Economic crisis in Sri Lanka: Are we recovering or falling?
Persistent trade union protests can deter economic growth.
(This article has been compiled based on the discussion organised by the Veemansa Initiative under the title “Economic Crisis in Sri Lanka: Are we recovering or falling further?” to examine the alternative approaches to move forward the crisis-ridden Sri Lanka. The event was held on the February 28 at the Faculty of Arts, University of Colombo. The discussion was enlightened by an eminent panel of resource personnel including Senior Prof. Sirimal Abeyratne, Policy researcher Chanuka Wattegama, Senior journalist Mohan Samaranayake, Prof. Priyanga Dunusinghe while the concluding remarks were given by Luxman Siriwardhana, Managing Director of Veemansa Initiative).
Earning Rupees (LKR)
to pay Dollars ($)
Among various factors that have been cited for triggering the economic crisis in the country, the deficiency of foreign exchange earnings can be viewed as one of the leading contributors to the ongoing economic crisis in
Sri Lanka. At present, a country’s economic survival is dependent on its ability to generate sufficient amount of foreign exchange. In the absence of sufficient foreign exchange revenue, even larger economies backed by their large domestic markets can only function for a short period of time. Thus, small economies such as Sri Lanka are bound to earn foreign exchange. If not, an economic collapse is inevitable.
This foreign exchange-driven economic structure was adopted in Sri Lanka in 1977 and despite the prolonged war and lack of policy changes, the country remained an export-oriented economy. However, following the implementation there has been a vacuum in needed inputs to maximise the benefits of these policies. Such inputs have lot to do with facilitating economic reforms that have been implemented at a very minimal level. The conditions have further weakened in the post-war era in accordance with the lack of policy reforms and a high level of anti-export biasedness that prevailed in the economy.
On one hand, instead of reforming the economy, the go-to policy was to finance large-scale development projects through borrowings. Although the economy was growing to some extent due to these investments, it was not enough to maintain higher growth without reaching export markets. On the other hand, when the economy was growing rapidly during the post-war period correspondingly the domestic rupee (LKR) income was also rising. This created a situation where the country had to earn LKR and pay $. Gradually, this mismatch became prominent and the deficiency in foreign exchange earnings was met with further foreign borrowings.
Sri Lanka started foreign commercial borrowings in 2007 and had to stop due to its inability to repay in 2019. In the last 12 years Sri Lanka has commercially borrowed a sum of $17.5 billion. On the other hand, after 42 years of adopting open economic policies, Sri Lanka has received only $13 billion worth FDI. This reflects the failure to secure sustainable foreign exchange earning income even after operating for more than four decades under open economic regimes. In addition, the irony is that Sri Lankans have never protested against foreign borrowings but most of the time protested against foreign investments.
Even though there were signs of an economic collapse in Sri Lanka much earlier some factors prevented it from happening until the pandemic led to the final blow. Thus, the path to move out of this crisis is only through earning sufficient foreign exchange without which a recovery is impossible to imagine.
Debt default and IMF
When it comes to the debt to GDP ratio there are number of countries that have much higher debt to GDP ratios in the world and still manage their economies well given that they have means to meet their debt obligations. Thus, the fundamental issue that Sri Lanka is struggling at present is its inability to service debt and it has become a known fact to the international community as well.
According to Sri Lankan debt statistics from the 1970’s onward it is clear that extensive borrowings have taken place in the aftermath of the war. In 2012, Sri Lanka obtained the highest amount of debt which was $10 billion. Accordingly, if the country had reached higher development status with higher debt the current economic sentiment of the country would have been a completely different one.
However, by the years 2016-2017, there had been at least an idea that the economy is heading towards a crisis and would have prevented or postponed the crisis if needed actions such as debt restructuring, and strict economic controls were implemented at the right time. Nevertheless, the typical policy response was to continue on the same path. By 2019-2020, the country had passed the point of no return, and the effects of the global pandemic and the government’s political moves led to unfold the crisis at full scale.
Even if the country would have gone for an IMF programme much earlier, it should not be the only way out. In addition, the failure to address the pandemic rationally by taking into account the cost of the lockdown (economy-wise) has played a notable role in bringing an economic crisis of this magnitude. Given the desperate conditions in the economy at the time, it had become unavoidable to go to the IMF by 2021. Nevertheless, the IMF involvement in South Korea and Greece provide contradictory signals on possible outcomes of any IMF interference in crisis-ridden economies and the IMF assistance itself may create additional burdens as well.
The broader perspective of the IMF assistance suggests that it may provide short-term solutions to issues such as ensuring sufficient foreign exchange reserves, political stability, and stability in the financial system but long-term solutions to such issues need to be done through domestic sound policymaking along with rapid industrialisation and digitalisation, if the economy is to see the path of economic revival.
Geo-political routes
of the crisis
The roots of the economic crisis in Sri Lanka can be viewed in line with the global geopolitical rivalry and its impact on the country.
The geopolitical rivalry was prominent among powerful nations before the Second World War era. However, geopolitical issues become prominent once again in the global arena in the post-cold war period when the unipolar world order was created. At present, with new global superpowers emerging including China, India, and Russia the world order is also subject to change. Given this change in world order, the US needed a new strategical approach to deal with the emerging superpowers.
According to the document complied by the foreign affairs committee of the US senate in 2009 under the title, “Sri Lanka: Recharting US strategy after the War”, “Sri Lanka is located at the nexus of crucial maritime trade routes in the Indian Ocean. Thus, the US cannot afford to lose Sri Lanka”. These words have been put into practice where US involvement in the Sri Lankan political landscape became evident in political regime changes that took place in the recent past. Thus, whether Sri Lankans like it or not; geopolitical factors are having a significant impact on the wellbeing of the Sri Lankan economy.
The response of the US administration to electing the communist-oriented President Salvador Allende show US actions towards hostile territories. Thus, it is completely irrational to expect to come out of the crisis unless Sri Lanka is going to recognise these geopolitical dynamics and respond accordingly.
Responsible fiscal
policy conduct
As identified above, the insufficiency of foreign exchange was one of the leading crisis-triggering factors. The deficiency of LKR to the Sri Lankan government also had a role to play in the crisis.
As per the data, it is a well-known fact that government revenue as a percentage of GDP has gone down over the years while the extensive dependence on indirect taxes for revenue generation has continued. On the other hand, the government expenditure is much higher than the revenue generated during a fiscal year that has resulted in financing it through local and foreign borrowings for extended periods of time. This continuous deficit-financing is not sustainable and contributed to the economic collapse in Sri Lanka.
The primary cause of this can be traced to the lack of fiscal responsibility. Thus, a high level of commitment is required in responsible and disciplined fiscal management, transparent and robust institutions, and committed delivery of public services to move out of the crisis.
So far, some steps have been taken in this direction by the government including working with the IMF, limiting borrowing from the Central Bank, tax revisions, expenditure rationalisation and cost-based pricing for public utilities.
However, there are areas to address further including improving the tax collection mechanism, rationalising public expenditure, and introducing all the elements of fiscal rule to the constitution including Revenue rule, Expenditure rule, Budget balance rule and Debt rule.
(The writer is a Lecturer in Economics at the University of Ruhuna).
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