By Punsarani Jayawardhana
Fate led with years of systematic corruption, short sighted political and economic “policies” and political mandate being swerved with populist agendas has shown the darkest of its colors in the island nation of Sri Lanka.
Sri Lanka has been facing a severe foreign reserves crisis since last year, and in August 2022 the country is still experiencing long queues for fuel, LP gas, milk powder, and hours of power outages for months. Ordinary life has become a hornet’s nest. The island is still in darkness despite the resignation of the former president and the formation of a new interim government as requested.
Following the escalation of mass protests on July 9, former President Gotabaya Rajapakse fled the country and resigned from office on July 14, 2022. The mass protests, which began in late March, became more organized starting April 9, 2022, with protesters camped out on Galle Face beach in front of the Presidential Secretariat. The protests were organized in an unprecedented way, demanding the resignation of the former President and demanding that those responsible, including the President, his brother, then Prime Minister and former President Mahinda Rajapakse, and other members of the Rajapakse family who held ministerial portfolios in the previous government, be brought to court for years of corruption.
The island nation’s nemesis is not an overnight event but only a brew that has been dribbling down through various facets- from economy to politics to corruption to (ir) responsible citizenship.
Fiscal mismanagement, unsustainable exchange rate policy and sheer mismanagement of the economy are the prime causes that drove the island’s economy into its destiny today. Since the beginning of 2020, Sri Lanka’s foreign reserves have dwindled from USD 8 billion to less than USD 2 billion. As gross reserves include already committed payments and loans with conditions, the actual amount of ‘usable’ foreign reserves by May 2022 were as less as USD 50 million.
Populist electoral policies, mismanagement and maladministration of economy, inefficient and ineffective fiscal and international policies, and excessive international donor dependence were, inter alia the catalysts of the crisis. Although the current economic crisis is reflected in diverse aspects, it is most visible in government revenue, foreign debt, foreign-exchange reserves, balance of payment, budget deficits, public and private investment, savings rate and foreign direct investment.
The most recent factor contributing for the crisis is the tax cuts introduced by the last government in the end of 2019. The Value Added Tax (VAT) was cut from 15% to 8%. The Nation Building Tax, the PAYE tax and the economic service charges were annulled. In terms of direct taxes, standard corporate income tax rates were dwindled from 28 per cent to 24 per cent. The annual income threshold for waiver of personal income tax was raised from LKR 500,000 to LKR 3,000,000. As per Financial Times, the loss suffered with these tax deductions is around $2 billion or about 2 per cent of the GDP. With the elimination of Pay as You Earn tax, the government lost over 1.5trillion SLR in tax revenue. A combination of tax cuts and high expenditures to contain the spread of the pandemic widened the budget deficit to SLR 1 014.5 billion
Simultaneously and concomitantly, Sri Lanka faced a severe forex shortage owing to lesser remittance flow as considerable number of expats had to return to Sri Lanka with the pandemic. The imbroglio got worsened with the downfall of tourism industry which began after the Easter attack in April 2019 and nosedived with the pandemic. Lesser remittance flow (fallen more than 20%), imports outpacing exports and decline of tourism (dropped almost 90% from its peak in 2018), ultimately caused the island’s trade deficit to rise from USD 6 billion to USD 8 billion.
This situation disseminated to other sectors and most specifically to agriculture with the ban on fertilizer imports imposed in 2021. This was whitewashed as a step to promote organic agriculture while the real purpose was to “mitigate” the looming forex crisis that was forcibly put behind the curtains as early as April 2021. What began with the inability to pay for fertilizer, herbicides and pesticides spilled over to other areas including (but not exclusive to) milk powder, medicine and ultimately and most crucially to the import of crude oil. As an illusionary rectification, the government started printing money that caused inflation to rise above 50%.
The mare’s nest that Sri Lanka is trapped in today is a continuum of policies that Sri Lanka adopted since the independence in 1948. State-led industrialization that began in the 1960s and 1970s got abandoned with the island opening its market in 1977. Neoliberal reforms discouraged the country from generating a production based economy. Private investments have been in decline since the 1990s and although there was an investment boom just after the end of the civil war in 2009, things became rather stagnant beginning from 2012. Political and policy instability, along with obsolete laws on foreign investments and weak international relations were discouraging private investments.
With the financial crisis in 2007, USD 438 million worth foreign funds invested in Treasury Bills and Treasury Bonds flowed out from the country while the prices of the major exports like tea, rubber fell significantly in the global market. This was worsened with the government failing to borrow USD 300 million due to the liquidity crisis of the global financial market. These three reasons had a cumulative effect on the ongoing depreciation of the local currency. As the island graduated to a middle income country, the concessionary loans by multilateral agencies and bilateral donors were also limited.
Recent governments were over dependent on a debt rollover strategy and have been living beyond their means for years. Former Central Banker and economist Dr. Anila Dias Bandaranaike illustrates the principal cause of the economic turmoil, Sri Lanka being in “champagne diet with a kassipu (illicit alcohol) income”. Despite the infamous “debt-trap” narrative that China was accused of having set for Sri Lanka, the island has borrowed more through international sovereign bodies and from Asian Development Bank and Japan than it has from China. Sri Lanka owes 16% to the Asian Development Bank and 10% apiece to World Bank, Japan and China, out of its approximated USD 51 billion debt at hand.
Despite being a small island with rich natural resources and being ideally located in a strategically crucial place in the Indian Ocean, a lack of concrete and long sighted economic and political policies sealed the island’s destiny today.Import dependent, consumption driven economy financed by debts and mindset of the island attributed for today’s quandary. The country failed in coping up with the global industrial capital accumulation even during the post-war era which began from 2009.
Nevertheless, ethno nationalism which “tolerated” and encouraged years of corruption, short termism and nepotism was the pivotal and underpinning factor that has been impending for decades. “Populist” election campaigns fuelled with xenophobic ideologies, systematic corruption and want of consistent and comprehensive national policies are the long operated malpractices in the island.
By August 2022, Sri Lanka’s interim government headed by the President (elected from the parliament) Ranil Wickremesinghe awaits the grant of the IMF assistant program. If negotiations were successful and Sri Lanka could adhere to conditions proposed by the IMF, particularly by re-structuring the debts, Sri Lanka will have its 17th IMF grant.
The World Bank also has stressed on the vitality of restructuring debts and adoption of a sustainable macroeconomic policy, while the US lawmakers have stated that the IMF support program will be contingent on Sri Lanka’s assurance of the independence of the Central Bank, of anti- corruption measures and promotion of rule of law. Sri Lanka also needs to ensure political stability and respect for human rights as prerequisites for successful international assistance; as Attiya Waris, the UN independent expert on foreign debt and human rights has stated that “any response towards mitigating the economic crisis should have human rights at its core, including in the context of negotiation with the IMF”.
The IMF granted financial assistance to Sri Lanka last in 2016 with the cardinal condition of cutting fiscal deficits. Levying indirect taxes, moving from subsidies to direct cash transfers, reforming state expenses, adopting flexible exchange rate regime and liberalizing trade and investment were some of its earlier conditions with which Sri Lanka had a rather successful journey from 2016 to 2019 as praised by the IMF itself. However, it is debated if Sri Lanka is yet to enter another vicious cycle of neoliberalism with the IMF program.
Despite the sheer political and economic turmoil, reawakening of peaceful political activism may signal the dawn of responsible citizenship in Sri Lanka. This new wave of political sensitivity, particularly seen from the youth demonstrators representing all walks of life, needs to be complemented with visionary economic and administrative policies implemented. Along with economic reforms, protests demand political accountability and measures against years of systematic corruption by political leaders.
Nonetheless, the vitality lies in economic reforms. Significant budget cuts and higher taxes are of paramount importance in restructuring the economy. Long-term stable interest rate and steady exchange rate would also be essential to incentivize a production economy. Banking system needs to have confidence in the concept and operation of development banking so as to energize a production based economy. Ensuring Central Bank independence, upholding the rule of law and adherence to human rights are much decisive in Sri Lanka’s expedition out from social, economic, political labyrinth.
Author: Punsarani Jayawardhana – Lecture for LLB programme, University of London (International Programme).
(The views expressed in this article belong only to the author and do not necessarily reflect the views of World Geostrategic Insights).
Photo credit: Reuters.