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Sri Lanka in Turmoil: An Old-School Economic Crisis

Wednesday, June 1, 2022

The economic emergency in Sri Lanka is a classic case of poor governance and misguided policy, exacerbated by global disruptions including the pandemic and the Ukraine war. Vasuki Shastry of Chatham House writes that international creditors should come together to facilitate renegotiations of Colombo’s debt and press for efforts by the new prime minister to implement measures and reforms needed to stabilize the island nation’s economy.

Sri Lanka in Turmoil: An Old-School Economic Crisis

Island ire: Protesters call on the president to resign, April 14, 2022, Galle Face, Colombo (Credit: Ruwan Walpola / Shutterstock.com)

The unfolding economic, political, and social crisis in Sri Lanka has distinct echoes from the past. Not just the Asian financial meltdown of 1997-98, which savaged the economies of Korea and Southeast Asia, but from a region far away from Sri Lanka – Latin America, where a series of failures in the 1980s led to debt defaults and skyrocketing inflation, setting back social progress for a generation. With Sri Lanka also reneging on its foreign debt obligations, the first Asian country to do so since Pakistan’s lapse in 1999, the parallel with Brazil and Argentina is evident.

The island nation’s path toward economic restoration will require more than a simple fix of its monetary and fiscal balance sheet, the objective of negotiations underway with the International Monetary Fund (IMF). Just as Indonesia and Brazil emerged afresh from their crisis spells in the 1980s and 1990s, Sri Lanka needs a major reset which will reposition the country away from the political blunders and excesses of recent years. The question is whether the political class and a pliant business community can rise to the challenge.

Family affair: President Gotabaya Rajapaksa addresses ministers, with his brother Mahinda, the prime minister, looking on, November 22, 2019 (Credit: Ruwan Walpola / Shutterstock.com)

Family affair: President Gotabaya Rajapaksa addresses ministers, with his brother Mahinda, the prime minister, looking on, November 22, 2019 (Credit: Ruwan Walpola / Shutterstock.com)

First things first, President Gotabaya Rajapaksa has gotten many things wrong in managing the crisis, notably in allowing his elder brother Mahinda to run amok with controversial policies during his stint as prime minister. The president’s decision to appoint opposition leader Ranil Wickremesinghe as prime minister, however, was a political masterstroke. In the weeks since Wickremesinghe assumed office, the seasoned politician, who had served as prime minister five times since 1993, most recently in the previous government from 2015-19, has attempted to calm tensions in a deeply polarized and toxic political environment. The fact that many members of the Rajapaksa clan are reported to have sought refuge in an army base after angry protestors targeted their homes demonstrates the president’s own diminishing political capital.

Wickremesinghe, who has also assumed the finance portfolio, must quickly deliver tangible economic and social benefits well before he too incurs the wrath of the street. The prime minister has four immediate priorities – secure emergency food and fuel supplies, negotiate an economic restoration program with the IMF and international donors, tackle Sri Lanka’s chronic foreign debt problem, and restore public trust in government. The food and fuel crisis that the country is facing is due to a combination of self-inflicted pain (the decision by the previous prime minister Mahinda Rajapaksa, who resigned on May 9, to ban the imports of chemical fertilizer, for example, which led to a sharp fall in domestic output) and an upsurge in global food prices due to the pandemic and Russia’s invasion of Ukraine. India, Sri Lanka’s giant northern neighbor, has provided an estimated US$3.5 billion credit line, with the World Bank and other bilateral donors also chipping in.

Crisis manager: Ranil Wickremesinghe, during his previous stint as prime minister, meets Indian counterpart Narendra Modi, Delhi, 2015 (Credit: Ministry of Foreign Affairs, Government of Sri Lanka)

Crisis manager: Ranil Wickremesinghe, during his previous stint as prime minister, meets Indian counterpart Narendra Modi, Delhi, 2015 (Credit: Ministry of Foreign Affairs, Government of Sri Lanka)

The scale of the emergency food and fuel assistance required by Sri Lanka is unfortunately receiving little global attention, due in part to the ongoing turmoil in Ukraine. As the country begins to negotiate an economic adjustment program with the IMF, PM Wickremesinghe has few good options. He has already announced cuts to ministerial salaries and scaled back non-essential spending. But with inflation soaring and the projected budget deficit in double digits, the government has to cut expenditure further, while protecting benefits for the poor. This will be a difficult balance to achieve because curtailing inflation will require a sharp tightening of monetary and fiscal policies.

A devalued Sri Lankan rupee will prohibitively increase the cost of importing food, fuel and other essentials. The prime minister has to sell a difficult austerity package to his citizens, with no immediate prospect of a return to stable economic conditions. Adding to Sri Lanka’s woes is the negative global economic outlook, with the World Bank projecting global growth to be trending sharply lower (3.8 percent in 2022 compared with a robust 5 percent in 2021).

Sri Lanka might find some relief by renegotiating its foreign debt obligations, but talks are at a standstill after the country failed to pay US$78 million in interest payments on two sovereign bonds earlier in May. The country’s overall foreign debt stands at US$51 billion, an estimated 10 percent of which is owed to China. International media coverage, however, has overwhelmingly focused on the Chinese debt dimension, a resolution of which will have to be part of an overall debt relief package for the country.

Romancing the president: Chinese Foreign Minister Wang Yi greets Gotabaya Rajapaksa in Colombo, January 10, 2022 (Credit: Foreign Ministry of the People's Republic of China)

Romancing the president: Chinese Foreign Minister Wang Yi greets Gotabaya Rajapaksa in Colombo, January 10, 2022 (Credit: Foreign Ministry of the People's Republic of China)

There was considerable unease within Sri Lanka about the Rajapaksa family’s romance with the Chinese, which raised serious governance concerns and culminated in the construction of the controversial Hambantota port, typically cited by critics of China’s Belt and Road Initiative, its signature foreign economic policy, as evidence of what the US has called Beijing’s “debt-trap diplomacy”. While debt owed to China is nowhere close to exaggerated unofficial estimates, China can demonstrate good faith by supporting a common approach to resolving Sri Lanka’s debt problems.

Since the pandemic, the G20 has established a common framework for debt treatment, to allow heavily indebted countries and their creditors (private and public) to establish a viable path forward. While the framework has primarily focused on African nations and progress has been slow, there is a clear, compelling case for the inclusion of Sri Lanka in the process. This will enable Sri Lanka’s largest official creditors to agree on how and when the debt will be repaid.

A final point about restoring public trust, which has evaporated in the last few months. Faced with the prospect of a lost decade of low growth and diminishing economic opportunity, Sri Lankans have targeted their wrath at the political elite by torching their property and taking to the street in unprecedented numbers. The president, who declared an emergency on May 6, has refused to resign, despite public protests calling for him to step down. Prime Minister Wickremesinghe is the nation’s man of the moment and has a historic opportunity to reverse decades of neglect in public policy and erosion of trust in institutions. But besides money, the country is running out of time.

Opinions expressed in articles published by AsiaGlobal Online reflect only those of the authors and do not necessarily represent the views of AsiaGlobal Online or the Asia Global Institute

Author

Vasuki Shastry

Vasuki Shastry

Chatham House (The Royal Institute of International Affairs)

Vasuki Shastry is associate fellow in the Asia-Pacific Programme of Chatham House, The Royal Institute of International Affairs. He is the author of Has Asia Lost It? Dynamic Past, Turbulent Future, published in March 2021 by World Scientific. He began his professional career as a journalist in his native India and then in Singapore and Southeast Asia. He has since held senior positions in communications and public affairs at the International Monetary Fund (IMF), the Monetary Authority of Singapore (MAS), and Standard Chartered Bank, where he was global head of public affairs and sustainability until November 2018. His book Resurgent Indonesia: From Crisis to Confidence was published by Straits Times Press in 2018.


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