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REVIVING SRI LANKA

July 23, 2022 | Expert Insights

To even the most poorly informed bystander, it was clear as day that the economic mismanagement by successive governments in Sri Lanka left national expenditure more than income resulting in the economic collapse of a once relatively self-sufficient nation. 

President Gotabaya Rajapaksa fled the nation in a requisitioned military plane, prompting the declaration of an emergency. Following months of mass protests over the island's economic crisis. While attempting to calm the situation, acting Prime Minister Wickremesinghe proclaimed a state of emergency throughout the nation and enforced a curfew in the western region.

The G7 group of countries - Canada, France, Germany, Italy, Japan, the UK, and the US – announced their support for Sri Lanka's attempts to reduce its debt repayments. But the nightmare has just begun for this Emerald Island, as it was once called.

Background

Sri Lanka’s President Gotabaya Rajapaksa on July 14, 2022, sent his resignation letter. He will be the last of the Rajapakshas to resign from office, following his brothers, including former Prime Minister Mahinda Rajapaksa.

The unprecedented resistance to the Rajapaksa, Sri Lanka's most formidable political brand for over 15 years, has decisively eliminated the first family from political prominence for the near future.

At the end of its civil war in 2009, Sri Lanka chose to focus on providing goods to its domestic market instead of trying to boost foreign trade. This meant its income from exports to other countries remained low, while the bill for imports kept growing. Sri Lanka now imports $3bn more than it exports every year, and that is why it has run out of foreign currency. At the end of 2019, Sri Lanka had $7.6bn in foreign currency reserves, which have dropped to around $250m.

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Analysis

Deep tax cuts implemented by the Rajapaksa administration soon after taking office in 2019 made the situation worse. A few months later, COVID-19 broke out. A significant portion of Sri Lanka's revenue base was destroyed as a result, most notably from the lucrative tourist sector. Remittances from citizens who were working abroad also decreased as a result of an unfavourable foreign currency rate. Sri Lanka's credit ratings were reduced starting in 2020 due to the government's finances and inability to pay off a sizable amount of foreign debt, which ultimately prevented the country from accessing international financial markets.

Tourism, tea exports, clothing, textiles, rice cultivation, and other agricultural items are the nation's primary economic sectors. Along with these economic sectors, employment abroad makes a significant contribution to foreign exchange profits. One of the greatest setbacks the nation experienced was a decline in the tourism industry.

To come out of such a situation, the legislature decided to lease the Hambantota Port to Beijing for a tenure of 98 years, aiming for an economic boost and employment opportunities.

What Next?

India has been a long-standing trading partner with the Lankan administration. But the previous experiences restrict India from aiding them in the current situation. Instead, India, along with other several nations, is providing economic and health care aid. To rise from this situation, the new upcoming government needs to focus on several branches of administration to unify the country and restrict it from going back to its previous experiences. "Fiscal prudence and responsible governance" are the mantras emanating from the Indian government for its neighbour.

The impending catastrophe was forecasted by the Asian Development Bank in a 2019 working paper, pointing out the classic twin deficit economy, which has led to the country defaulting on its loans. These were taken through the sale of state bonds to foreign investors on a commercial basis. Now, these must be paid, or no international institution will be willing to come forth with additional loans. For one, the new government will have to renegotiate its loans on a bilateral basis. Sri Lanka enjoys a good rapport with the international community, as the G7 declaration promising to reduce its debt burden showed. The Sri Lankans must now gather as much foreign assistance as they can muster and in a transparent manner, ensure its judicious outlay to partly pay back loans and recover investment confidence and partly ease its people's hardships by careful selection of imports and their strictly controlled and rationed distribution.

Bigger Asian partners like China and India will have to step in more generously to help their neighbour overcome its economic collapse. China which owes more than 10 per cent of Sri Lanka’s external debt, can do more.

Assessment

  • Sri Lanka presents a living example to the rest of South Asia of how unfettered dynastic political power, combined with populist financial policies and short-term fiscal goals, turn into an explosive mix in a matter of a few years. The correction was long due and ignored for a long, it caused a near-total collapse of the economy..
  • Sri Lanka needs to focus on several solutions such as political, economic, and social stability and tackling internal threats. All this can only be brought up only if there is a stable government.