Time Is Running Out to Save Sri Lanka from Total Economic Collapse

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Yves here. Not that the US would have done much for Sri Lanka even in the best of circumstances, but our insistence of throwing money into the arms makers/arms dealers sinkhole called Ukraine assures that we have excuses for not helping out.

But another reason for featuring this story is Sri Lanka (or perhaps somewhat less dire versions) is where many low income countries are likely to wind up as energy and food costs continue to rise, and a sky high dollar makes their terms of trade even worse. And that’s before getting to the Fed’s desire to slow inflation by killing the US economy (when that won’t produce more oil or fertilizer or aluminum or wheat) denting global growth, which will also hurt the countries in Sri Lanka’s boat.

By Rashmee Roshan Lall, who writes on international affairs. She has lived and worked in eight countries in the past decade, including Afghanistan, Haiti and Tunisia, has a PhD, blogs at www.rashmee.com and is on Twitter @rashmeerl. Originally published at openDemocracy

Sri Lanka is in a state of chaos. Faced with the worst economic crisis of its 74 years of independence, the country has been roiled by days of violent unrest – leading the government to the brink of collapse.

For months, nationwide protests have taken place over soaring food prices, severe shortages of everyday essentials, weeks of power cutslasting up to ten hours a day, and crippling petrol and diesel costs, which are up 92% and 76% respectively since January.

A national emergency remains in force, the army is enforcing a nationwide curfew and threatening to shoot looters on sight and some Western countries are issuing advisories to warn their citizens against non-essential travel to Sri Lanka.

Its growing notoriety – as a failing state and an unstable no-go area – is a bitter blow for the tear drop-shaped island nation, which once counted tourism as its third-largest foreign-exchange earner and was not too long ago hailed by the World Bank as South Asia’s “development success story”.

State of Play

President Gotabaya Rajapaksa’s government is struggling to remain in office as he attempts to cobble together a national unity administration. This would replace the 26-member cabinet, whose members resigned in unison last month bar the president and his elder brother, the prime minister, Mahinda Rajapaksa.

The situation is volatile. Mahinda, who hung on until Monday, when he also resigned, has had to be evacuated by the army, after protesters tried to storm his official residence in the capital, Colombo. He is currently sheltering at a naval base in the north-eastern city of Trincomalee.

On 12 May, Ranil Wickremesinghe was sworn in as Sri Lanka’s prime minister for the sixth time, but it’s not clear if cabinet formation will be speedy and smooth. The lack of a new cabinet is taking its toll on Sri Lanka’s people and its prospects. On 11 May, the head of Sri Lanka’s central bank, Nandalal Weerasinghe, said the country has just 48 hours to save itself, lest “the economy will completely collapse”.

Meanwhile, angry protesters chant “Go Gota, go”, while the International Monetary Fund (IMF) – with which the government is urgently negotiating a bailout – has said talks for a loan can advance only once a new cabinet is in place.

The IMF also expressed concern over “rising social tensions and violence”, according to a statement shared with local media.

A mounting debt crisis has left Sri Lanka unable to refinance foreign debt totalling more than $50bn. And with foreign currency reserves as low as $50m, the country is unable to import food, medicine and fuel.

Its 22 million people have suffered weeks of severe shortages of everyday essentials. Even the most basic food has become unaffordable. Lentils, for instance, rose from 168 Sri Lankan rupees (37 pence) per kilo in October to 500 rupees (£1.11) in April. Meanwhile soaring fuel costs are forcing public transport and private vehicles off the roads and leaving farmers unable to run tractors or start their rice paddy crops, despite it being planting season.

A desperate government has sought bailouts from India and China and even poorer Bangladesh.

How Did It Come to This?

But how did Sri Lanka get here? It was the first South Asian country to embrace market liberalisation way back in 1977 and was often compared to Singapore, says P. Jayaram, a visiting professor at Amrita University in Coimbatore, India, who reported from Colombo in the 1980s and 1990s.

Barely a decade ago, a report for the research-focused International Growth Centre was hailing Sri Lanka’s 7% growth rate and its “substantial reduction in poverty”. As recently as 2018, Sri Lanka’s per capita GDP was more than $4,000 (by 2020 this had fallen to $3,680). According to UNESCO, an astonishing 92.5% of Sri Lankans are educated, with non-profit Borgen Project declaring the country’s relatively new education system “has shocked the world with its success”. Sri Lanka’s free and universal healthcare was celebrated as “a success story in South Asia”.

On 16 May 2009, Mahinda Rajapaksa, then the president, declared victory in the nearly three-decade civil war against Tamil Tiger rebels. There wasdancing on the streets of Colombo and a stream of congratulatory messages poured in from world leaders for this stunning defeat of ‘terrorism’.

Sri Lanka seemed poised to reap the harvest of peace and prosperity. But the decisions made after the end of the war put the country on a quite different, perilous path.

Flawed Choices

“Sri Lanka made a series of flawed choices after the end of the civil war,” Sumit Ganguly, a professor of political science at Indiana University, told openDemocracy.

“Amongst other matters, it went on a borrowing spree and it cut taxes. The debts came due and the revenue losses undermined public finances.”

Sri Lanka was Asia’s largest high-yield bond issuer, borrowing heavily in the years following the war for several ambitious infrastructure projects, such as South Asia’s tallest self-supported tower and wide highways in the hinterland. Critics call these projects “the Rajapaksa white elephants”. The pile of debts continued to grow, with roughly a third owed to international bondholders and China and India as other large creditors.

Mahinda was in charge of the country from 2005 until 2015; his thumping election victory in 2010 leading political analysts to label him “a man with a Midas touch”. But that seemed not to extend to the country’s finances, with Mahinda taking Chinese loans to build the expensive Hambantota port in his southern home district.

This controversial relationship with China went back a long way, as Ganguly wrote in a 2018 paper. Mahinda’s final military onslaught against the Tamil rebels, Ganguly noted, “found significant support, especially in the form of substantial amounts of military equipment, including six F7 fighter jets, from the People’s Republic of China.

“The PRC also provided millions of dollars’ worth of other military equipment and about $1bn in overall assistance.”

The Hambantota project followed on from that – but it hasn’t ended well. In 2017, the port was leased to Beijing on a 99-year debt-for-equity swap, after Sri Lanka failed to pay off the loan. Critics say Mahinda caused Sri Lanka to fall into the “Chinese debt trap”.

The man with a Midas touch lost the 2015 election, but with brother Gotabaya chalking up an emphatic win in 2019, the Rajapaksa family was back in power. At the time, Sri Lanka’s economic situation was fair – it had foreign reserves of some $7.5bn and a budget surplus – there seemed a chance it could turn the corner on the bad deals of the past.

But Gotabaya put in place sweeping tax cuts, in what some Sri Lankan commentators call “voodoo economics”. With value-added tax nearly halved to 8% and seven other taxes abolished, government revenue fell. Ganguly indicates that it changed Sri Lanka’s progressive, poverty-cutting arc. “Economic disparities certainly had widened with the tax cuts as the benefits mostly accrued to the wealthy,” he told openDemocracy.

The pandemic didn’t help because “there was a dramatic drop in tourism… and the country lost significant remittances from the Middle East,” Ganguly added. “To compound matters, with the exchequer drained an import-dependent economy saw soaring inflation.”

In April 2021, the Rajapaksa government announced a bold and aspirational transition to organic farming. Chemical fertilisers were banned and their import halted. Virtually overnight, farmers were left to get on with farming in an organic way.

“There was no proper plan, no training or education,” Vimukthi de Silva, an organic farmer in Rajanganaya, later told The Guardian. Yields of rice, the country’s staple food, dropped precipitously, as did formerly plentiful banana and tea crops. Vegetables became five times as expensive as before the ban.

The cash-strapped government slashed funding for school meals. A food crisis loomed. Donations of Chinese rice were supplemented by high-priced purchases from Myanmar. Sri Lanka’s failed organics experiment became a salutary story in South Asia for how not to do it.

What Happens Next?

The president promised, late on 11 May, that he would form a new government within a week. But this may not be quick enough. The situation remains fluid and the only certainty is flux.

Writing in The Guardian in 2009, celebrated British-Sri Lankan writer Romesh Gunesekera described his country of origin in lyrical terms. Sri Lanka, he wrote, “is an island that everyone loves at some level inside themselves. A very special island that travellers, from Sinbad to Marco Polo, dreamed about.

“A place where the contours of the land itself forms a kind of sinewy poetry.”

But Gunesekera’s article was headlined: ‘A long, slow descent into hell’. It may have been prescient, albeit unintentionally, about a country whose leaders’ aspirations catastrophically exceeded their ability to sustainably deliver.

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15 comments

  1. Egidijus

    How it happens that all these revolutions are on the Chinese Belt and Road Initiative transit countries, land or sea: Kazakhstan, Belarus, Sri Lanka etc.?

    Reply
  2. lance ringquist

    if you look at every one of these countries that are failing, all one needs to look at is free trade, THE IMF, and other quack economics which are at the bottom of all of this.

    https://www.lankaweb.com/news/items/2021/09/14/wither-the-sri-lankan-economy/

    “Imports were not to be controlled,

    A High interest rate was imposed. This meant that entrepreneurs in the country had to obtain loans at high interest rates. In Sri Lanka, when this Neo Liberal- Free Trade Model was enforced, the bank loan rate was raised to 25%. The local entrepreneurs could not compete with the imports that came in without paying tariffs or paying low tariffs. The result was that local entrepreneurs gave up their businesses. Instead they found easy money by depositing the money in Fixed Deposits. Imports took the place of local production and this increased the debt of the country. This was advantageous to the Developed Countries because they found buyers for their manufactures.”

    “Milton Friedman of the Chicago School of Economics, the author of the Free Trade- Liberalization Neoliberal Model of the IMF died recently having taken all Third World countries and even some European countries to their graves.

    All these countries have followed the Neo Liberal –Free Trade Model. This Model also brought riches in billions from the Third World to the Developed Countries.”

    and really, sri lanka was forced into trying something, they simply ran out of money to pay for imports, which in the past they were self sufficient in. now look at the mess the free traders have made again. none of this can be turned around over night. sri lankas people are becoming radicalized, so instead of trail and error, violence will erupt because the system of free trade has robbed them of their future.

    Reply
  3. Rita

    They have to replace fossil fuels with renewable energy: human labour. The farmers don’t have tractors, but they can employ hungry citizens. The latter would have to live in the countryside for months or even permanently. Luckily the weather is warm and clothes, shoes, heated homes are not vital.
    Martial law will be necessary for years.

    Reply
    1. lance ringquist

      its the collapse of the complete quack economics of free trade, and it will take decades to reverse, if it can that is.

      Reply
    2. Old Jake - Feeling Crochety Sometimes

      Human workers have to eat. Just saying you can replace fuel with manual labor is, what, a category error? You have to at least keep them alive until the harvest. And these are very different systems. People who have been living in cities don’t just walk into the fields and dig holes, farming involves skills, and physical conditioning is an issue.

      Martial law will be necessary for years? Who’s going to feed that army? It seems to me that this suggestion is based on a paradigm that regards the Cultural Revolution as a success. Of course we may have been propagandized about it, but some of those tales probably have some nuggets of truth, and even though you don’t have to treat intellectuals like criminals you do have to persuade them to change life styles. That’s a tough slog.

      Reply
  4. sharonsj

    At the first mention of tax cuts, I immediately thought that the tax cuts probably went to the rich and big business. After all, that’s what corrupt politicians usually do. And sure enough it was confirmed later in the article. Since most of the tax cuts in the U.S. also have benefitted the rich and large corporations, I’m afraid we’re heading in the same direction as Sri Lanka. We have the same shortages and food and fuel is getting quite expensive.

    Reply
    1. lance ringquist

      tax cuts, deregulation, privatization, these are all quack fascists economics. but the tax cuts did not totally collapse the economy, they hurt, but the over whelming damage was done by the crank policy of free trade.

      sri lanka just ran out of money to import stuff, when they used to be self sufficient in many of the things that they imported. free trade ran the locals out of business, free trade robbed the government of the necessary tariff income to buy stuff on the world markets that they were not self sufficient in. there are no free trader dupes that understand this, the rich do however.

      Reply
  5. Sibiryak

    Critics say Mahinda caused Sri Lanka to fall into the “Chinese debt trap”.

    The previous NC article on Sri Lanka argued that China has been scapegoated:

    Sri Lanka has just defaulted on its foreign debt for the very first time. Attributing its current predicament to a Chinese ‘debt-trap’ is a new Cold War propaganda distraction – which we will undoubtedly hear much more of.

    In this fable, Sri Lanka is a country caught in a debt trap due to white elephant projects mooted and financed by borrowings from China. Blaming Sri Lanka’s debt crisis on Chinese loans is not only factually wrong, but also prevents understanding the origins and nature of its current crisis.

    Outstanding Sri Lanka government foreign debt in April 2021 was US$35.1bn. Policy errors have reduced foreign direct investment (FDI), exports and government revenue, changing the composition of its foreign debt for the worst.

    Debt to the Asian Development Bank (ADB), World Bank, China, Japan and other bilateral lenders, including India, came to about a tenth each. Borrowing from capital markets – 47%, or almost half – is mainly responsible for its debt unsustainability.

    After all, borrowing from multilateral development banks – mainly the World Bank and ADB – and bilateral lenders are mostly on concessional terms, while debt from commercial sources incurs higher interest rates.

    Commercial loans tend to be more short term, and subject to stricter conditions. As sovereign bonds or commercial loans become due, their full value must be repaid. External debt servicing costs surge accordingly.

    As of April 2021, about 60% of Sri Lanka’s debt was for durations of less than ten years. The US dollar denominated debt share rose sharply – from 36% in 2012 to 65% in 2019, as Chinese renminbi denominated loans remained around 2%.

    Adding government guaranteed debt to state-owned enterprises, total borrowings from China were 17.2% of Sri Lanka’s total public foreign debt liabilities in 2019. Meanwhile, commercial borrowings grew rapidly from merely 2.5% of foreign debt in 2004 to 56.8% in 2019.

    The effective interest rate on commercial loans in January 2022 was 6.6% – more than double that for Chinese debt. Unsurprisingly, Sri Lanka’s interest payments alone came to 95.4% of its declining government revenue in 2021!

    https://www.nakedcapitalism.com/2022/04/sri-lanka-economic-crisis-inflicted-by-self-serving-elite.html

    Reply
  6. Indrajit Samarajiva

    Hi, I’m in Sri Lanka and this article is not very good for this site, which is usually insightful.

    For example, this is misleading: “The pile of debts continued to grow, with roughly a third owed to international bondholders and China and India as other large creditors.” As of 2021, nearly half of the debt was to international bondholders, 10% China, and 2% India.

    The article also seems to hint that China is the problem and it’s not, we can easily restructure or roll over those debts, and they at least have assets behind them, however stupid. Foreign bondholders are what’s choking us, and ratings agencies and the IMF have come in to break our legs.

    They also mention tax cuts as the problem, and they were dumb, but we’re having a DOLLAR shortage and taxes are collected in rupees. The article doesn’t discuss our trade imbalance and neoliberal lack of investment in industrialization.

    This article also discusses this island out of context, when there are now global outflows out of ‘developing’ regions and being sucked back into the heart of Empire. This is not just an isolated case of dumb country cut taxes and explodes, this is a case of a poor country losing access to capital markets while other rich countries doing equally dumb shit still have it. And this is happening all over the world, we’re just the first.

    This is actually a pretty shit article for Naked Capitalism to be honest, which usually has deeper context.

    Reply
    1. H. Alexander Ivey

      Well, to be honest, The Guardian (UK) articles are worse. But I, a resident visa holder of Sri Lanka, do agree with Indrajit’s main points. It’s the lack of access to US dollars that is causing the run on petrol and medicines (import items).

      Good manners, tiny keyboards, and a high regard for my hostess’ disdain for vulgarity and ah homien attacks keep me from adding more.

      Good night and good luck.

      Reply
    2. Jason

      Yes, the Anis Chaudhury and KS Jomo piece from April is of much better quality than this one.

      The only takeaway of the current piece that seems useful is that the IMF is waiting for the cabinet to be reconstituted before starting negotiations. What’s lacking is the story of why that hasn’t already happened.

      Reply
  7. sbarrkum

    Our two big problems are
    a)loss of foreign exchange inflows.
    b) Living beyond our means, i.e. much is imported including lentils and rice that are staples.

    Quick run down of FX inflows in 2018.
    Worker Remittances, 30%
    Tourism 20%
    textiles and Garments , 22%
    Industrial exports 16%
    Agri Exports (Tea Rubber) 12%

    Foreign remittances, i.e. workers in the mid east fell by account for 30% of FX. It fell by half during 2020 and 202 because because workers were sent back.
    Almost no Tourism since 2019 Easter Bombing
    Textiles and Garments affected by2020 lockdown.

    NOTE:, taxes cannot pay our external debt unlike western countries where sovereign bonds are in their own currency. External debt can only paid by Foreign exchange inllows.

    In SL very little direct taxes, mostly indirect regressive taxes.
    a) Corporate taxes, Income taxes are only 18% of total tax revenue
    b) PAYEE taxpayer are 57%(2.3M), Individuals 38% (157K), Corporate 5% (18K)

    That means Individuals pay just 6.84 of the total Tax revenue.
    Corporates pay just a measly 1% of total taxes.

    Reply
  8. sbarrkum

    That said I think we are freer than the say US.

    You house cannot be seized for non payment of property taxes.
    Property taxes are negligible. A friend in Colombo in a Tony neighborhood and a USD700K house pays about USD100 per year on taxes.

    Even non payment of mortgage, cannot be evicted if that is the only house one owns.

    Reply

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