Sri Lanka’s Crisis

A Story of Descension

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Sri Lanka, Asia’s oldest democracy, is facing its worst politico-economic crisis since its independence. People have thronged the roads demanding the resignation of the regime. The angry agitators stormed into the presidential complex, replicating the ‘fall of Bastille’ episode of the French revolution. The nation of 22 million was angered by the deep economic mismanagement of successive regimes that resulted in the depletion of forex reserves which rendered Sri Lanka being unable to import its basic essentials. The nation is currently ridden with inflation, shortage of basic needs, violation of human rights, corruption, and a neck-deep debt crisis. As an aftermath, the incumbent president has fled the country, and the government is running from pillar to post to secure foreign aid to salvage the ailing nation. But how did a country reported to be one of the best performing economies in Asia descend into this chaos?

The Story of Descension:

  1. Lopsided economic growth, post the end of civil war: Sri Lanka has undergone a civil war for over 26 years which was finally brought to an end in 2009 with the uprooting of LTTE through military action. As expected, Sri Lanka soon embarked on a path of economic ascendency as peace and political stability prevailed following the end of the civil war. But the growth was lopsided and was widely touted to be the genesis of today’s crisis. Sri Lanka adopted a complex tariff regime that discouraged foreign trade with an intent to safeguard domestic industry. Though gradual relaxations were allowed in the later stages, it remained protectionist as a whole. As a result, Sri Lanka continuously fell short on foreign reserves, whose effect was showing up today. In the first three years after the end of the civil war, Sri Lanka recorded a growth rate of 8% annually. However, the growth, as noted by the world bank, was largely driven by the non-structural, short-term, and non-tradable sectors like transportation, construction, domestic trade, and real estate. Most of the infrastructure that was built in the subsequent years was with foreign aid, which left Sri Lanka in a vicious debt trap. Post the civil war; the government relied disproportionately on tourist income as tourism saw a surge after 2009. So now, when the pandemic has struck, tourism tanked, and the revenue coffers are being choked.
  2. Economic mismanagement: In 2019, yielding to the populist demands, the government decided to cut the taxes, which resulted in a loss of 1.4 billion dollars per annum to the government exchequer. Moreover, the state has excessively depended on the revenue accrued from tourism which is an unstable sector. Foreign exchange mismanagement of successive regimes has wiped off 70 percent of Sri Lanka’s foreign reserves, leaving Sri Lanka with an all-time low of just $50 million left in the coffers with a debt repayment burden of over $4 billion. Sri Lanka failed to ramp up its exports and, at the same time, has relied on imports disproportionately. Even for the basic essentials like sugars, pulses, cereals along with fuel, Sri Lanka depended on imports. This has widened the trade deficit, which resulted in the depletion of forex reserves. Apart from these, the populist measures and the subsidies have turned the economy upside down. The GST was slashed to 8% from 15%; income tax slab was raised to 30 lakhs from 5 lakh, which released 33.5% of the taxpayers from the income tax radar.
  3. Agri sector crisis: The recent reforms introduced in the agricultural sector have gone a little overdrive. The government has banned the usage of fertilizers in the island nation in order to embrace organic farming and to slim down the growing trade deficit, as Sri Lanka is totally dependent on imports for fertilisers. It is estimated that domestic rice production fell by more than 20 percent. The decline in tea production is reckoned to cost the country about $425 million.
  4. Fall in tourism: Sri Lanka is blessed with beautiful landscapes which attract a huge number of tourists annually. In 2018, just before the pandemic, the nation welcomed a whopping 2.33 million tourists. So naturally, revenue from tourism is the backbone of the nation’s revenue. But the pandemic-induced lockdowns and the serial blasts in 2019 have severely hampered the inflow of tourists. Consequently, the number of visitors came down to 1.94 lakh arrivals in 2021, and tourism revenue declined from $4.4 billion in 2018 to a paltry $633 million in 2021.
  5. Fall in remittances: The pandemic has hit the entire globe, as a result of which economies have come to grinding halt. This has dented remittances to the countries like Sri Lanka severely. Workers’ remittances fell down sharply to $5.49 billion in 2021, its lowest since 2012.
  6. Pandemic: Further compounding the woes, pandemic has struck at the wrong time for the already crippling nation. Pandemic has left devastating effects on many countries, but since Sri Lanka is already reeling under plethora of political and economic woes, it was in no state to absorb the pandemic shock. This has further spiralled down the nation into abyss.
  7. Accumulating debts: As with any other rebuilding economy, most of the island nation’s economic rise was Info 1fuelled by foreign loans. But the nation was never in a position to repay the debts. So, it resorted to restructuring the debts and acquiring new loans to serve the older ones and finally ended up accumulating a pile of debt weighing upon its shoulders. Sri Lanka is also a victim of the debt-trap diplomacy of China. As a result, the total Sri Lankan debt held by China amounts to 6.9% of its GDP. Japan held debt amounting to about 4.4 percent of Sri Lankan GDP, and India holds 1 percent. The total external debt of Sri Lanka has piled up to $51 billion. 
  8. Rise in inflation: The shock waves of the Ukraine war has reached Sri Lanka and have taken a serious toll on nations’ import bill and inflation. The prices of crude oil have hit a record high in 14 years. Alongside crude oil, the prices of edible oil and wheat have skyrocketed, rendering them unaffordable to a large chunk of the population.
  9. Sharp fall in FDI: Series of events like we have mentioned above have dissuaded the foreign investors. According to the official figures, FDI stood at $548 million in 2020 compared to $1.6 billion in 2018.
  10. The family’s oligarchy: The Rajapaksa family enjoys great fandom in Sri Lanka for ending the decades-old civil war. They were hailed as heroes among the majority Sinhalese community. But as calendars flipped, today majority of the Sri Lankans pin the blame for the crisis on the Rajapaksas. They were ruling the nations for nearly two decades. They were accused of relying heavily on the military to enforce policies, passing laws that weakened the democratic institutions, monopolising the policy formulation, corruption, trampling on civilian rights, etc. Many of the men from their families have been holding cabinet posts resulting in the concentration of power. Even their handling of the pandemic was criticised widely.

All the above factors have cumulatively resulted in the depletion of forex reserves, mounting debts, and surging inflation, which landed Srilanka into the ongoing crisis.

Repercussions

  1. Food crisis: With food inflation soaring as high as 80%, Srilanka stares at an acute food crisis. The United Nations estimates that nearly 5.7 million Sri Lankans are in dire need of humanitarian assistance, with 22 percent of the nation being deprived of consistent and assured access to sufficient and nutritious food. As per the survey of UNICEF conducted in late 2020, nearly 36 percent of the population has been reported to have reduced their consumption. This figure has spiked to 70 percent in the latest survey conducted in 2022 as the crisis worsened.
  2. Inflation: Inflation often ends up as both the cause and the effect. The inflation in Sri Lanka spiralled down, taking the economy into a deep abyss. Annual inflation hit a record high of 60.8% in July of 2022. Food costs jumped by 93.7%, and prices of non-food items jumped by 50.2%. The price of rice has gone up by 64%, and potatoes are dearer by 75%.
  3. Poverty: The COVID-19 crisis, rising oil prices and economic mismanagement has left the island on the brink of its worst crisis since independence from Britain in 1948. The World Bank has warned that at least a quarter of the population is on the verge of slipping below the poverty line.
  4. Electricity and fuel shortages: The crisis has resulted in a severe crunch on basic essentials like electricity, fuel, and cooking gas. The finance minister has to urge the government authorities to turn off all the street lights to conserve power. More than a thousand bakeries have been shut down due to a shortage of cooking gas. Kilometres long queues can be found at petrol stations, and the government had to deploy the military to discipline the crowd in queues. Even civil aviation, which incurred losses of 37,200 crores, was badly hit due to a shortage of fuel.
  5. Education: Several schools in Sri Lanka have postponed the academic examinations indefinitely due to paper shortages throughout the country, as Sri Lanka depends on imports for paper. Also, many students haven’t attended classes due to fuel shortages.
  6. Health: The lack of supply of essentials have forced several hospitals to suspend surgical operations and Info 2laboratory tests. Many hospitals ran short of life-saving medicines jeopardising the lives of many. Doctors are found to have been forced to reuse the used medical equipment to treat patients due to the shortage of new supplies. The Medical Council of Sri Lanka had warned that there would be a catastrophic number of deaths, which could outnumber the combined death toll of COVID-19, the 2004 tsunami and the Civil War unless replenishments arrive within weeks.
  7. State of turmoil: Entire nation was enraged and was out on roads protesting against the monumental misgovernance of the regime. The protester even barged into the presidential residence and the prime minister’s residence, forcing them to escape pre-emptively. The incumbent office holders were reported to have fled the country, triggering a political vacuum.
  8. Out migration: The chaos prevailing in the island has forced many to flee the country. Many Sri Lankan Tamils, the largest ethnic minorities, were found to have been reaching India.
  9. Violation of Human rights: Government has resorted to extensive use of its brute power to suppress the raging agitations. It was coming down hard, even on peaceful protesters. New York-based Human Rights Watch has remarked that Sri Lanka’s military is hell bent on curbing the protests through intimidation, high-handedness, surveillance and arbitrary arrests of demonstrators, activists, lawyers and journalists.

The Bail Out

The government has embarked on slew of measures to bail out the nation from the crisis. A few of those are;

  1. International aid:
  2. World bank has provided a loan of $160 million as bridge financing.
  3. India has announced another USD 1 billion as a credit to Sri Lanka.
  4. The IMF has agreed to provide USD 2.9 billion over four years under a preliminary agreement to help the crisis-hit country tide over its worst economic hardships.
  5. US President Biden announced $20 million of additional humanitarian assistance for Sri Lanka.
  6. Decision has been taken to suspend repayment of nearly USD 7 billion in foreign debt due for this year to conserve the limited forex reserves.
  7. Fuel is being rationed to reduce the imports and thereby to arrest the widening of the trade deficit.
  8. The Cabinet has approved to declare Fridays as holidays for the public sector employees to conserve the electricity and fuel that are fast depleting.
  9. Sri Lanka’s Cabinet approved a bill to impose a 2.5 per cent tax on companies with an annual turnover of Rs 120 million. It is labelled as social contribution tax, intended to increase the government’s revenue.
  10. Green Agriculture Steering Committee was formed on June 16 by the Sri Lankan Army to provide food security.
  11. Schools And offices were shut down for a while to conserve the energy, especially the fuel.
  12. Ban on fertilisers was revoked to restore the production levels back to pre-ban era.
  13. Resignation of the president Rajapaksa, to assuage the enraged masses.

Despite this string of measures, Sri Lanka is far from coming out of the crisis any sooner.

The Geopolitical Ripples

In this era of globalisation, a crisis in one part of the world would mandatorily send shock waves across many other nations, particularly across the immediate neighbourhood. The spillover effects of the crisis have reached Indian shores in quick time. As India shares a strong historical connection with the island nation, the crisis has impacted India and, at the same time, captivated the attention of the Indian think-tank.

Impact on India

The boiling crisis in Sri Lanka has cast both positive and negative impacts on India.

Negative impacts:

  1. Refuge crisis: History has been a witness to the fact that whenever a crisis brewed in Sri Lanka an influx of Sri Lankan ethnic Tamils into the Indian mainland has followed. Already, few migrants have been reported to have reached Tamil Nadu coast.
  2. Investments: Indian have invested heavily all across the island. Most of the investments are in sectors like real estate, tourism and hotel, telecommunication, manufacturing, banking and financial services, and petroleum refining. Since these sectors are badly hit by the crisis, Indian investors are staring at deep abyss.
  3. Chinese role: The crisis has come as an opportunity for China which is leaving no stone unturned to spread its footprint in Sri Lanka. China has been the biggest lender to Sri Lanka and the largest source of FDI. As the economy tanked, Sri Lanka has already leased its Hambantota port to China and the Columbo port is on the verge of meeting the same fate. The expanding presence of China in the Indian ocean is a worrying trend for India.
  4. Logistics: To everybody’s surprise, Colombo port handles more than 30 percent of India’s container traffic and 60 percent of its transhipment. A disruption in the services of the port is crippling India’s sea trade.

Positive impacts: As every coin has two sides, the crisis is catering India with a few advantages like,

  1. Apparel Industry: this industry accounts for 44 percent of the nation’s exports. However, as the industry has been severely hit, importers are now preferring India in place of Sri Lanka. This has provided a big fillip to India’s apparel industry.
  2. Tea exports: Tea plantations were hit by the power crisis. Indian tea producers are increasingly replacing the Sri Lankan producers.
  3. Tourism: Similarly, international tourists are desisting from visiting the island and are rather finding new destinations like India which is close by.

India’s Generous Aid:

India, staying true to its foreign policy i.e., neighbourhood first, is quick to intervene and provide assistance to the crisis-ridden nation. The government has dispatched a delegation of senior Government of India officials, led by the Foreign Secretary, to Colombo in June 2022 to take stock of the ground reality in Sri Lanka.

  • India has played a decisive role in the IMF, regional and plurilateral organisations in persuading other countries to lend a supporting hand to Sri Lanka.
  • Government of India has announced food, health and energy security package along with foreign reserves in the tune of more than US$ 3.5 billion that includes a concessional loan of US$ 1 billion.
  • Indian Oil has dispatched a consignment of 40,000 MT of fuel to Sri Lanka.
  • To cease the depletion of foreign reserves, India has extended a currency swap facility of US$ 400 million under the SAARC Currency Swap Framework 2019-22.
  • India permitted Sri Lanka to defer the payment of dues of about US$ 1 billion till March 2022.
  • A large consignment of drugs and medical supplies was gifted to various hospitals in Sri Lanka in response to the dwindling health infrastructure.
  • The Tamil Nadu government has extended a humanitarian assistance worth around US$ 16 million which includes 40,000 MT of rice, 500 MT of milk powder and medicines.
  • The establishment of the air bubble arrangement between India and Sri Lanka in 2021 and the inaugural flight from Sri Lanka to Kushinagar airport are in tune to revive the ailing tourism.

How to fix the rot

The following steps would go a long way in bailing Sri Lanka out of the crisis;

  1. Fair taxation: The populist measures taken up by the Gotabaya Rajapaksa has eroded the tax revenues of Sri Lanka as the tax to GDP ration fell to 8%, which is the lowest in the world. Government should ensure that future taxation policies, including those introduced as a part of IMF program, are progressive and do not further deplete the coffers. Measures like taxing the wealthier sections, increasing corporate taxes, taxing foreign entities which are otherwise out of taxation radar, etc, could be handy in this regard.
  2. Contain the corruption: The IMF had openly sought structural reforms to plug the menace of corruption. Even the World Bank has demanded to address the rampant corruption that denies the poor of their due benefits, if Sri Lanka wants it to supply financial aid.
  3. Equitable debt restructuring: Government is currently renegotiating the debt restructuring with its creditors. China and Japan each hold 10% of the debt, Asian development bank holds another 13%, and private creditors who are mostly American and European firms hold 47%. Economists have opined that if these debts aren’t adequately reduced government has to resort to restructuring of the domestic debts, which would culminate in a banking crisis. Government’s provident fund is the largest holder of Government’s bonds and the poorest strata are the biggest investors in provident fund. So, the burden of restructuring has to be borne equitably by all the stake holders.

Lessons to the World

As the adage goes, “Every crisis provides a learning opportunity”. Similarly, the ongoing crisis that shook the island nation offers scores of lessons to the other countries. Some of them are;

  • Don’t put all your eggs in one basket. Countries should diversify their revenue generating activities rather than relying on a few handfuls of sectors. Sri Lanka over-relied on tourism, apparel & Tea industry and paid the price.
  • Government policies should be driven by long term visions and not yield to populist demands.
  • Embrace the ‘open trade’ policy as there is no instance in entire history where a country’s economy has prospered after adopting protectionist measures.
  • Be prudent while borrowing.
  • Public’s patience has a limit and that the ultimate power belongs to the people.
  • A stable polity is a pre-requisite for the economic prosperity.

As Winston Churchill once famously remarked, “Never let a good crisis go to waste”, Sri Lanka should turn this crisis into an opportunity to tread the nation into a new path. Countries like India and Thailand have been through these crises earlier and have emerged victorious. Similarly, Sri Lanka should embark on new pathways that it could never attempt earlier- from addressing economic mismanagement to stonewalling the political institutions. It may take time, but no crisis is beyond redemption.

References

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