% votes in the 2019 presidential election. The new President, however, has said that he had no magic solution to hardships people were facing, but would seek a collective effort to end the crisis.
Rather than being a geopolitical player, Dissanayake wants to rescue Sri Lanka from its economic collapse. The island nation has €34 billion worth of external debt, rising poverty levels, and soaring prices for essential goods. He criticised both the ruling party and the main opposition for adhering to the same neoliberal economic model, which he claimed had led to the country’s economic plight.
Country not out of woods yet
The 2019 suicide bombings harmed the Sri Lankan tourism industry badly. Less than a year later, the COVID-19 pandemic and ensuing global food and fuel price rises, combined with interest rate hikes, further complicated things.
In April 2022, Sri Lanka defaulted on its debt, sparking protests that forced out President Gotabaya Rajapaksa. However, there were some positive changes under President Ranil Wickremesinghe, who took office in 2022.
Sri Lanka’s economy is expected to grow 3% in 2024, reversing 2023’s contraction, while inflation, which peaked at 70% in September 2022, moderated to 0.5% in August this year. Vital foreign reserves which were once so low that Sri Lanka ran out of fuel and medicines bounced back to $6 billion.
Anura Kumara Dissanayake, as per the Citi analysts, need to deal with the situation where there will be a heightened risk of delays to IMF reviews which trigger the release of money, and a “high probability of debt deal renegotiation.”
Sri Lanka signed a $10 billion debt rework with official creditors Japan, China and India in June 2024. Colombo also struck an 11th-hour deal with bondholders recently to revise the restructuring of $12.5 billion in international bonds to get crucial IMF signoff, a key part of getting the country out of default. However, the bondholder deal is particularly tenuous as a new government could seek changes or even scrap it in search of a better proposal.
Since Dissanayake has dissolved the Parliament, the snap elections will add another source of uncertainty among investors and observers.
Economy: Key issue in 2024 polls
Anura Kumara Dissanayake leads both the National People’s Power Alliance (NPP) and the Janatha Vimukthi Peramuna (JVP). In 2019, under Dissanayake’s leadership, the NPP was formed as a socialist alliance with several other organisations. While the JVP continues to adhere to Marxist principles, the NPP has shaped itself as a centre-left, social democratic platform.
For the first time, the economy replaced “national security” as an issue in a Lankan Presidential election. All main contenders promised to fix the country’s broken economy, which has been the product of rash policy decisions made by former President Gotabaya Rajapaksa.
In April 2022, Sri Lanka announced it would default on its foreign loans as the “last resort.” As the imports-reliant South Asian country ran out of dollars, essential supplies were affected, along with prolonged power cuts. The agitations became a mass uprising and evicted Gotabaya from the presidency. Soon after, Ranil Wickremesinghe was elected to the country’s top office through a parliamentary vote.
Although Gotabaya was considering seeking IMF assistance, it was only in March 2023 that the agreement for a $3-billion Extended Fund Facility (EFF) was finalised by his successor. Although Sri Lanka had obtained IMF assistance 16 times earlier, this was its first agreement after defaulting on its loans.
The IMF, in return, underscored the need for a “comprehensive anti-corruption reform agenda.” To meet the targets set, the government undertook various policy measures, like restoring the taxes that were cut by the previous administration and increasing the Value Added Tax (VAT) to 18% from January 2024.
In June 2024, Sri Lanka sealed an agreement with the Official Creditor Committee (OCC), to restructure the debt owed to its bilateral lenders including India, and signed a separate agreement with China for debt treatment. The OCC comprises 17 countries including India and Japan, from whom Sri Lanka has also borrowed from. OCC was formed in May 2023 to simplify Sri Lanka’s debt negotiations following its default. With the OCC, Sri Lanka reached a restructuring agreement for $5.8 billion of its bilateral loans.
Sri Lanka in September 2024 reached agreements to restructure approximately $14.2 billion of sovereign debt with the holders of its International Sovereign Bonds. On the domestic debt front, Sri Lanka’s restructuring efforts aim to protect local banks, while transferring the burden to superannuation funds, including the Employees’ Provident Fund.
Foreign investment of around $1.5 billion made its way into Sri Lanka in 2023. The tourism industry saw arrivals double, compared to 2022, bringing in revenue totalling over $2 billion. In the first half of 2024, Sri Lanka’s tourism revenue reached over $1.5 billion. Remittances showed an uptick of over 50%, amounting to nearly $6 billion in 2023. The country’s gross official reserves rose to $5.9 billion in August 2024. Export revenue increased; however, the apparel and textile industry experienced a drop in earnings.
Still, a majority of Sri Lankans are reeling under the enduring impact of the crisis. The electricity tariff hike in 2023 threw over a million families off the grid, as they could not afford their bills. Sri Lanka has reportedly the highest electricity bills in the region, with consumers paying nearly three times more than their South Asian counterparts. In early 2024, the nation reduced the tariff by around 20%, but those who lost their connections in 2023 don’t have enough household savings to settle the outstanding arrears.
Despite its reduction, inflation is very much there in the country. From the time food inflation soared to 94% at the height of the crisis, shoppers have been forced to pay more for essential goods. According to the Central Bank of Sri Lanka, food inflation accelerated marginally to 1.5% in July 2024 from 1.4% in June 2024. Further, non-food inflation also accelerated to 2.8% in July 2024 from 1.8% in June 2024. Inflation continued to remain below the apex bank’s 5% target, but higher utility bills, cooking gas and transport costs, are draining out the families. Add to this the 18% VAT.
While some essentials, including wheat flour, baby food, and medicines are VAT-exempt, everything else costs three or four times as much as it did before 2022. The increased cost of producing, sourcing, and supplying items in Sri Lanka’s food ecosystem is travelling at a much faster rate to the consumer.
During the 2022 economic crisis, around half a million jobs were lost, food insecurity and malnutrition became widespread, poverty doubled, and inequality widened, according to the World Bank. Small and medium-sized businesses are still struggling to return to the path of profitability. A UNDP report published in March 2024 said approximately six in 10 (or 55.7%) of all people are multi-dimensionally vulnerable in at least three of the 12 weighted indicators of access to health, education, employment, and income.
All eyes on Dissanayake
Sri Lanka’s economy made a stunning recovery under Wickremesinghe. After securing an agreement with the International Monetary Fund (IMF), the currency stabilised, the central bank rebuilt foreign reserves, and inflation fell to single digits. By the first half of 2024, the economy had grown by 5%.
The government successfully restructured its domestic debt, followed by a restructuring of its bilateral debt (government-to-government loans). Just days before the election, an agreement was reached with international bondholders to restructure the remaining sovereign debt. However, Dissanayake will inherit an economy where 54.9% of Lankan households are still indebted, and 60.5 % of families are grappling with a drop in household income after the crisis.
While there have been structural reforms to rein in public spending, apart from raising tax revenues, debt restructuring measures with bilateral lenders have also helped attract additional financing from the World Bank and the Asian Development Bank.
Still, poverty levels more than doubled in the island nation from 2019-23, with over a quarter of the population living below the poverty line. Sri Lanka also holds the world’s highest interest payments to government revenue ratio and the grace period on bilateral loan repayments will expire in 2028.
China is the country’s largest bilateral creditor and Colombo has become a perfect case study for understanding the phenomenon called “China’s Debt Trap Diplomacy.”
Claims over China’s predatory economic and lending activities occupied the media headlines as Beijing secured a 99-year lease for the Hambantota port project in 2017 after Colombo was unable to service its debt obligations.
Sri Lanka has also become the hotbed of geopolitical rivalry between China and India, and this has policy implications. For example, delays in the release of the second tranche of an IMF loan to Sri Lanka in 2023 were attributed to China’s stalled approval of a debt relief framework. This was also fuelled in part by Beijing’s reluctance to join the official creditor committee that is co-chaired by India, alongside Japan and France. The Xi Jinping government preferred to discuss debt relief efforts with Colombo bilaterally through its Exim Bank.
Colombo needs both New Delhi and Beijing. And it seems that even the United States have entered the geopolitical battlefield. In 2023, the US International Development Finance Corporation announced a commitment of half a billion dollars to support the development of a deepwater shipping container terminal in the Port of Colombo. Such projects aim to dilute China’s economic influence and reaffirm Sri Lanka’s geostrategic importance along vital maritime trade routes in the Indian Ocean.
Anura Kumara Dissanayake will have limited room to manoeuvre around, even as voters expect him to fulfil popular demands. The new President will likely pursue policies to reflect collective decisions made by the politburos and central committees of the NPP and JVP, rather than his individual views. He advocates for an economic system where activities are coordinated through a central government plan, emphasising the importance of “economic democracy.”
The new President wants to transform Sri Lanka into a production-based economy, instead of solely depending on service industries. One of his key policies is to promote local production of all viable food products to reduce reliance on imports. To support these activities, the NPP plans to establish a development bank. Additionally, the NPP proposes increasing government spending on education and health care, in line with Sri Lanka’s tradition of providing free, universal access to both.
IMF test awaits
Sri Lanka reached a draft deal with creditors to restructure $12.5 billion of international bonds, in a major boost to the island nation’s fragile recovery just before its presidential election. The country had to renegotiate parts of a previous draft deal, which it announced in July 2024, after objections from the International Monetary Fund and official creditors.
Colombo also finalised a preliminary deal to restructure $3.3 billion in debt with the China Development Bank, one of Beijing’s two main trade policy banks.
Former President Wickremesinghe told the media that the IMF would likely visit Sri Lanka two weeks after the election. However, there are now chances that Dissanayake eyeing changes in some terms of the IMF bailout, and this may also impact restructuring efforts.
“The latest draft agreement raised the GDP thresholds under which bondholders would get bigger payments under so-called macro-linked bonds. The previous agreement would have triggered a GDP of $92 billion-$100 billion, while the latest agreement increased those targets to $94 billion-$107 billion,” Reuters reported.
The latest deal was hailed as a major step forward in Sri Lanka’s efforts to emerge from more than two years of debt default, while its Finance Ministry bond debt service payments during its IMF programme would be $9.5 billion lower as a result of the proposed agreement.
Anura Kumara Dissanayake’s tax cut pledges won over the Lankans fighting poverty. However, jumpstarting the economy while making good on promises to expand welfare, rework the $2.9-billion IMF bailout and negotiate better deals with debtors, presents a difficult conundrum for Colombo and its investors.
His promises to change the parameters of the IMF bailout and, crucially, the way it determines how much debt is sustainable, may delay new money from the Fund and also force lenders to renegotiate debt deals. The Fund was set to review progress on reforms by October 1, before its board paves the way for a payout of the next tranche, which had been expected in November 2024. Analysts now expect this timeline to hold.
While a general election could, of course, help bolster Dissanayake’s support, it also means more delays in tackling key questions around the economy and debt. The IMF said it would work with Dissanayake and discuss the timing of its third review of the current programme with Sri Lanka “as soon as practicable.”
Given the severity of Sri Lanka’s economic crisis, Dissanayake has no other option, but to stay within the IMF programme for now. Still, he has vowed to renegotiate to make the programme more “people-friendly.”
Dissanayake’s proposals include raising the personal income tax exemption threshold to double its current level and removing taxes on essential goods. His party also plans to add jobs to the public sector, despite the ongoing effort to reduce the government workforce to manage the deficit.
These populist policies will likely strain government revenues while increasing expenses. The IMF programme requires Sri Lanka to maintain a primary budget surplus of at least 2.3% of GDP to ensure debt sustainability. Dissanayake has promised not to jeopardise the country’s economic stability by deviating from this target. His strategy is to improve the efficiency of tax collection, to generate enough revenue to fund his policies.
Anura Kumara Dissanayake wants better terms. However, since most of the IMF agreement terms are already in place, it remains uncertain whether the new government will attempt to renegotiate them.