A few weeks ago, people around the world were treated to videos of a large number of protesters invading the Sri Lankan presidential mansion situated in Colombo, the country’s capital. This was a culmination of a nation-wide protest which had begun in march in response to the economic crisis befalling the country. During the course of the protests, the Rajapaksa family home, the family home of the then president and prime minister was incinerated. These protests also caused Gotabaya Rajapaksa, the former president, to flee the country and resign his position, his brother Mahinda Rajapaksa had earlier resigned as prime minister.
What is happening in Sri Lanka?
Sri Lanka is currently undergoing a serious economic crisis; this crisis as described by their government, is the worst since their independence in 1948. Sri Lanka will also have its first default on its foreign debt obligations. It is currently experiencing a catastrophic inflation as its currency has devalued relative to the dollar and the prices of goods and services have skyrocketed.
It is experiencing severe shortages in fuel, cooking gas and other essential goods as well as being plagued with daily power outages. Long queues have formed in petrol filling stations and many of its industries have shut down due to the shortages of electricity, fuel and gas. This has led the Sri Lankan government to ration the supply of fuel and electricity. Lack of foreign reserves to import materials has led to the scarcity of important goods such as medicines and medical supplies, there is even a scarcity of printing paper which has caused exams in various schools in the country to be postponed.
Hospitals have been severely hampered by the prevailing conditions as many hospitals have cancelled routine surgeries, many are forced to sterilize and reuse medical equipment, there is scarcity of essential medications and many surgeons now perform surgeries using their mobile phones’ torch as their light source.
What caused this crisis?
Some are of the opinion that the origins of this crisis can be traced back to the year 2019, they assert that the policies and actions of Gotabaya Rajapaksa’s led administration are the sole genesis of the current crisis; but that opinion is partly false as the precursors to this current crisis were present long before 2019.To understand the current problems in Sri Lanka we must examine its economic situation prevalent since its independence; post-independence Sri Lanka majorly exported coffee, tea, rubber and spices, later it began exporting garments. It used the foreign exchange accrued from these exports as well as the foreign exchange gotten from tourism and remittances from Sri Lankans abroad to import essential goods. In order to import goods that it needed and couldn’t produce, Sri Lanka had to earn enough foreign reserves.
Therefore, it was imperative that Sri Lanka develop means of increasing their exports and other avenues of generating foreign reserves, in order to match their import needs. Since Sri Lanka imported many essential goods needed for the smooth running of its economy, any affectation of its foreign reserves was doomed to significantly affect its economy. One of the components of the crisis that Sri Lanka faces is its huge external debt; on April of this year, it announced that it will be defaulting on its debt.
While many are quick to name Sri Lanka’s unsustainable debt levels as the cause of their crisis, few mention rampant borrowing as the primary cause of their debt crisis. Since shortly after its independence, Sri Lanka has been borrowing from capital markets, countries and the International Monetary Fund (IMF), recently it started issuing government securities to foreign investors and these securities have high interest rates. The debt that Sri Lanka acquired also accrued compound interest such that a large percentage of Sri Lankan revenues went into debt servicing, it even had to borrow more money in order to pay off other debts. This debt servicing also depleted its foreign reserves and it was unable to import essential goods it needed as reserves were used to repay debt.
Was it necessary for Sri Lanka to borrow money?
Various studies have questioned the necessity of developing countries to borrow money to stimulate their economy, some have concluded that the advice peddled by the world bank and IMF to countries; to borrow money to stimulate their economy, was not in the best interests of borrowers. These studies showed that countries who borrow tend to have their currencies depreciate in comparison to the dollar, these countries being commodity exporters will over time see the relative price of their exports decline and the relative price of their imports increase. They note that borrowing results in mounting debt and interest outflows from the borrower in excess of what was borrowed due to accruing interest as present in the Sri Lankan case. This mounting debt will then lead to calls for debt restructuring which will entail equity swaps and handing over control of national assets to foreign lenders.
Sri Lanka following its independence needed to develop its economy and increase its exports, in line with the findings of the aforementioned studies, the best way to have gone about doing that would have been to guide domestic bank credit to finance essential areas of its economy which would have been productive and led to high stable and non -inflationary economic growth as seen in countries such as China, Taiwan and Japan. Since Sri Lanka did not go through this route and opted to borrow, it should have invested the money borrowed in key areas of its economy that would have resulted in economic growth but the money borrowed was used on vanity projects that ran at a loss.
It was also used to fund public services that yielded no returns, used to finance imports, embezzled by corrupt politicians and solely invested in the hospitality sector.Between 1983 to 2009 a brutal civil war was waged in Sri Lanka between the Sinhalese dominated Sri Lankan government and the Liberation Tigers of Tamil Eelam (LTTE), who fought for an independent Tamil state. The government won the war but the costs incurred as a result of that war were high and the Government borrowed massively in a bid to jumpstart economic growth, this also served to increase their national debt.
Although Sri Lanka had been running budget deficits in the years leading up to the administration of Gotabaya Rajapaksa, things were still somewhat stable as Sri Lanka was still able to generate enough revenue to finance its imports and service its debts; but certain policies of Gotabaya Rajapaksa caused the economic situation to become unstable and one of them is tax cuts. Fulfilling its campaign promises of tax cuts, the administration of Gotabaya Rajapaksa upon assuming power instituted tax cuts that severely reduced government revenue, this was an unwise decision as due to its debt levels it was not advisable to reduce taxes without instituting measures to make up for the loss in revenue.
The 2019 easter bombings in Sri Lanka was a huge blow to the country’s tourism sector and severely affected its revenue. 8 suicide bombers allegedly affiliated to the National Thowheeth Jama’ath, Jammiyathul Milathu Ibrahim and the Islamic State of Iraq and the Levant – Khosan province attacked three churches, three luxury hotels, a housing complex and a guest house in the nation’s capital. These attacks resulted in 269 deaths including 45 foreign nationals and left several hundreds injured. This resulted in a severe drop in the revenue accruing to the country from tourism, also the covid crisis which placed restrictions on travelling also adversely affected the tourism sector.
The recent reduction in official foreign remittances also caused a reduction in foreign reserves available to the government thus contributing to the current crisis. This fall can be largely attributed to foreign nationals shunning official avenues of remitting money, as the fixed exchange rate maintained by the central bank in a bid to prop up the country’s currency was far lower than obtainable in the black market. This made people to remit money through unofficial channels, also the covid crisis contributed significantly to this fall in foreign remittances.
Another contributor to the current economic crisis was the government’s organic farming policy; in April 2021, it banned the importation of fertilizers, pesticides and other inorganic agrochemicals citing health concerns, although certain critics assert that it was lack of foreign reserves that made the government embark on such a policy. The policy was ill advised as critics warned that such policy would lead to reduction in agricultural yields. This policy led to a drastic reduction in tea and rubber exports which further reduced their foreign reserves and exacerbated their current economic crisis. It even caused food shortages and they were forced to import rice which they had previously produced self-sufficiently. They soon abandoned this policy and reversed course but the damage had already been done.
The war in Ukraine has contributed its fair share to the economic crisis in Sri Lanka; the prices of commodities such as oil and wheat have risen drastically further straining their foreign reserves. Russians who previously made up the biggest share of Sri Lankan tourists, are unable to make such a journey as flights to Moscow have been suspended as a result of US led sanctions. Ukrainians who are also a significant proportion of tourists are severely restricted due to the war in their country.
The way forward
Ranil Wickremesinghe was just elected president of Sri Lanka by a parliamentary vote, a career politician he has served as Prime minister five different times. He is unpopular with many Sri Lankans and has vowed to crackdown on protesters referring to them as fascists. While politicians in Sri Lanka are confident that he is the right man for the job as he will resolve the crisis and restore confidence in the economy, others are of the opinion that he is a stooge for foreign financial interest and that his actions will be detrimental to Sri Lankans.
While some are of the opinion that an IMF bailout is essential for economic recovery and they say that the conditions attached to such a loan: a massive downsizing of the public sector by laying off of civil servants, broadening the tax base and raising taxes, privatizing state-owned enterprises, cutting subsidies, cutting public services and basically implementing austerity measures are the way to go, others are vehemently opposed to this and they fear that Ranil Wickremesinghe will forcefully implement these policies thereby leading to job cuts, reduction in wages, increase in prices of water, electricity and other essential goods and dismantling of public health and education.
A viable way out of this crisis will involve the concerted effort of all Sri Lankans, it would involve them choosing a competent leader who has sound economic principles. As stated earlier, it may not be in the best interest of Sri Lanka to borrow more money especially if the conditions attached will further worsen the plight of Sri Lankans. It can boost its exports and its economy by guiding bank credits to productive sectors of the economy and restricting loans to ventures that are not GDP gaining. Sri Lanka will also have to meet its creditors and work out a deal to restructure its debt. Sri Lanka will also need to reduce corruption and mediocrity in governance to a bare minimum and ensure that sound policies are also developed.
Written by,Emeasoba Sylvester Uzonna